Break down DC charges to assess value for money

For some, the reflex response is, 'Save more, retire later' – pension savers would need to put more into their pension plans, work longer or adjust their investments, thus taking on more risk for a similar outcome.

However, the onus should lie not just with savers but also with defined contribution schemes to do everything possible to secure the best outcomes, net of costs, for savers’ investments.

The dangers of a single all-in cost approach

All pension providers must continue to focus more on delivering value for members. This requires thoughtful cost management, so that greater process efficiencies are balanced with sufficient investment allocations in pursuit of the best possible risk-adjusted returns.

Breaking overall costs down into the administrative and the investment elements would enable well informed regulators, independent advisers and employer pension committees to hold providers to account.

They could then ask providers whether too much is being spent on costly administration and services that few members access, and too little on the investment of the default strategy, which will determine member outcomes.

Providing a single bundled charge, with little or no transparency on how it is spent, does not encourage good behaviour on the part of pension providers, or indeed buyers.

With an increasing number of providers selling on headline prices alone, investment budgets have been decreasing faster than any other item in the overall cost budget.

Some providers are spending as little as 10 per cent to 20 per cent of the costs they incur on their investment budgets. This is driving a focus on the cheapest possible investment strategies and not on those that will deliver the best net outcomes.

Some asset classes are marginally more costly to access, but, if used appropriately, can secure better diversification, and hence outcomes. Examples include liquid alternatives, such as private equity, infrastructure or smart beta products.

And some strategies would benefit from spending on more sophisticated risk-control mechanisms, like currency hedging overseas investments.

Allocating more of the overall charge towards investments can potentially improve pension savers’ final outcomes. This raises big questions about the wisdom of spending 80 per cent or more of the cost budget on administrative expenses, like data management and recordkeeping, member communications, platform fees and governance administration.

In the bigger and more mature US market, administrative fees can lie in the low single-digit basis points. There are important structural differences between the US and UK markets, but the US example shows what can be achieved.

Transparency on costs, outcomes and governance

Given the wide variations on how the pension charge breaks down across the industry, greater transparency is required.

Instead of focusing on the all-in cost, schemes should be clear about how much is allocated to generating investment returns and how much is spent elsewhere, especially when it comes to default strategies, where the marginal benefits of much of the other costs incurred may be minimal.

Overall, providers should be spending at least 40 per cent of the pension charge on the investment-related budget – around 30 bps, assuming a 75 bps charge.

This would deliver a better product mix and greater diversification, and allow for better risk-adjusted returns. It could significantly improve many people’s pension outcomes.

To ensure that schemes are held accountable for the performance they deliver, they should be required to publish the historic returns achieved by the default strategy on an age cohort or other suitable basis, net of all costs incurred by members.

Finally, all trustees and independent governance committees should address two simple governance questions in their annual value-for-members review of the default investment strategy:

• 'Could I achieve the same investment strategy at a lower cost to members?'

• 'On balance, could I achieve better net outcomes for members by spending a bit more?'

David Hutchins is head of pension strategies at asset manager AB