I have previously written at some length about transfers out of final-salary pensions but here I will pay most attention to transfers out of personal pensions.
A couple of years ago, I started to change the regulatory status of my firm from appointed representative to being directly authorised by the FSA. As my entire turnover came from pension transfers, the regulator paid particular attention to our activities during the authorisation process, which took a great deal longer than usual.
One of the main issues which occupied the FSA’s thoughts, leading to frequent questioning about my firm’s business processes, was the fact that most of my business had by that time developed in money-purchase transfers.
“What justification could there be to transfer from one personal pension to another?” it asked.
Its line of questioning seemed to assume that all that was likely to be achieved by such transfers was an additional one-off charge to the client, primarily to fund our commission. It also questioned my reasons for directing a very large proportion of my firm’s business to one insurer, as it noted that most IFAs spread their business between a number of providers.
Hence this article, in which I will outline and briefly discuss my answers to the regulator, which were accepted although only after a visit by FSA authorisation and technical staff to Sheffield and a request for a return visit by me to Canary Wharf. These answers are likely to be of interest to many IFAs with regard to other classes of business as well as pension transfers.
How can a transfer from one personal pension to another be justified or, for that matter, from an occupational money-purchase scheme to a personal pension?
Let us start with thoughts about charges although, in practice, I find this is not usually the main reason for a transfer. Many people believe that charges levied by product providers on personal pensions have fallen over the last decade or so. Perhaps they have but, on closer investigation, I would suggest that, for the most part, this has taken the form of a change of emphasis from higher up-front charges (nil allocation period or the use of higher charges on units allocated in an initial period) to a more even level of charges throughout the term of the contract, usually accompanied by an early exit penalty.
The level of charges on an annual basis has changed relatively little or, indeed, has risen where the client makes use of a range of focused funds from the provider.
Here, I would suggest that the regulator’s line of questioning, which assumed there would be a one-off loss to the client during a transfer, overlooked this fundamental change in charging structures – no one-off charge to the client but frequently an increase in annual charges where a structured portfolio is recommended.
“But why should the client incur this higher level of charges under the new policy?” the line of questioning continued.
Regular readers of my articles will perhaps guess my answers – historical poor performance by some pension funds on the one hand and the benefit of asset allocation between good performing funds within the new product recommendation on the other hand.
Dealing with the first issue – the historical poor performance of a client’s existing policy – the FSA prompted me with the suggestion that “past performance is not a guide…” and all that. Perhaps so, but I reminded the regulator of research from a few years ago.
You may or may not be aware that the Investment Managers Association commissioned research into the degree by which funds which performed well in their sector in one year were likely to also perform well in the following year or years. In a nutshell, the IMA’s research found a weighted statistical probability that a good performing fund in one year would remain a good performing fund in the following years.
In this respect, past performance can indeed be a guide to the future. Even more pertinently, this research showed that there was an even stronger probability that a poor performing fund in one year was likely to demonstrate poor performance in the following year.
Note that all these comments relate to a fund’s performance against its peers in the same investment sector. The implications of this research were that perhaps the regulator should amend this particular client warning from “not a guide to the future” to “probably a guide to the future” or, at the very least, “possibly a guide to the future”. Not a very fashionable suggestion, I know, but a valid one.
Anyhow, following this IMA research, the FSA commissioned its own independent research to verify or challenge the IMA’s findings. In fact, this second research reached the same overall conclusions although stressing more strongly that poor performance in one year is a stronger indicator of continued future poor performance than good performance in one year is an indicator of good performance in future years, if you get the point.
Supported by these two reports – one from the regulator itself – I felt that, in a significant number of cases, the poor investment performance of a client’s existing pension fund could be used as an indicator as to expected future performance.
Care has to be taken where a client’s existing provider has experienced poor performance in the client’s previously selected fund but gives the option to switch into more competitive funds. This possible course of action – switching funds within the existing policy rather than transferring to a new provider – should then be set in the context of asset allocation.
Regular readers will know that I am a great believer that appropriate asset allocation can mitigate downside risk while still maintaining potential investment returns or increasing potential investment returns while maintaining an acceptable level of risk. Where my firm recommends a transfer, an integral part of our recommendation is a range of funds driven first by asset allocation.
Almost all my firm’s recommendations consist of a significant proportion of equity-based funds, commercial property funds and fixed-interest funds, sometimes with a proportion towards cash where appropriate. Not incidentally, this strategy has outperformed the average managed fund (which, as we know, is largely an equity fund in semi-disguise) in almost every single month over the last three years.
This means that a preferred pension provider must give cost-effective access to strong funds in the key sectors. These are, of course, the equity sector (this is normally possible from most providers nowadays but is by no means always the case with existing policies), the fixed-interest sector (not quite so obviously the case) and the commercial property fund sector (much more difficult as relatively few funds in the sector appeal to my research results).
To summarise this week’s article, money-purchase transfers can often be justified on the grounds of poor past performance and a well-thought-out future strategy using strong investment funds. More reasons in my next article.