An increased focus on costs has meant that many trustees cannot afford better diversified products
The charge cap began in April, limiting the fees a member may be charged in a default scheme to 75bps. These constraints are likely to have major implications for those 90%-plus of members in a DC default fund.
Of course, those funds that are not defaults are not – yet – covered by this regulation. However, Jo Sharples, an investment principal at Aon Hewitt, says the biggest differentiation will be between the schemes that are trust-based and those that are not.
The fear is that if you end up at 50bps, so much will be eaten up by administration”
Administration will tend to cost around 35bps and once this has been taken off the charge cap – the lucky ones in trust-based schemes will have a little headroom – that leaves very little other than the most basic default funds available to members. And things may get worse if certain politicians – and let’s not forget providers, too – have their way and force that cap lower.
“The fear is that if you end up at 50bps, so much will be eaten up by administration,” says Sharples. “That rules out the possibilities of funds that may offer better risk controls and returns, and you need the investments to work hard to get the outcomes schemes want for their members.”
She adds that the industry needs to look beyond the investment to be sure members are getting best value for their charges.
Seeking an alternatives path
The limits imposed by the charge cap have effectively removed some of the more expensive – arguably better diversified and index-linked returns – assets from the funds that carry most pension savers.
They still need to get a better understanding of how these will work in their funds”
Even if trustees were ready to invest in alternatives, they still need to get a better understanding of how these will work in their funds, says Guy Hopgood, investment consultant at JLT.
And even if they are confident about the assets and structures, it will take some blending, as UCITs (Undertakings For The Collective Investment Of Transferable Securities) hedge funds, which are being touted as another option to the institutional market, still attract fees of 1% and above.
Hopgood says: “Member education is more important. If you educate them about their options, they can move away from the default towards self select.”
However, one of the biggest obstacles to incorporating alternatives is not driven by regulation, but liquidity”
He suggests if the self-select funds come in at around 60-75bps, some members may be comfortable about making a selection.
However, one of the biggest obstacles to incorporating alternatives is not driven by regulation, but liquidity. Trustees and sponsors fear liquidity drying up like it did in 2008, but they are also trapped by the inertia from an industry that has built trading platforms that rely upon daily liquidity and pricing.
DC funds are told they need liquidity, but are hampered from seeking illiquidity premia because no platform will run anything but plain vanilla products because it doesn’t suit the technology.
Trustees are still largely using insurance wrappers from insurance companies and the choices are limited”
“Property, infrastructure and private equity are perfect for the 20-year-old starting off on their pensions journey,” says Sharples, “if you could access it at a reasonable cost.”
However, trustees are still largely using insurance wrappers from insurance companies and the choices are limited. D’Costa says: “Trustees are not worried about daily liquidity, but want access as they have obligations to daily payments.”
And it is going to have to come from the provider, as no regulator is likely to suggest providers should change their platforms to make illiquids more available, even if that is exactly the debate being had in DB.
“As the UK moves away from DB, assets will reduce and traditional institutional investors will disappear,” says D’Costa. “As a provider, I’d think I need a solution for trustees.”