The charge cap blinds investors to the true value of their assets, argues Sara Benwell
When you’re buying a washing machine, you don’t always buy the cheapest one, do you? You buy the one which, within your budget, is the most reliable, least likely to need fixing and that has a good reputation for getting your clothes clean. That tends to be true of most things in life. While cost is clearly a consideration when making purchasing decisions, what we really want is the best value for money.
Why then are pensions regulators so obsessed with cost? To the point of introducing a charge cap for defined contribution default funds.
When looking at the charge cap, it’s easy to show that it does not always lead to good value for money. If my more expensive default yielded more (net of costs) than my new, sub-75 bps one does, then I have cut costs, but ultimately lost value for my members.
Annabel Duncan, a defined contribution client adviser at J.P. Morgan Asset Management, believes that it is crucial for trustees and IGCs to focus not just on cost, but on the overall aims of their scheme.
“I think the conversation or decision-making should start with: ‘What are we trying to achieve for our members, what is the objective here and what is the best way to do that? What asset classes or kind of asset allocation is going to get us there?’”
She points to the guidance from the Pensions Regulator on elements to consider when building a default fund: “Cost obviously does play a key part in how you feel about a default fund and extortionate fees will ravage members’ ability to be able to retire. That’s why TPR does include it in the six principles that you need to think about, but I think the thing that’s been forgotten about is that it was 1/6th, there were multiple other things that you need to think about when building a default fund.”
Telling members they are unable to retire because picking the cheapest funds hasn’t left them with a big enough pensions saving, is unlikely to be well-received. It may also lead to questions about whether the trustees or scheme managers have met their fiduciary responsibilities.
Alan Pickering, chairman of BESTrustees, agrees: “In the DC world I get really, really angry when I see that costs are being used as a one-dimensional measure of the quality of a DC offering. I think we really are storing up problems by blindly driving down costs…. the Plansponsor, the trustees and the members should expect an arrangement that is quality across the offering and not just cheap.”
Duncan argues that the charge cap was unnecessary and that market forces would have naturally have pushed investment fees for DC products down as schemes got bigger and more economies of scale could be achieved.
She is also concerned that it has automatically pushed people towards passive management, despite the fact that it is possible to have a fully active default fund within the cap.
She explains: “It’s a very real challenge and again it drives a behaviour which is just picking what I think I can fit in, in terms of cost, rather than thinking about what’s the most appropriate thing, and what will get most of my members to a safe level of income replacement.”
Both Duncan and Charlie Crole, who oversees Jupiter Asset Management’s institutional business, argue that it is time to move the debate on from active versus passive, and agree that trustees and IGCs need to be looking at a strategy that uses both approaches.
Crole explains: “All these different approaches, different fee scales, different asset classes, different philosophical approaches to investment management all have a part to play in fund structures.”
Pickering suggests that good governance is key. “A robust layer of governance is a much better way of trying to ensure that value for money leads to good outcomes, rather than applying a prescriptive charge cap which takes no account of the quality of the offering or the varying level of challenge that you face when meeting the needs of customers.”
He concludes: “As a professional trustee, cheap is a one-dimensional yardstick that isn’t appropriate.”
After all, there’s no point in buying the cheapest washing machine only to have to replace it a week later if it’s not fit for purpose.