The UK government seems to want to Build Back Better at any cost. And the cost in question is the fees being paid by the nation’s savers through their pension schemes.
Such is the urgency on this topic that the last reform aiming to get more of savers’ cash into less liquid asset classes like infrastructure and private equity was given all of two months to show results.
As of October, pension schemes could smooth the performance fees typical for these types of investments over several years to avoid breaching the 75 basis point charge cap that protects savers in default funds for defined contribution schemes.
This in itself was controversial. The cap is an important plank of consumer protection, particularly for these schemes handling auto-enrolment money. Workplace schemes tend to compete on costs, which is why average charges are actually only about 48 basis points.
The change was, as some feared, merely a first step. The government last week proposed scrapping its smoothing mechanism and instead removing performance fees from the cap altogether.
This could, it suggested, give trustees flexibility to improve outcomes for savers, while accommodating the types of 2 and 20 fee structures common in private markets, maintaining member protection against high or unfair charges, and also funding long-term projects to the benefit of the UK economy.
If the upsides of removing the cap sounds to good to be true, it’s because they probably are. This is an idea that — while recently mooted by the Productive Finance Working Group, which includes the Bank of England, the Treasury and regulators — has long been advocated by the private equity and venture capital industry. The sector’s fee structure has proved pretty bulletproof. Now some of the biggest workplace schemes, like Nest, are investing more in private markets but with a policy of not paying performance fees.
There is indeed a challenge around auto-enrolment and a generation of workers who are unlikely to be saving enough to secure a comfortable retirement: LCP and Interactive Investor reckon that a worker paying the statutory minimum into a scheme would need to save half as much again to achieve the same pension pot as a worker starting a decade ago, because of lower investment returns. Cutting off potential sources of growth is unhelpful.
But the cap exists for a reason, namely that the impact of higher fees on pension pots is substantial. The Pensions Policy Institute found that typical charges within a default scheme erode retirement savings by about 14 per cent. Paying charges at the level of the cap eroded savings by 20 per cent.
The latest government reform would leave the high management fees charged by private asset funds within the cap, while exempting “well designed” performance fees.
No one has decided yet what that means. But potential design requirements could run up against the industry’s classic objection that it raises money on a global basis on global terms. The government hopes this reform would incentivise investment managers to change their fee structures although it’s unclear how or why that would be the outcome.
The Pension and Lifetime Savings Association argues there are other factors limiting investment, including liquidity concerns and the requirement to “take careful consideration of risk and reward”.
The latter could easily keep schemes on the sidelines at a time when there are increasing questions over whether private equity really generates better returns than public markets over the long term, whether the returns justify the additional leverage involved, and whether the flood of money into private markets is likely to moderate returns further. The fact that returns in private capital are heavily skewed to top performers adds to the risk of paying over the odds for average performance.
In any case, notes Esther Hawley, a senior investment consultant at Barnett Waddingham, the government’s speedy timescale for getting money flowing is at odds with the reality of most pension funds, in a market that is still cost driven and trying to consolidate into larger pools that might have more bargaining power.
Which makes you wonder what reform, lever or cattle prod the government might grasp next to get money moving in the direction it evidently thinks it should be.