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Personal benchmark

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John Greenwood

Private sector pensions will need to show genuine expertise in the field of investment to differentiate themselves from the passive approach of the personal accounts default. John Greenwood reports

Investment strategy and performance must be a key differentiator between private sector pensions and personal accounts, according to delegates at last month’s Corporate Adviser/Aviva pensions round table.

Advisers at the event, Countdown to 2012 - Shaping The Delivery of Workplace Pensions, which took place in London, agreed that personal accounts will pose a potent threat to workplace pensions and argued that corporate intermediaries will need to be able to show that they are recommending solutions that perform in ways that are demonstrably better than personal accounts. Advisers will need to be able to show they are recommending investments that perform and that match the risk profile of employees if they are to justify their fees, said delegates.

So, with personal accounts offering employers a government-backed blame-free optout, what will be the benchmark of success for advisers who recommend paying for more than the state-spon- sored option?

A number of potential gauges of success were proposed by delegates, some relating to improved performance, others linked to member engagement.

Robin Hames, head of technical, marketing and research at Bluefin, argued that rather than being measured in terms of how well a default fund created or selected by the adviser had performed, one measure of success could be the proportion of employees who do not opt for the default because they are engaged to make their own investment decisions.

“If we end up with 90 per cent of those auto-enrolled into personal accounts going into the default fund, the question is, is it better that you have got 50 per cent of the people in the default fund and another 50 per cent actively managing their money? Will this become a benchmark we set ourselves or will it be that we try to come up with a slightly better fund manager who achieves an extra 0.5 per cent a year performance?”

Corporate Adviser editor John Greenwood suggested that the performance of the personal accounts default fund would become a nationally understood statistic, akin to the FTSE 100. This then could become a benchmark for the default options put forward by the private sector, he argued.

But Duncan Howorth, managing director of JLT Benefit Solutions, said he did not think that the performance of personal accounts would become a defaqto benchmark for all default funds across the board because it would not be possible to extract a single performance figure for what would be a fund operating for many different investor profiles.

He said: “This sort of index is not relevant because we will have to have different levels of performance for different age profiles as we do in all other DC schemes so everybody should be getting different investment performance relative to the risks that they decided they want.”

Howorth said the industry would be wrong to try to take on personal accounts on performance. “If we try to take them on on this, we will miss the point and we will lose. As advisers, the role we play in helping develop the investment solution for members is a key one. Advisers can channel a lot of help to members in terms of engaging with their money and making it work for them, education and pulling the other benefits together as a whole,” he said.

Rudi Smith, a senior consultant at Watson Wyatt, pointed out that the investment approach of pers- onal accounts will develop in a different way from the contract-based market, which is moving in the direction of investing towards scheme members’ own personal targets.

“If you look at the way lots of occupational schemes are going, and I suspect a lot of contract-based schemes will go too, their results are focused around what is it that members are trying to achieve rather than investing purely in asset classes,” said Smith.

He argued this means the types of funds in the private sector will be different and therefore hard to compare with whatever basic passive structures personal accounts come up with. “I don’t think that basically they are in the same market because of the charging structures, so we may not be comparing like with like,” he added.

Greenwood raised the issue of whether the personal accounts default fund will become a benchmark for performance in the workplace pensions industry. If so, and it is, as is expected, largely based on passive funds, he argued, this would bring the debate over passive v active fund management into sharper focus. So will widespread appreciation of what one ultra-cheap but well-balanced tracker fund can do put the onus on the advisory and fund management industry to do more to justify the higher charges inherent within their active management strategies?

Advisers pointed out that the FSA has warned in its consultation paper CP09/18 that simply offering access to a wide range of investment funds through a GPP will not, of itself, be sufficient to satisfy the regulator that a corporate intermediary is acting within the spirit of the retail distribution review.

So does that bring us back to the active v passive deb-ate? As to whether it is worth paying for active management was much if you are talking about getting more people into active managed funds do you think the FSA and the Goodman generally are convinced that that is a good thing?

Howorth said that it may not be as straightforward as this, as default funds themselves may become more actively managed in future. He said: “It may be that what we need is actively managed default funds, because most people don’t know what to do with their money, so if you have actively managed default funds rather than leaving them in passive funds for years with no one looking at them, that has to be better for the customer.”

Advisers agreed that getting employees to engage with their pensions and the investment decisions that relate to them would be a key part of their role in future. Smith pointed out that there will always be those who are going to engage and those who do not. “For people who are not, we are looking at default funds, whatever scheme they are in. For the people who are engaged, it is about giving them the right tools to manage their own portfolio.”

All delegates agreed that the issue of risk is going to pose an enormous challenge for those in charge of personal accounts’ investment strategy, on the one hand wanting to invest for growth over the long term while on the other hand dealing with a group of customers for many of whom taking risks with the stockmarket will be a new experience.

Paul Goodwin, head of pensions marketing at Aviva, said that he had learned from discussions with the Personal Accounts Delivery Authority that they were looking at keeping employer and employee pension contributions divided and taking a less risky approach to investment with the emp-loyee’s own money.

Goodwin said: “We hear they are concerned that the people they are marketing to do not understand the concept of loss and risk. They do not understand that £30 invested is not £30 saved. They are trying to get around that and one of the things they are looking at is the concept of splitting the contributions into an employer pot and an employee pot.”

Howorth said: “The auth-ority ultimately in charge of the default fund would have a fiduciary duty to the members and so would have to opt for a strategy that is going to meet these peo-ple’s retirement objectives. They would have to say ’we think we need to put money at risk to overcome inflation.’”

Hames felt that with the right education programme, the personal accounts target market would be equally able to understand risk as wealthier economic groups. “I do think that there is a certain condescension to the view that ordinary people cannot understand these things. If a person can work out a tricast betting system down at the betting office they are intelligent enough to be able to understand risk. The fact is that they are just not interested,” he said.

Suzi Lowther, head of corporate marketing at Hargreaves Lansdown, said: “If you actually bother to take time and talk people through what risk actually means, then they will understand it.”

David Bird, a principal in Towers Perrin’s retirement practice, explained what he felt was the dilemma faced by all pensions professionals making decisions about investments on behalf of uninformed investors.

He recounted an example from his office where a colleague had asked him for advice on her investment choices and was in a fund that was 75 per cent equities and was described on the fact sheet as an average risk fund. “What does the phrase ’average risk’ mean to her? Are we saying that she understands that in a year that her fund may fall in value by 30 per cent? Her time horizon is now, whereas our time horizon is over time,” said Bird.

“Members don’t get that and this is a huge problem for us in the industry. There is the mismatch between what we think is the right thing, although we might not have been right over the last 10 years, and what they think is the right. We might think we are doing the right thing for them because we are investing for their retirement. But they will not perceive it that way because their risk horizons are very different from ours,” he addedClive Grimley, a partner at Barnett Waddingham, said: “There is the risk of excessive conservatism. People say ’I don’t want any risk at all’ but that can hit their returns over the long term.”

Howorth argued that the issue of reckless cau-tion could be addressed by smarter member communication. “At the moment, some questionnaires and check lists are asking questions too similar to those you would ask a saver or an investor. So when you say “would you not sleep at night if your money was at risk,” unprovoked, immediately everyone ticks the box. However, if you start saying that some of this money is not accessible for 30 years and it needs to deal with inflation, people hopefully will start to understand and say ’okay, I can start to take this long-term view with my money.’ But I think it is very unclear at the moment.”

So with personal accounts targeting low-income groups who are both likely to be less comfortable with risk and less able to afford risk, will this reckless caution mean the private sector will be able to differentiate itself in terms of performance and access to quality funds?

Advisers were loath to promise better returns for investors than were going to be achieved through personal accounts but argued that the industry would win out on matching individuals’ portfolios to their own personal risk profile.

Smith said: “The key issue is about understanding risk for individuals, understanding which risks are important to people, given their time in life and their circumstances. That is not to say every person who is a year from retirement should be invested in corporate bonds. It is saying you should understand what are the key risks you face, what is important and how that influences the decisions you make.”

So, how are corporate intermediaries going to offer employers and employees a better investment solution than they can get from personal accounts?

Howorth said: “Our challenge and our opportunity, and I can’t see why we cannot achieve this, is that we do engage with employers who are the conduits to reach these people and we achieve better education, communication and understanding of risk.”

Hames argued it was time for the industry to show what it is made of. “I would hope that the industry can do a better job of communicating to people and explaining to them what their investments mean than personal accounts,” he said. “And if it cannot, then we do not deserve to succeed.”

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