For me, the recent market shakeup has highlighted the growing pension apartheid in this country. There is a clear division between…
1) The pension haves (final salary pensions usually public sector) and
2) The have nots (everyone else on defined benefit/ personal pension).
I won’t go into the politics of it all here, but following the recent turmoil, George Osbourne might find he is in a stronger negotiating position going into the next round of public sector pension negotiations.
As companies and governments close off their final salary schemes, there will be more people shunted onto defined contribution type plans which depend not on the number of years of your service/ final salary, but on the performance of your investments in the long run.
There are many problems with this:
- Most people don’t understand pensions and left to their own devices don’t contribute anywhere near enough towards their retirement. This is why the government is (sensibly in my opinion) bringing rules for automatic pension opt in for all company pension schemes.
- Most company pensions will be outsourced to one of the major fund providers which automatically creates a problem of lack of choice for workers. Secondly, it is doubtful that most HR directors in small to medium sized companies will have both the time and expertise to carefully choose the company to run their pension in the best interests of their workers. Does a hard working HR director of a 300 person construction company necessarily understand the impact of a 5% up front fee charged on their staff’s pension fund? Do they understand the huge difference a 0.6% annual management fee could make compared to a 1.5% annual management fee?
- The FSA’s RDR plan is laudable, but there is gap in terms of what happens to small investors who are likely to be of little interest to the new school of truly independent financial advisors. We can shop for car insurance ourselves reasonably well, but there is not enough transparency in pension fees to allow people to make the same autonomous choice.
The pension chasm
There is also a gaping chasm opening up for small private investors vs more wealthy individuals. I fully support the FSA’s Retail Distribution Review which seeks to ban IFA’s from earning commission on fund recommendations if they want to retain the title ‘Independent’. Instead of commission, IFAs will come to other arrangements such as set fees or a pay on performance fee.
Alternatively, banks will continue to offer free ‘tied’ investment advice based around their own funds.
However, it does leave most people around the age of 30 potentially without a decent avenue for investment advice. Take the following hypothetical situations for example.
a) John is a business development manager for an events company earning an above average salary, but would be described as affluent. He wants advice on starting a pension, but no IFA will speak to him because his assets are too small to bother with. Instead he visits his bank advisor and they help him sort a pension out which seems ok on the face of it.
b) Bill is a self employed fitness instructor. He uses price comparison sites a lot so thinks he’s found a good option via a fund platform provider which offers access to various funds at a low cost. He’s not good with spreadsheets so cannot calculate some fees to do a broad comparison of fund networks vs SIPPS.
c) Simon works in IT for a hedge fund, thanks to his bonus, he’s got a large pot of money to invest. Aside from a stake in the fund, he wants to start his own pension, so he meets with an IFA who agrees a set consulting fee and sets him up with a SIPP focusing on very low cost index trackers.
Who’s likely to be best off?
a) John’s pension is ok, but has a high up front fee and annual management fees of 1.5%. These fees do not include hidden costs from trading fees.
b) Bill does fairly well picking up some funds with no up front fees, but he can’t construct the balanced pension with a 5% exposure to gold because the fund platform only includes certain funds, which coincidentally pay the best commission fees to the fund platform.
c) Simon is able to create a nicely balanced portfolio through ETFs with ultra low costs as well as providing exposure to specific markets such as gold. The advisor’s fees are likely to be easily absorbed by the size of the fund.
Who are funds being run for?
I recently came across Matthew Vincent’s columns in the FT and was very pleased to finally find someone not only identifying many of the issues I have blogged about in the past, but also taking action to change things.
On the issue of under performance of managed funds, he has some startling numbers:
- A study of 108 funds run by 6 major UK firms from 2000 to 2011 showed that 99% of the funds were in drawdown. Not surprising given the FTSE’s loss over the same period, but it does put paid to the poppycock spouted by some managers that they add value by being able to step in to protect investors at the right time. I blogged about this here.
- 60.80% of the funds made more in fees for the manager than they did for the investors on a one year investment horizon
- 25.7% of the funds made more in fees for the manager than they did for investors over the entire period.
As I’ve blogged about here, the real cost of investing in the UK is much higher than advertised as trading costs and stamp duty are usually not included in Total Expense Ratios. Vincent likens this to the low cost airlines which have had to become more transparent with their fees and pricing following numerous complaints. In the grand scheme of things, an unexpected £5 fee for booking a flight with a credit card is nothing compared to the loss of tens of thousands of pounds on your pension pot due to hidden fund charges. Yet the funds get away with it. Probably 0.5% a year hidden fees on future potential earnings is harder to feel than £5 added to your bill on a £100 flight.
Vincent has put forward an admirable plan for clarity in fund charges which he calls total cost of ownership.
If individuals are going to be able to make appropriate decisions for themselves, they need to have comprehensive and transparent information to allow them to do so.
A total cost of ownership proposal would be a massive step in the right direction.
However there also needs to be an easy to understand calculator that allows people to see what might be best based on their expected contributions and identifiable fees.
SIPP vs Stakeholder pension.
I’m looking to change my pension plan without the (supposed) advice of an IFA.
Cost is my main driver in being able to create a balanced portfolio. After much research, it comes down to a choice of either a SIPP via SIPPdeal or a cheap stakeholder pension from Scottish Equitable.
Sipp Deal: http://www.sippdeal.co.uk/Sipp/Charges/
SIPP Deal allow you to build a flexible pension through low cost ETFs or low cost trackers with annual dealing costs and management fees as follows:
- £9.95 per deal
- £12.50 quarterly fee total (due to investing in funds beyond Sippdeal funds)
- Various fees at pension close which should be negligible in 25 years.
- Stamp duty on bond fund.
- I’ve assumed one single annual purchase of each fund.
Fund fees:
Sippdeal have access to Vanguard funds imposing no minimum purchase. I’m attracted to Vanguard because of the campaigning on fees. There’s no guarantee that Vanguard will not have hidden nasties like other funds, but I would bet it is unlikely. The SIPP also allows you to build a well-diversified portfolio on your terms.
- Vanguard Global Small Cap Index (0.40% TER). 30% holding
- Vanguard Developed world ex UK (0.30% TER). 30% holding
- Vanguard global bond index (0.20% TER + 0.20% stamp duty). 40% holding.
Scottish Equitable: http://www.cavendishonline.co.uk/pensions/shp_scottish_equitable.php
Bog standard pension with plain vanilla type funds:
- AMR of 0.6% for regular premiums.
- £35 one off set up fee.
The advantage of this set up is that it is cheap with no annual/ monthly cost for additional contributions. The disadvantage is that the annual fee is ‘AMR’ not ‘TER’ which leaves the door open for fund underperformance due to hidden fees such as stamp duty. You also do not have much flexibility with the portfolio construction.
Returns comparison
This is where an easy to understand calculator would be invaluable because depending on your circumstances, either option would make sense. The main factor is the size of your fund because the SIPP has fixed dealing costs for annual contributions/ rebalancing. I’ve changed the amounts below from those that may suit my own circumstances.
Hypothetical assumptions:
- £10,000 initial contribution
- I’ve assumed an annual return of 5% before fees.
- Annual contributions of £5000 increasing by 5% a year.
- Stamp duty and platform fees accounted for where stated.
After 30 years the position would look like this:
- SIPP: £606,268.
- Stakeholder: £581,973.
That’s an advantage of £24,294 come retirement time. In 30 years time, that’s probably going to be less than the price of an iphone 4000, but still better than nothing.
The SIPP’s advantage only starts to come into effect once the fund grows big enough to swallow up the fixed annual costs, so £9.95 per deal becomes a smaller and smaller cost as a % of the fund.
Note I’ve not increased these fixed costs in the years in my assumptions. Potentially not unreasonable given that trading costs have come down in the last decade thanks to online dealing and increased competition.
Summing up
There’s not much in it between these funds but I would opt of the SIPP because of the flexibility there and the unknown surrounding hidden costs.
If such a comparison tool was available to all investors along with a total cost of ownership calculation, then the pension apartheid might just start to dissolve.
