Could the focus on cost in DC default funds create the next pensions crisis? Charlotte Moore takes a look.
“Fees are the last thing which should be considered when making a decision about choosing a DC provider.”
Maria Nazarova-Doyle, JLT Employee Benefits
The brief return of volatility to financial markets in February underlined the danger of the relentless focus on cost in the defined contribution (DC) world: a market correction could have a significant impact on the value of pension pots and could spark a crisis.
There is a worrying tendency for cost to be used as a proxy for value. This reflects the greater focus on costs across many financial markets and regions, but it is also a direct result of the introduction of the 0.75% management charge cap for default funds designed for auto-enrolled pensions.
The charge cap has been welcomed as a constructive step by the government to prevent scheme members from paying excessive charges.
Mark Fawcett, chief investment officer at government-backed master trust the National Employment Savings Trust (Nest), says: “High charges act as a drag on performance.”
However, the charge cap can also be viewed as an overly simplistic measure which has fostered an invidious attitude to price.
JLT Employee Benefits head of DC investment consulting Maria Nazarova-Doyle says: “Fees are the last thing which should be considered when making a decision about choosing a DC provider.”
The primary focus should be on ensuring the scheme will deliver the best possible retirement outcome for a member, she adds.
State Street Global Advisors head of European DC investment strategy Alistair Byrne agrees: “It’s right to want to keep costs down but it’s not a good idea to drive them to a minimal level.”
It’s in the interest of members to include risk management and diversification in a default fund, he says.
Royal London Asset Management pension investment strategy manager Lorna Blyth adds: “Cost is only one of five or six key metrics which determine whether a member will have a decent retirement income.”
The unintended consequence of introducing a charge cap is that it has encouraged companies and pension providers to focus on cost rather than value. It has encouraged providers to compete on price and price alone.
SEI’s managing director of defined contribution EMEA and Asia, Steve Charlton, says: “Among master trusts, the best way to gain market share in the auto-enrolment market was to compete on price.” Many companies wanted the scheme to be as cheap as possible so it can’t be criticised by the workforce, he adds.
