The difference a charge makes to pension savings

For those of you not old enough to remember, there were days when the industry had charge caps of 1.5 per cent for the first 10 years and 1 per cent for the remainder of the life of a stakeholder policy. That’s up to twice the current cap of 0.75 per cent for default investments.

Of course, some of the reduction came as the result of political pressure, in the form of the auto-enrolment charge cap. But added to this was the entry of master trusts into the market, pooling the fixed costs of pension scheme provision over a much larger group of members.

This gave rise to a workplace pensions market that was more competitive and much cheaper.

So you might think not much more needs to be done with lowering charges. But you’d be wrong.

A fairer charge for all

The hard part in setting workplace pension charges is that costs, complexity and fairness trade off against each other. With all this in mind, we reshaped our annual management charge (AMC) last year to strike what we think is the right balance between these three things for our members.

The revised charge structure features an annual £2.50 cash charge, a management charge of 0.5 per annum and a rebate on some of the management charge.

The reason for change

When the AMC is calculated on a percentage basis only, it may result in a low charge rate but high pounds and pence figure for members with larger pots. Conversely, those with very small pots pay a fee that doesn’t cover the cost, or even the regulatory fees, of providing a pension pot.

In an environment where there are millions of small, deferred pension pots, common as a result of auto-enrolment, schemes may rely on members with larger funds to cross-subsidise the costs of managing the smaller pots. This is not a sustainable situation for a well-run scheme and this issue was a factor in the introduction of our annual £2.50 charge.

But we know there’s another underlying issue here – that of the growing number of small deferred pension pots. It’s why we’re working with the Department for Work and Pensions and others in the industry to bring forward a solution to the small pots problem.

Giving something back

As touched upon above, we also cut our annual management charge by means of a rebate which works to help boost members’ pension savings. As a member’s savings hit key milestones – £3,000, £10,000, £25,000 and £50,000, we apply a monthly rebate and automatically add money back into their pension savings. The level of rebate increases at each stage, reducing the impact the charge has on their savings and, in so doing, leaving more money invested for their future.

For someone with £15,000 in their pot, over the course of a typical year, £17 will be added to their pot, with this increasing the more they save for their retirement. This might not sound much to start with, but compound the rebates over the years and they could add a significant amount to an individual’s retirement savings – more than £14,000 for an average earner1.

Change is the only constant

Nothing stands still and further change is inevitable. We expect the workplace pensions market to become even more competitive with significant consolidation of both providers and pots. We expect the latter to be driven both by dashboards and, increasingly, by government encouraging the industry to automatically consolidate small dormant pots. This will create a tougher operating environment for providers but we expect the emergence of stronger providers with even greater scale leading to lower charges for members.

We’re not there yet but we’ve come a long way in the last 20 years. We hope that the next 20 see as much progress.

Keen to know more about our annual management charge and how members can receive a bigger rebate? Visit our member charge page for all the details.

  1. Assuming a member aged 35 with a starting fund of £15,000, a salary of £30,000 per year, paying 8 per cent gross contributions, based on qualifying earnings for the 20/21 financial year, investment returns of 5 per cent per annum, inflation of 2.5 cent per annum, and a retirement age of 68, this could add up to an extra £14,566.

A podcast on charges, defaults & responsible investment

10 million – that’s the success of auto-enrolment in numbers. 10 million people saving billions into a pension. But the job of pension providers and the government is far from being complete.

In this podcast with Hymans Robertson, I discuss what the DWP’s consultation on charges could bring for pension savers and give an insight into the latest activity from The People’s Pension in our members’ best interests.

Podcast highlights

  • Not-for-profit – what it means to be a master trust provided by B&CE, an organisation that’s for people and not profit.
  • Benefit of our new charging structure – the more our members save the lower their charge could be.
  • Our take on DWP’s consultation on charges – a potential solution to millions of cross-subsidised dormant pensions.
  • The importance of the default fund – our report, ‘Workplace defaults: Better member outcomes’ with State Street Global Advisors, depicts the behavioural biases and the common investment mistakes made by savers.
  • Our approach to responsible investment – the steps we’ve taken to ensure our investment funds reflect environmental, social and governance factors.
  • Support for our members and employers how we do things differently to other providers.

Listen to the podcast

Hear from me and host, Victoria Panormo, Senior DC Investment Consultant from Hymans Robertson in the podcast now:

Podcast: Hymans Robertson on… DC Master Trusts – The People’s Pension

Other reading

For more about our report, ‘Workplace defaults: Better member outcomes’ with State Street Global Advisors and our findings read my blog post:

Why default funds are the simple and sensible choice for most

Glenn Dobson is a former National Development Team Manager at B&CE, provider of The People’s Pension. He has been replaced by Phil Taylor.

Default funds – the simple & sensible choice for most

What do you think when you hear ‘default fund’? Look it up in the dictionary and it says ‘default’ means something that exists or happens if you don’t change it intentionally by performing an action.

It’s a shame something so positive has this label. Default funds are, in my opinion, the next success story after auto-enrolment – a well-governed default is the simplest path to achieving good returns. People lead busy lives, get overwhelmed by too much choice and complexity, and if left to their own devices may make poor decisions. The beauty of the well-governed default is that it’s simple for members. They don’t need to actively do anything to benefit from the default but, behind the scenes, there’s a huge amount of dedicated activity by experts in the complex world of investments.

And with 99.7% of savers in master trusts remaining in the default (according to the Pensions Policy Institute), it’s a part of the system I believe we should be celebrating as an industry.

Risks for DIY investors

A recent report by The People’s Pension and State Street Global Advisors highlights the risks for most people of taking investment matters into their own hands rather than staying in the default. ‘Workplace Defaults: Better Member Outcomes’ models potential outcomes from the most common mistakes DIY investors make with their pension savings and compares them with a typical default fund. Over 40 years the default investor amasses a pot of nearly £430,000. The DIY investors risk missing out on as much as £247,000 by switching out of the default.

  • Mistake 1 is chasing past performance – ‘Performance chasing Patricia’ buys high into a strong performing fund expecting it to continue to do well but sells when it falls, and she loses faith.
  • Mistake 2 is putting all your eggs in one basket – ‘Eggs in one basket Elliot’ fails to diversify his portfolio and invests in only UK funds.
  • Mistake 3 is not taking enough risk – ‘Cautious Connor’ doesn’t like taking risk so invests in a cash fund.
  • And finally mistake 4 is forgetting to take account of changing circumstances – ‘Forgetful Fiona’ is initially an active investor but as time goes by, she forgets to review her investments.

Default is not a last resort

I’ve spent my working life trying to demystify pensions, and I know that savers and employers alike crave things to be as simple as possible. It’s true there may still be a lot of complicated technical detail within the inner workings of pension schemes, investment funds and regulatory input. But that’s the point with a default fund. Dedicated experts whose job day in day out is to be specialists in this stuff take the necessary action to ensure a scheme is well run and investments are managed with great scrutiny, so that members don’t have to. A default isn’t a last resort. In well-governed master trusts, they represent a solution which is in the best interests of the vast majority – a lot of thought goes into it so that members who don’t have the time or the specialist knowledge can get better outcomes.

Add to that the tight regulation and governance assigned to master trust defaults, in particular, and it’s clear they are far more than just a back-up position for those who don’t engage with investment decisions.

We should celebrate a system which offers better outcomes for most members in a simple way without them having to make any difficult decisions. In a world where we’re so often faced with an overwhelming array of choices, it’s hugely reassuring.

Read more

Read the report, Workplace Defaults: Better Member Outcomes.

Glenn Dobson is a former National Development Team Manager at B&CE, provider of The People’s PensionHe has been replaced by Phil Taylor.

DIY savers could miss out on £247,000 by switching

Switching from pension default fund could cost ‘DIY’ investors up to £247,000

DIY investors risk missing out on up to £247,000 by switching from their workplace pension scheme’s default investment strategy and making their own fund choices instead, according to new research from The People’s Pension1 and State Street Global Advisors2.

Largely due to the success of auto-enrolment and its more than 10 million new savers, billions of pounds are saved into individual UK workplace pension pots each year. The vast majority are invested into well-managed and cost-effective default funds and exposed to a wide range of investment types and markets in order to manage the risk for savers.

The new report, Workplace Defaults: Better Member Outcomes3, has revealed the potential cost of four of the most common mistakes made by pension savers who choose to be their own investment manager rather than investing in a default fund.

It shows how different savers, who display particular behavioural biases, perform over 33 years, compared to someone who stays invested in a well-run default fund throughout and amasses a pot of nearly £430,0003:

  • Cautious Connor – Doesn’t like taking risks so invests in a cash fund – could miss out on nearly £247,000.
  • Performance Chasing Patricia – Buys high into a strongly performing fund expecting it to continue to do well, but sells out again when it subsequently falls and she loses faith – could miss out on just over £173,000.
  • Eggs in One Basket Elliot – fails to diversify his portfolio, for example, investing only in UK shares – could miss out on just under £31,000.
  • Forgetful Fiona – Is initially an active investor but fails to keep her portfolio under review and circumstances change. This means she doesn’t ‘lifecycle’ switch to lower risk funds when approaching retirement – could miss out on nearly £31,000.

The report also focuses on the lack of knowledge around charges paid on pension accounts, with almost eight in 10 (78 per cent) savers unaware that a fee is taken from their pot.4 The research shows that, on average, ‘retail’ pensions carry a charge of one per cent, compared with a workplace average of 0.5 per cent.

Nico Aspinall, Chief Investment Officer at The People’s Pension, said:

“Most people enrolled into a workplace pension stay invested in a default fund which, as this study confirms, is by far the simplest path to take to achieving good returns. There will undoubtedly be some who will want to take investment decisions and try to quickly make up the losses from this year’s fall in markets but this research shows that DIY investment is fraught with dangers.

“Members in the default fund typically face lower charges and every investment decision is made with their best interests at heart to help improve their retirement outcomes.”

Alistair Byrne, head of pensions and retirement strategy at State Street Global Advisors, further noted: “Investment decisions are complex and most busy pension savers can’t give them the time and attention they deserve. Investing in the default strategy means putting your future finances into well-governed and efficiently scaled products managed by experienced professionals.”


Factor funds for master trusts

When the $1 trillion Norwegian government sovereign fund lost almost a quarter of its value in the financial crisis of 2008-09, it turned not to passive managers but to factor investing.

The fund’s absolute performance in the decade since the crisis has been better when compared with the preceding decade. This moment was a real watershed for the investment industry – so it’s worth looking at the detail.

Stung by the losses, and a national parliament anxious for answers, the Norwegian Ministry of Finance commissioned academics to analyse the fund’s active returns – that’s actual returns minus the benchmark – to see what their internal and 200-odd external active fund managers were doing for them.

They found that active fund managers added less than 1% of overall returns, with the benchmark doing the rest. But they also found that this modest contribution could be mostly explained by a small number of systematic factors, not least value, liquidity and low volatility. These weren’t deliberate choices by the client – but were by-products of the way the fund managers worked.

The academics recommended that the Ministry of Finance (which set the benchmark) should actively decide the level of factor exposure and that these exposures should be included in the benchmark.

And that’s factor investing in a nutshell.

It’s based on decades of academic research which says a number of investment factors can offer higher returns and better diversification than the traditional indices used for fund benchmarks. And this mode of investing usually comes at a lower fee level than active management.

Today, it’s widely accepted that there are 5 factors:

  • Value – where the price of an investment is cheap compared to its fundamentals.
  • Momentum – the tendency of securities to continue to perform as they have previously, whether good or bad.
  • Quality – which means ‘better’ companies (measured by profitability and other metrics) outperform lower quality companies.
  • Low volatility – some shares or bonds respond to market shocks more modestly than others, and therefore offer high returns over the long run.
  • Size – smaller companies tend to outperform larger ones, not least because they are under researched and, in many cases, overlooked by the very large institutional investors.

As you might expect, we’re fans of factor investment and made our first investment last year – into a fund also intended to achieve our goal of significant reductions in our exposure to fossil fuels.

Why factor investing appeals to us

One reason is their provenance. Unlike many new ideas, which originate from fund management companies and turn out to be fads, this comes from the client side and has a vast body of academic literature behind it.

Another is the enhancement to the risk/ return profile. We added factor investments to our default strategy and, while one year is far too short a time to assess their usefulness, we would expect them to play a notable role in achieving our target of beating inflation over the coming decades.

We also like the low fees. At The People’s Pension, we aim to keep member charges as low as possible. Factor funds can offer better returns than passive investments, without the sometimes excessive fees for actively managed funds.

The other reason is time. We have a very long investment time horizon whereas markets have an increasingly short one. This means market movements are dominated by short-term factors and noise, not long-term information. Factors funds appear to have a better long-term risk and return payoff to us, so offer us a more effective way of delivering for members over the decades.

Time will tell if we’re right – but we’re greatly encouraged by a decade of Norwegian experience and, more importantly, decades of academic research.

Read more

Find out more about how investments work with The People’s Pension on our investment webpages.

Investing with climate change

It’s beyond doubt that climate change presents a very real risk to the future investment returns achieved by pension schemes. But deciding what to do about it is complex.

Pension schemes must seek returns for their members and not take too much risk. This, coupled with a belief in the efficiency of markets and passive investment approaches, has led to caution in reacting to climate change.

Climate change is a true burning platform

The longer the industry waits to see how others react, the worse a problem it must react to. The Pensions Minister and DWP have responded to the issue by asking all DC schemes to publish their investment principles on ESG and climate change.

So, what can we do? We know less fossil fuel will be used in the economy in future. Simple reductions to companies with fossil fuel reserves will reduce exposure to the risk of investing in a defunct company. At The People’s Pension, newly authorised as a master trust by The Pensions Regulator, we added a multi factor fund last year into our default which halves its exposure to fossil fuel reserves. We expect to make further and more specific reductions in future, keeping in line with developing research on climate impacts.

How we could use data

Our current analysis is to see whether we can identify companies likely to do better or worse in the future because of the sector they sit in – or how well they perform on keeping their emissions lower compared with peers. This means using data to construct screens to remove companies at risk of being left behind or to identify the companies ahead of the curve who we could invest in positively. Unfortunately, the data on greenhouse gas emissions is patchy because many companies don’t report it. Much may in fact be estimates.

A good example is the auto sector. A factory making cars will create direct greenhouse gas emissions, or ‘scope 1’ emissions, perhaps in the steel making process. The company will also buy energy, which creates indirect, ‘scope 2’ emissions. These are all regularly measured and disclosed, although different industries may still be patchy. These emissions are simple to keep a handle on. ‘scope 3’ emissions are those from just about everything else to do with the product, including transportation to market, product use (including petrol) and product disposal. These are impossible to measure directly and ‘scope 3’ emissions data is estimated. For an investor such as The People’s Pension, it can make a big difference to your investment screening if you rely on ‘scope 3’ data from the company or a data provider.

Good news: things are changing, and data sets are improving

The London Stock Exchange is one of many organisations seeking more corporate disclosure of climate risk and the strategy of the company in response. This gives us more data to react to and may enable us to gain in confidence over time.

At this point the data isn’t useless but at the same time it may not be enough to act with high conviction. We want diversification, so there are always going to be compromises – especially when you overlay wider measures such as ESG scores. It would be nice to find that the most polluting companies are also the worst run, with the worst impact on society, but that may not be the case. Tesla scores lower on governance than its peers, according to some data providers. The trade-off between good governance and electric vehicles isn’t easy.

What we’re doing

We’ll make further portfolio changes and expect to have good progress to report in a year’s time when we publish the implementation of our climate and ESG principles. I’d like to think many if not all in the master trust industry will have made similar progress and that advisers will start to hold us accountable for climate change performance.

Master trusts are natural candidates for innovative climate change investments. That’s because they have a trustee board with a legal duty to act in the best interests of their members – and make their approach publicly available.

Read more

Read more about The People’s Pension’s approach to responsible investment.