DC costs need more transparency to create member confidence

Without clear, comprehensive disclosure of all investment costs it is impossible to make a true appraisal of VFM. Future regulation should focus on greater transparency for employers and members.

This should include not just clear disclosure of what the total member-borne costs and charges are, but also how and why they are incurred. Only then can fiduciaries make VFM judgments with confidence.

Accuracy and consistency should be improved

DC pension regulations should prioritise rules for accurate and consistent collation of data, and for transparent reporting of transaction costs. Only after these rules are in place should the emphasis shift to assessing whether costs are excessive or should be included in the charge cap.

A reduction in the charge cap will result in worse member outcomes if the impact is to reduce market competition. This will result in higher fees in the long term, with minimal financial benefit in the short term

For instance, pension providers should be given clear guidance on how to measure and disclose transaction costs resulting from the ‘swing pricing’ approach to valuing units in pooled funds, which we believe may often go under-reported or obfuscated.

And they should be required to split transaction costs between those resulting from day-to-day management of the investments and those related to cash  flows into and out of members’ accounts.

Without this split, employers and members may be confused by inappropriate comparisons between the transaction costs of new, innovative providers that have large annual inflows, and big industry incumbents where flows are likely to be considerably lower as a proportion of the total assets they have under management.

Charge cap must work for members

So far the industry has reacted positively to the charge cap and has become more competitive as a result. Most auto-enrolment savers are now in plans with charges well below the current level of the cap.

But the charge cap rules could still be improved to create better outcomes for members. We believe that the cap has reduced the quality and diversity of the available investment solutions.

We estimate that less than 25 per cent of the charges borne by members in typical master trusts are now going towards services that aim to increase the value of their pot. More than 75 per cent are going in administration and plan management.

That is a very disappointing statistic in our view, and comparable to a hospital spending only a fraction of its budget on medical staff and equipment.

Recently, simple low-cost passive equity and bond strategies have performed well, and so a lack of wider diversification or risk management has not impacted members’ accounts. But it would be wrong to assume that this benign scenario will continue.

An overemphasis on short-term cost control may backfire — according to the example below, considering a 21-year-old contributing £150 a month.­­­

Our calculations show how a reduction in the charge cap will result in worse member outcomes if the impact is to reduce market competition. This will result in higher fees in the long term, with minimal financial benefit in the short term.

Currently, larger member accounts effectively subsidise smaller accounts. We are concerned that reducing the charge cap further will make this cross-subsidy unsustainable.

In fact, combined with other industry developments (such as the pensions dashboard), it could bring on a potential economic collapse of parts of the industry to the detriment of less wealthy members.

Fees must be proportionate

Flat fees impact small pots disproportionately, and contribution-based charges can be particularly unfair to members with short investment horizons as they have limited time to make up the fees with investment performance before retirement.

We believe in limiting the use of flat fees and moderating their quantum relative to the size of each member’s account.

Pension regulation should focus on bringing transparency and consistency to costs and charges. Employers and DC members should readily be able to answer the key questions: how much, for what reason, and for whose benefit.  

As a minimum, we would like to see the charges incurred by members split between the following categories:

• Which service? Management, administration, investment and communication.

• Who benefits? Fees that benefit the plan provider and its shareholders directly, versus fees that are paid to independent third parties.

These disclosures are the prerequisite for truly independent VFM assessments, and enable both improved governance and lower costs without jeopardising the quality of provision.

David Hutchins is portfolio manager of multi-asset solutions at AllianceBernstein