Pensions News Bulletin January 2016
1. Multi asset funds. Too many to survive. Innovation key to funds success
Core multi asset funds, often called diversified or dynamic growth funds (DGF) designed for defined contribution (DC) pension schemes, have been trending in default funds for almost a decade.
Default funds are important because generally more than 90% of a pension schemes members are invested in the default fund with the corresponding level of contributions. Therefore every fund manager wants to provide the default.
Promoted under the banner ‘equity-like returns with bond-like risk’ the DGF aims to improve on the 1980/1990’s balanced fund approach by enabling a more sophisticated mix of asset classes that our age of higher technology makes possible.
DGFs came to market at a time when commercial property had boomed – so trustees and members wanted property exposure. Also pension funds faced criticism for sticking to their traditional assets such as FTSE100 equities, government bonds and higher grade corporate bonds.
The multi asset funds were created to embrace property and alternative investment classes as well as overseas equities and the traditional balanced fund assets. The cost of a fund increases with its wider reach and asset mix complexity, and it can be the case that the undisclosed costs of the DGF are double the disclosed costs.
These funds hit a sweet spot in that there is an incentive for fund providers to construct them and make them available, and for pension schemes to use them as they sound so right. A fund that has such wide asset class diversification and provides ‘equity like returns with bond like risk’. (A phrase whose veracity is disputed by some investment experts). They also fit well into target date funds and period to retirement (‘lifestyle’) derisking structures.
Their utilisation was initially slow. For several years the employee benefit consultants were not supportive on the worry that if fund managers were determining the asset allocation what purpose the investment consultant? Time and persistence overcame that hurdle and then multi asset funds became, by and large, the only default funds that consultants recommended. Which is the case today.
This has led to a plethora of similar funds which has been further boosted by the pension freedoms of the 2014 budget as the multi asset fund is easy to adjust to satisfy the flexibilities that pension freedoms allow.
The result is that multi asset funds have been over created and oversold and many may be vulnerable to closure. Figures from Scopic Research for Investment Week show that around 12% of all multi-asset funds from a universe of 600 have assets below £10m (as at 30 September- FE Trustnet), while a further 16% have AUM between £10m and £25m.
Pension freedoms and the significance of the default fund have given a boost to the power of the multi asset fund but the tendency of pension schemes to use the bigger funds belonging to the first mover investment providers means that smaller funds may cease to be viable.
Differentiating between multi asset /DGF propositions is very difficult and from the pension schemes view point the default fund’s purpose is to minimise governance risk to the pension plan sponsor and trustee as much, or more, than it is about providing the best investment and retirement outcomes to its pension scheme members.
The impossibility of all DGFs achieving optimal size by representing DC schemes default funds may threaten some manager’s business models but managers who look outside the default can succeed.
Innovation and the ability to create and socialise interesting propositions will give opportunity to fund managers who can visualise the future workplace proposition.
With auto enrolment generating extra billions of assets within 10 years this is also a future that will see people invest more for much longer. A growing proportion of them will look for something better suited to them, such as blending a greater risk tolerance with variable income and reinvesting potential. With the asset sizes involved, only a small percentage shift from the default will provide a great business proposition for the fund groups looking to the future.
2. FCA abandons review of bank culture but Bank of England bans directors
After news from the Financial Conduct Authority that it was abandoning its review of bank culture it was noteworthy to see the Bank of England flexing its powers by banning two former Co-Operative Bank directors from holding senior positions in the City. They were found to have posed an unacceptable threat to their former company’s financial position and were fined.
This is the first time the BoE has used its new powers to take action against individuals including the first bank chief exec to be censured since the financial crisis.
With regard to the abandoned FCA review of bank culture, they have stated that they are working within individual firms to achieve change in a more focussed way. They certainly need to succeed.
It appears to be the case that where making very large sums of personal money is relatively easy (compared to the perceived drudgery of a regular manual or clerical job) the line between honesty and dishonesty appears to be confusing to the cleverest people. This is of course not just about banks. Human nature is what it is and some of us have less integrity than others.
The honesty and dishonesty I refer to is not just the obvious example of referring to the facts of the moment. Where a product or business plan is for longer being honest and open about inherent future risk, as it applies to the case, is even more important.
Regulators should consider how their thousands of words of regulation are read and understood by practitioners responsible for doing the activity. I wonder how much this style of governance is part of the integrity problem. In financial institutions the sales people, marketeers and senior executives cannot and do not read this material. And this is understandable for those in touch with business reality.
The solution? An easy one is that each company has an appropriate and frequently communicated governance framework (including email and social media policy) and a range of readily usable sanctions. This framework must be simple and there is no need for it to be more than 500 words excluding the sanctions policy. In fact if it is you should worry about its effectiveness.
Connected to this, good leadership and management needs to be introduced or reintroduced. Key people at every level should have some accountability. The most important attribute (as it is the most elusive) of the dozen or so key requirements for building a high performance team is the readiness of every member to call out bad behaviours wherever they see them – immediately and fairly. And this is the interpersonal skill that keeps the team, the company and the customers safe. (When creating a high performance team it is astounding to see the difference this behaviour makes).
The board must also be seen to be accountable for the activities in its highest earning and complex departments as well as for the normal areas with which they feel most comfortable.
Good luck to the Bank of England and The Financial Conduct Authority. May you write less and achieve more.
3. Pension changes effective April 2016
Those who don’t think about pensions may have forgotten there are quite a few expected changes to pension schemes being introduced from 6 April.
- Adviser commissions and active member discounts will be banned in auto enrolment qualifying schemes.
- Defined contributions (DC) schemes to be allowed to pool the contributions and risks of its members and pay pensions from the scheme. Known as collective DC (CDC).
- Basic state pension to become a flat rate amount set at just above the pension credit level at £155.65 per week. However, additions will be made for additional earnings related contributions and deductions made for contracting-out where the entitlement is paid from an employer’s scheme. For full details you can visit the governments website here.
- Pensions annual allowance for tax effective contributions will be tapered from £40,000 for those with income of £150,000 or more, down to £10,000 for those with income of £210,000 or more.
Income will also be ‘adjusted’ to include employer pension contributions or any other income including savings, bonuses or even an individual’s buy-to-let property rental – taking many more people into a higher earnings bracket. The annual allowance will reduce by £1 for each £2 of adjusted earnings above £150,000 until it reaches £10,000.From 6 April 2016,
Most people don’t realise that if employees earning £150,000 or more don’t reduce their pension contributions from 6 April, they will be taxed at 45% on any excess and face a surprise tax bill when they submit their tax return.
- Another change is the reduction of the lifetime allowance from £1.25m to £1m. After April 2016, anyone who breaks through the £1m threshold may be liable to 55% tax on any amount over the limit if the excess is taken as a lump sum. Alternatively If any of the excess is taken as income, the tax charge is 25% although the income itself will remain subject to income tax at the earner’s marginal rate.
Financial Adviser Secondsight says that ‘taking into account an annual growth rate of 5%, any individual with a pension fund currently worth £358,000 with 20 years to go until retirement is likely to hit the £1m ceiling. Similarly, someone retiring in 15 years with a pension pot today of £463,000 could also be affected. An unintended consequence is that most ‘death in service’ benefits paid out will count toward the £1m – a factor which could leave a bereaved family with less than half of any expected pay out, once the tax is taken.’
What can be done?
Employers should be requiring advice from their compensation and benefits specialists and advising their at-risk employees of the general situation at the very least. Employees can apply to HMRC for fixed protection, at a lifetime allowance level of £1.25m, but their pension contributions must cease by the 5 April if the protection is to stand.
People in this situation should enquire further as changing jobs and inadvertently entering a death in service or a pension scheme could trigger new unexpected tax liabilities.
Thank you for reading.