Personal PensionMay 25 2016

If the charge cap fits, wear it

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If the charge cap fits, wear it

One of the abiding issues in investment at present is the concept of charges – many are arguing that the charges imposed by fund managers have such a big impact that they have a material effect on performance.

But the Pensions Policy Institute, the pensions think tank, is arguing the precise opposite.

In a new report, sponsored by Standard Life (and written by a former Aegon UK employee, Rachel Vahey) the institute claimed that other factors have a much greater bearing on the outcome of a pension fund performance.

The report, called Value for money in defined contribution workplace pensions, said that sometimes it may be worth paying a bit extra so that fund managers can opt for ‘volatility management’, so that the fund can take full advantage of the returns for equities, without suffering so much of the downside.

It added: “Charges are not the factor with the biggest impact on outcome, and there is an increasing focus on other ways in which these can offer value for money.

“Some providers and advisers... argue that higher charges sometimes allowed them to offer a range of higher-quality services.”

The charge issue is a potent one, not least because a charge cap of 0.75 per cent has been placed on default funds in auto-enrolment, a level which some providers complained about.

The report said that the average charge for contract-based schemes qualifying for auto-enrolment was 0.55 per cent, with 76 per cent of members in these schemes operating under the 0.75 per cent cap.

For master trusts, the compliance was higher, with 100 per cent of members operating under the charge cap, while trust based schemes had 88 per cent.

Overview of charge rates

QualifyingNon-qualifying
Average chargeMembers with charges under the 0.75% charge capAverage chargeProportion of members with charges under the 0.75% charge cap
Contract-based0.55%76%0.81%26%
Master Trust0.46%100%0.60%51%
Trust-based scheme0.42%88%0.67%55%

Source: DWP

None the less the report found, using a hypothetical fund, that changes to the charges imposed by providers had neglible effect to private pension income, when compared to other factors.

Lower charges, for example, 0.3 per cent annual management charge, would increase income by 5 per cent, whereas higher charge of 0.75 per cent would decrease income by 6 per cent.

However, of far greater impact on pension income, perhaps not surprisingly, are contributions. The report said that increasing contributions by 50 per cent, from 8 per cent to 12 per cent, would have a 50 per cent uplift in pension income.

In addition, retiring later, for example two years after state pension age, would increase pension income by 20 per cent, whereas retiring two years earlier would take out 16 per cent of pension income.

The report said that managing volatility was a key component of obtaining good outcomes.

It said: “Individuals invested in the volatility managed funds could have greater certainty around the range of pension pot values that they may have.

“However, this would only be the case if the volatility managed fund was able to achieve the same level of return as equities at 67 per cent volatility for the additional annual charge, for example 0.4 per cent.”

The study compared two hypothetical examples of pension funds: one where 10 per cent of the fund was invested in equities with lifestyling used during the last 10 years, with a charge of 0.35 per cent; the other was volatility managed throughout accumulation, for which one pays an additional 0.4 per cent to the 0.35 per cent, achieving 67 per cent of the equity volatility.

The result was that the volatility managed fund achieved nearly 5 per cent more in the fund at £220,507, than the lifestyling fund which achieved £210,450.

The report posited that there was in fact a tipping point at which one could keep paying for the volatility management before it became too much and would start to eat into performance; this level was 1.15 per cent.

Jamie Jenkins, head of pensions strategy at Standard Life, said that the firm felt confident that it could offer the right funds with the charge cap at 0.75 per cent. He said: “Employers are getting a very good default fund that helps to manage volatility.

“If the charge cap were to reduce further, there would be a question as to the extent to which we could offer everything that we currently do to the employer now. If the charge cap were reduced further and to include trading costs, that creates a big question about what providers can offer as to the default investment fund.

“Charges have been reducing dramatically over the past 10 or 15 years; we have reduced charges to less than 1 per cent – moving from less than 100 basis points to less than 75 is not a huge transition.”

Moving lower raised questions over whether the company can create a “valuable proposition”, he added.

Steve Herbert, head of benefits strategy at Jelf Employee Benefits, said: “The focus on charges by Westminster and Whitehall has long been disputed by the industry. Charging levels have been low ever since (or indeed slightly before) the introduction of stakeholder pensions, and auto-enrolment, and the new charge cap has forced this ever lower.

“While low charges do of course improve member outcomes, I would agree with the report findings that suggest that better saver engagement, which leads to higher contributions, is perhaps a more important criteria than the constant focus on low charges.”

Moving on to the positive aspect of what can create better performance of pension funds, the report focused on accumulation, highlighting the importance of employers pushing employees in the right direction.

It said: “Automatic escalation can lead to higher contributions and is popular with both employers and employees.” It cited the example of one 401K scheme – an American version of the DC scheme – where employees increased their pension contributions from 3.5 per cent to 13.5 per cent over a four-and-a-half year period.

The report said: “Take-up has tended to be highest where individuals are provided with financial advice. This suggests that, in some cases, combining approaches based on ‘nudge’ and on engagement may have the largest impact on employee outcomes.”

Another important factor was the contribution from employers, and a ‘total reward statement’, which encouraged a more favourable attitude to pensions and better saving habits.

Mr Herbert said: “Ultimately ensuring that savers understand the basics of saving – be that through financial education in the workplace or other initiatives – is likely to have a more significant impact on member outcomes over time.”

Melanie Tringham is features editor of Financial Adviser

Key Points

The pensions industry has had a lot of pressure to bring down charges on pensions.

A charge cap of 0.75 per cent has been placed on default funds in auto-enrolment.

The report focused on accumulation, highlighting the importance of employers pushing employees in the right direction.