Making a contribution
In the debate around DC investments, the experts’ voices have not been loud enough. Stephen Bowles, head of DC at Schroders and chairman of the DC Investment Forum plans to change all that. John Greenwood reports
Most pension experts agree that default funds are far from ideal. And with the level of assets set to soar as the trend to DC is boosted by auto-enrolment, competition for control of those assets is growing.
Pension reform and the arrival of Nest, and others, into the market have sparked fresh thinking around how to make default funds better, and insurers and intermediaries have started to build propositions that service the investment needs of pension scheme members.
With so many players fighting for this lucrative and growing market, it is perhaps no surprise that the active fund management community should want to make its voice heard more loudly.
It is against this backdrop that the DC Investment Forum was born last autumn, bringing together Baring Asset Management, Henderson Global Investors, JP Morgan Asset Management, Schroder Investment Management, Standard Life Investments and Threadneedle Investments to give a collective voice to active managers.
The group is the brainchild of its first chairman, Stephen Bowles, head of DC at Schroders, and Spence Johnson director Magnus Spence. Bowles says: “The original concept came from a conversation between Magnus and me last summer. My feeling was that as a group we were not particularly well represented. Each provider has pockets of resource but by pooling it together we can get some economies of scale and promote investment in DC, an area that is growing in importance.”
The group aims to be a voice for the active management community through the publication of research papers and press commentary.
Bowles says: “The bundled providers and the insurance companies have been around for a long time in DC and have got extensive lobbying and marketing resources. Asset management asset managers who have come into DC individually did not have the same level of resource. Ours is a voice that is not being heard but is one that has something to say.”
“As a group we were not particularly well represented. Ours is a voice that is not being heard but is one that has something to say”
The group’s first paper, The prodigious use of passive funds in UK DC: A new perspective, suggests that the UK market has been over-reliant on passive funds, particularly when compared with best practice in the US.
Bowles says: “That paper says nothing should be off menu when it comes to DC investment and that there are perfectly valid arguments for looking at all the different styles of investment.”
A cynic might suggest that that is precisely what active fund managers such as Schroders would say. Bowles believes that the group has more than marketing spin to bring to the table.
“To be blunt, the investment management community is a source, more than anyone else, of new ideas about how to take DC investments forward.
“Historically the consulting community and the clients have decided what sort of solutions they want and the investment managers have essentially provided those solutions. Part of the market can stay like that but I think supply led DC investment is also a valid concept, which is essentially saying that investment managers have got something to offer. You can see that to some extent in the retail space with those investment managers that identify the market, find the gap, design something for it and then fill that gap. There is more scope for that in institutional DC now.”
Is part of the motivation for setting up the group the increased scrutiny of asset management charges, particularly following the work done by David Pitt-Watson for the Royal Society, and the recent early day motion in Parliament on hidden costs in pension and saving funds?
“There is an element of that, but it is a broader issue. The message I took out of this research was that actually through the institutional side, charges are not high at all. They are very competitive. They are very competitive relative to the market a decade ago, and very competitive relative to other global defined contribution markets. And I don’t think there is any reason why the industry should shy away from that message. I’m not saying the market is perfect, but to label everything as excessive is an exaggeration,” says Bowles.
Bowles sees the Retail Distribution Review as being a limited issue in the top end of the market, as most of the intermediaries in that space are already operating on a fee basis. But going forward, the RDR and other factors will undoubtedly push down charges for the expanding DC market.
“Nest and the general move to lower charges will have an impact and as advisers on the retail side move to fees post-RDR we will get that force coming up too.
There is a whole big melting pot of factors and forces going on. It is hard to see what is going to happen but it is unlikely that fees are going to go up. So yes there is a broad base of pressure and scrutiny on fees. The government and the regulator both see this as a topic worthy of attention, and just the fact that they are going to look at it will probably have an effect,” he says.
Bowles points to the handful of lower fee solutions that Schroders has launched as evidence of the investment management community already responding to this trend. Its QEP Global Core carries an annual management charge of 0.35 per cent, and its Dynamic Multi-Asset Fund, which is a reconstruction of the Schroder Diversified Target Return Fund comes in at 45 basis points.
“We think these are solutions that should appeal to some segments of their market where we haven’t appealed before,” he says.
“I don’t think we can stand still when everyone else is looking at new ways of delivering to the market”
And is Schroders set to target the growing contract-based side of the group pensions world more actively in future?
“It is an area that on the institutional side, bluntly putting it, we are not engaged in particularly well. We have focused mainly on trust based pension schemes. The split in the business is about 90/10 in favour of trust. That is changing. But part of the problem is that there are two elements, investment management and the admin fee. So there isn’t quite as much scope for active.
“A multi-asset fund at 75 basis points is a perfectly palatable solution, but when you start adding on the insurance companies’ administration costs, you are well north of 100 basis points and that is where DMAF, the dynamic multi-asset fund comes in. We wanted to create a good diversified fund but fees have to be more of a dynamic in the mix. So rather than being 75 basis points, it is 45 basis points and with some reasonable negotiation with an insurance company you can get the whole package in for 100 basis points. And it then starts to become a viable proposition.”
Life offices and intermediaries are also looking to get in on the asset management game themselves. So does Bowles think they can make a success of it, and are they stepping on the toes of the likes of Schroders?
“Stepping on our toes? They have identified an area of the market and I can see why they have done what they have. Can they do it? Time will tell. There is opportunity for everyone. The roles of adviser, investment provider, insurance company are blurring and the divisions between them will start to disappear. And that is what Mercer has done. It is working with insurance companies to create a solution and good luck to them. It’s vertical integration has the adviser at the front, asset managers providing funds and the insurance company providing the platform. And maybe that vertical integration model can work elsewhere. I don’t think we can stand still when everyone else is looking at new ways of delivering to the market,” he says.
And what do the DCIF and Schroders plan to bring to the table when it comes to transitioning from accumulation to decumulation? Has Dr David Blake’s idea that investors should be 40 per cent in equities the day they retire worked its way through to the asset manager’s drawing board yet?
“My personal view is that this is not relevant today because funds are too small. The method by which advice is provided is too expensive for most cases and drawdown needs to be advised. So the majority of people over the next decade should annuitise and should do so between 60 and 70. Therefore traditional lifestyle targeting at a set age is not inappropriate. But we may need to start communicating more as we approach retirement.
“Through the institutional side, charges are not high at all. They are very competitive.They are very competitive relative to the market a decade ago, and very competitive relative to other global defined contribution markets”
“Going forward though, there is absolutely a huge piece of work to be done on glide paths to see how we derisk, but it is a difficult problem. If you don’t know when people are going to retire, if you have no end point, then how can you calculate what proportion of equities people should be in? And it also depends on how much risk they want to take. We have only started thinking about risk from peoples’ 50s onwards. But it may be that period of risk is going to extend out,” he says.
“The other factor is the different investment tools we can use. We have focused on gilts to match out that annuity risk. Going forward if you are going to extend out that investment period you may want to look at a diversified pot of different asset classes for growth. You may want to look at absolute return products because in that drawdown period you want more certainty about the level of return and we might want to start looking at things like swaps as a way of getting annuity conversion coverage at the back end as people probably want to take an annuity at some point in time.
“The advantage of using some of these swap-based derivatives is they are more efficient so you can get that annuity coverage without having to convert all your growth assets into protection assets.”
Bowles sees the DC at-retirement space as ripe for improvement, although nothing is going to appear just yet.
“There is a whole range of building blocks that are just coming onto the horizon now that in the next five to 10 years with a bit of clever thinking and wizardry can be converted into something that will serve the average DC member a lot better when the average DC member stops annuitising at the age of 65,” he says.
Better thinking around DC investments should be a priority. And bit of wizardry from the investment community is exactly what DC investors retiring a decade from now are going to need.
Funds too passive?
The DC Investment Forum’s first paper, The prodigious use of passive funds in UK DC: A new perspective, questions the much higher use of passive funds in the UK than in the US market.
The paper identifies six justifications for going for passives - cost, manager risk, legal liability, asset class selection, low maintenance and advice and then addresses the validity of basing selections on these criteria, comparing how much weight is given to these factors by those selecting pension scheme investments in the US, drawing on research from Stacy Schaus, chair of the US-based Defined Contribution Institutional Investment Association and Defined Contribution Practice Leader at asset management firm PIMCO.
The DCIF paper estimates that across the DC schemes of large UK companies (5,000 members or more), 69 per cent of assets are in passive funds, but factoring in smaller schemes, the overall average is likely to be 35 per cent. In the US it is predicted that passive funds will grow from their current 16 per cent to 21 per cent of assets by 2015.
The paper concludes that the fact that the UK has greater DC assets in passive funds than does the US is a signal that we may have a structural imbalance.