An increased focus on costs and better reporting allows trustees to better understand value for money, says Stewart Bevan, a cost benchmarking specialist at KAS BANK.
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“I often say that when you can measure what you are speaking about, and express it in numbers, you know something about it” Lord Kelvin
Current figures show that some 6.5% of UK GDP is dedicated to private pensions, and with such a sizeable contribution to our economy, the expectation would be that the UK Pension industry is confident in our knowledge of the associated costs to retirement savings.
Although to some extent we do seek seek to understand the costs of pensions, the real question should perhaps be whether we understand what we are measuring in its entirety?
With a mixture of familiar jargon being drawn upon - AMC, TER, OCF- it is easy for our attention to be diverted from the less obvious elements which could potentially be making a significant contribution to the total cost of investing in a pension.
Given that some costs are often not declared to investors, such as implicit trading spreads, turnover commissions, and additional custody charges, it may be time for the focus to be trained on the bigger picture.
The pension fund value chain is a complex system, simplified for non-industry experts predominantly to try and promote greater understanding.
Many charges that in the past have been deemed too challenging for the average scheme member or trustee to understand have been rolled up into the return figures and effectively hidden. This may simplify the process for most, but what about those who need to know this information? Are fiduciary duties being fulfilled if the full information is not clearly available? Would you be comfortable investing in an asset class if there is a large underlying cost that is completely hidden?
This doesn’t mean that high costs are a necessarily a negative thing, or that any charges are inherently bad - only that a lack of detail could be sub-consciously influencing the decision-making process.
Pension focus has traditionally been towards achieving the best possible returns. However, in a period of low interest rates, increasing regulatory change and low potential for impressive yields, focus is beginning to shift towards greater cost awareness due to the impact costs can have on outcomes.
This shift can be clearly seen; a study completed by the Royal Society of Arts showed that over the lifetime of a pension, with 40 years of saving and 20 years of drawdown, a 1.5% per annum charge would reduce the possible pension-in-payment by 38%.
Clearly with long-term investing, the compounding of small annual charges leads to a material impact which either directly benefits a member, or limits the burden for a corporate sponsor.
The Dutch independent supervisory authority, the AFM, proved that a cost reduction of 0.25% over a period of 40 years, leads to approximately 7.5% higher collective pension assets. Whilst 0.25% might be difficult to save if you are paying 0.50% for the end-to-end service, what if you are paying 2.5%?
You will have noticed significant momentum building around the topic of transparency in the pension industry, particularly around costs and charges.
Scheme members, authorities and regulators have noticed the importance of greater governance in this area, and are now seeking information from their downstream providers.
The demand for fuller and fairer information is not an unreasonable one, and is certainly long overdue; however, there needs to be due consideration of the limits. Excessive information that is overly complicated may well perverse opinions and lead to inefficient decision-making.
We must simply and carefully define the criteria that will provide us with useful and beneficial information. This in turn should support the delivery of best possible outcomes for members and sponsors, therefore improving governance with minimal additional effort.
Many look towards the Dutch pension system as “best-in-class”. It has a solid framework enforced by its regulators, reporting in depth on investment risks, funding ratios and costs.
As expected, between 2012-2013 the management fees across the Dutch industry fell due to better accountability and improved negotiating positions. However, this is only part of the story.
In 2015, the AFM’s paper, ‘Asset Management and Transaction Cost in Focus’, showed the median cost of asset management increasing by a factor of 3 between 2009 (pre- regulatory reporting) and 2013. The weighted average asset management costs increased from 0.19% in 2009, to 0.55% in 2013 (0.62% including transaction costs). The Dutch authority estimated this to be between €1.5-3 billion a year that was going unreported.
This increase is not due to any new costs being incurred, but simply that there is an increased focus on costs and better reporting taking place, allowing a fairer representation of the truth.
Stewart Bevan is a cost benchmarking specialist at KAS BANK.