November 2016

PENSIONS: Building trust with millennials

Getting the young to save for their pensions is difficult when suspicion about charges is rife, finds Fiona Rintoul – even if charges have never been lower.

Hand-wringing about why the millennial generation does not save as much as it needs to for retirement has become a favourite activity in the finance industry. A 2015 BNY Mellon report on the topic entitled ‘Generation Lost: engaging millennials with retirement saving’ – one of many – puts forward some theories for the problem. These include lack of information and lack of suitable products.

However, some believe the pensions crisis runs much deeper than that and requires a fundamental rethink of pension provision.

Many of those people are based in the UK, which faces a huge challenge in providing millennials with anything approaching the pensions their parents have. Moreover, historical pensions mis-selling scandals in the country have eroded trust in both private and workplace pensions, and a combination of student debt and spiralling housing costs, particularly in London and the south-east of England, mean millennials often don’t have any money to save in a pension plan even if they want to.

According to an August 2016 primer on millennials and centennials from Bank of America Merrill Lynch, university graduates in England (Scotland has a different system) face the highest debts in the English-speaking world, and modelling carried out by the Institute for Fiscal Studies suggests that about 70% of UK students will never finish repaying their loans. Add to that the economic uncertainty around Brexit, which could disproportionately affect this generation, and it’s no surprise that a growing body of activists – some of them from within the finance industry – is challenging the savings status quo in the UK.

FORCED TO REVEAIL CHARGES
An important area for discussion is charges, brought sharply into focus recently in the UK by the Financial Conduct Authority’s decision to launch a consultation on transaction costs. In the future, asset managers investing money for defined contribution (DC) pension funds in the UK could be forced to reveal transaction costs or explain why they can’t.

Understanding these and other costs is considered important because they affect the pensions that people receive when they retire.

“There is public concern in the DC area because what members pay has a direct impact on the value of their pensions pots,” says Mark Nicoll, a partner at Lane Clark & Peacock, a firm of financial, actuarial and business consultants.

But are charges in DC pension funds as problematic as all that? David Blake, director of the Pensions Institute at Cass Business School, says that they are, and he cites the example of Chile, once the poster child of funded DC pensions, to make his point.

“What damaged the reputation of the Chilean model was high charges,” he says. “Now people have retired with rubbish pensions. The reason was that the companies running the funds extracted huge management charges.”

You might have thought this problem would have been solved in the UK by now due to an already considerable scrutiny of charges. Indeed, some people feel that the charging situation is much better than it used to be.

“Charges on pensions have never been lower,” says Chris Sears, a financial adviser who runs his own advice firm, CTS Financial Services.

“The initial charge has gone, and the annual management charge has come down.”

But the likes of Blake still question the hidden costs connected with the running of funds, which include the transaction costs now being scrutinised by the FCA, as well as other costs, such as opportunity and market impact costs.

“Ninety per cent of the costs are hidden,” Blake says. “In the industry, everyone knows it. I was told years ago that the tax breaks on pensions are effectively a transfer of income from the state to the finance industry.”

It’s this sense of a cosy cabal that enrages consumer activists and damages the investment industry’s reputation. Whatever the true extent of the costs, some observers believe the industry must look livelier on this issue or risk a backlash.

“We still struggle today to get meaningful numbers from investment managers,” says Nicoll. “The consequences of managers not being open are quite a lot of suspicion.”

Nicoll does not believe the costs are huge. He suggests they might be in the order of 0.5%-1% per annum. And he notes that they are already reflected in members’ statements.

“The issue is when investors are not aware of what the costs are, and costs can vary quite markedly,” he says.

Another issue is whether it’s worth paying for investment management at all. Robin Powell, who runs The Evidence-Based Investor, a blog site that seeks to promote positive change in the investing industry, argues that for the vast majority of people, it isn’t. They’d be better off in low-cost index funds.

“The only justification for paying for active fund management is a reasonable expectation that, by doing so, you will end up with something higher than market returns,” he says. “In fact, the evidence shows that only about 1% of funds outperform their benchmark over the long term. What’s more, those very few winners are almost impossible to identify in advance.”

The only way to allow investors to make an informed choice, in Blake’s view, is to measure all the costs – and he is dismissive of those in the industry who claim this cannot be done.

“Companies should know these costs anyway,” he says.

“It’s no excuse to say: ‘our systems aren’t good enough’. If your system isn’t good enough, then get another system.”

For the likes of market impact charges, Blake suggests that the FCA should step in. It could carry out studies of the typical effects of these charges on different groups of funds; companies could then use those studies or do their own calculations.

CONSUMER SOVEREIGNTY
Without this full disclosure, Blake believes consumers of financial products cannot exercise their sovereign rights.

“Consumer sovereignty doesn’t work in finance, because consumers are not sophisticated,” he says.

“We can start by measuring and publishing costs. What gets measured gets managed.”

That would be one way to inspire confidence within millennials, who tend to value transparency even more than their parents.

“Greater transparency around costs will undoubtedly help,” says Powell. “People need to see that putting money away is first and foremost for their own benefit, and that they’re not just lining the pockets of fund managers, brokers and other intermediaries.”

And it is essential to inspire with that confidence, because in a low-return environment, charges are just one murky part of a very bleak picture.

“Charges could be minor compared to returns and low savings amounts,” says Blake. “It’s an incredibly serious problem. It could lead to inter-generational conflict.”

Daniel Godfrey, the former head of the UK’s Investment Association, whose tenure there came to an end over disclosure of charges, has just launched a new venture that approaches the problem from a different angle. He has started raising money from investors, paying as little as £20 each, for a project called The People’s Trust.

“While costs are obviously hugely important, sometimes we take our eye off the bigger imperative, which is how we can best deploy this money to get investment returns and economic growth,” he says.

“Even more, how can these pooled savings contribute to a society in which our beneficiaries can live in a more peaceful and environmentally cleaner world?”

The People’s Trust, which will take the form of a listed investment trust, is an attempt to address these issues.

In some ways, it’s a return to the past, as the trust will have a mutual structure.

According to Godfrey, this means there will be no “rent seekers” with short-term imperatives pulling the strings.

“If The People’s Trust gets off the ground, its structure and its authentic long-term objectives should help it deliver better returns for beneficiaries and for society – not at the lowest cost, but at the lowest cost possible,” he says.

It’s too early to say if The People’s Trust will succeed. But such new initiatives could be both a symptom of a system that is not serving investors as best as it might, and a spark of hope for the future. For one thing is certain: carrying on regardless is not a good option at this point.

Beyond that, the clarion call from those in the UK who would like to see reform in DC pensions is for simplicity as well as transparency.

“I would like to see DC pensions made far more simple and easy to understand,” says Powell.

“The fact that they are so complex simply gives investment consultants and other financial professionals an excuse to charge more.”

©2016 funds europe