Britain cracks down on DC fees

When Britain’s former economic watchdog, the Office of Fair Trading, published a report in 2013 about the country’s workplace defined contribution pension market, it was the latest call in the country’s ongoing conversation about pension governance and delivering value for money to plan members.

The report estimated more than 186,000 pension plans in the country were subject to an annual investment charge of more than one per cent. It set out a sobering example: a person saving 100 pounds each month for 46 years could lose almost 170,000 pounds with a one per cent charge and more than 230,000 pounds at 1.5 per cent.

Read: What can Canada learn from Britain’s pension reforms?

On the back of that report, the government’s Department for Work and Pensions launched a consultation that led to the introduction of a 0.75 per cent annual cap on investment charges in April 2015. The cap applies only to plan members invested in the default fund, which is the case for the majority of those in Britain’s defined contribution pension plans, according to Michelle Cracknell, chief executive of the country’s independent pension advice organization, the Pensions Advisory Service.

Also, much like the Canadian market, the majority of British pension plans bundle fees, so one flat rate pays for administration, communications, investments and the provider’s profit. So considering administration fees are typically about 30 or 40 basis points, there isn’t much left over for the actual investment management fees, notes Stephanie Condra, head of Canadian business at Irish Life Investment Managers Ltd. in Toronto. “And the implications of that were a lot of the money ended up going passive, right to indexed products.”

But the cap didn’t necessarily have a major impact since the majority of Britain’s default funds were already under passive management and were compliant with the limit of 75 basis points, says Calum Mackenzie, associate partner and head of central Canada investment at Aon Hewitt. “There’s already much greater use of passive investment within U.K. pension funds in comparison to Canada.”

Read: More pension plans using target-date funds as default option

Tim Gosling, the defined contribution policy lead at Britain’s Pensions and Lifetime Savings Association, notes the average charge among the organization’s members is less than 50 basis points. “We do think, though, that if you were to go much below 75 basis points, you’d start seeing much more consolidation of schemes setting up shop and transferring their assets into larger schemes.”

Industry innovation

Another consideration is the fact that since Britain’s defined contribution market is still very young, only beginning to grow significantly with the introduction of automatic enrolment in 2012, a new member’s pot size could be quite small, says Tim Banks, a principal at Mercer Global Investments in London, England. He provides the scenario of someone with an account balance of 500 pounds. “At 75 basis points, that pays the provider 3.75 pounds to spend on administration, communications, investment and profit. Now, 3.75 pounds is the price of a pint of beer in the U.K. That doesn’t leave a lot of margin to be spent on investment. It seriously impacts on providers’ ability to utilize active management where it’s appropriate in the investment default strategy.”

Britain had already seen a move towards diversified growth funds and other types of active management for plan members who are a bit further along in their investment journey and have more savings to protect, says Mackenzie, noting the fee cap did catch many of those plans, which in turn led to more innovation from both consultants and asset managers.

Read: 2015 CAP member survey: Understanding the decumulation dilemma

Consultants considered how to construct passively managed portfolios that offer expectations for risk and return that are similar to those under active management, while asset managers looked at how to build new investment products that cost just 35 to 45 basis points. “That’s been one of the big areas of innovation in the last few years — more DC-focused diversified growth funds — and we’ve seen more of the big diversified growth fund managers come out and create lower-cost vehicles,” says Mackenzie.

Lessons for Canada

Matthew Williams, head of institutional and client service at Franklin Templeton Investments Corp., doesn’t think a fee cap is necessary in Canada. Instead, he believes the better option is to move towards unbundling fees. “At the moment, you see one fee, which is the aggregate of the asset-management fee, the record-keeping fee and the advice fee. And I think, in time, if I look to where other markets are, particularly the U.S. and Australia, that may well occur here in Canada. I don’t think plan sponsors or DC plans here pay higher fees but I think they will evolve or move to an unbundling of those fees so that plan sponsors and their members can see the different buckets of fees they’re paying.”

Read: CRM2, actions abroad put fee transparency under the microscope

But Britain’s focus on value for money, which led to a number of its pension reforms in the past few years, is also necessary in Canada, says Mackenzie. He’d also like to see a greater emphasis on determining where active management adds value. “The fees [in Canada] are broadly comparable, but I do see a lot more use of active management. The main thing that we saw [in Britain] is that the focus should be on value, rather than on cost. The other big difference was that the market had already accepted the diversified growth concept, so there was a greater use of alternatives and of indexation, and that really allowed greater value to come through. And I think that’s really the next step for Canadian DC pensions, is to start offering that choice for members.”

In the meantime, while the conversation continues in Britain, the charge cap has remained at 0.75 per cent. In November, the Department for Work and Pensions and the Financial Conduct Authority (which took over the functions of the Office of Fair Trading in 2014) carried out a review of the asset management market, including the charge cap. It found “significant progress had been made by plans with high charges, and now more than two-thirds had charges that would be lower than one per cent per annum,” says Cracknell, who adds the issue of charges hasn’t gone away completely.

Read: Canadian pension plans moving slowly but surely towards DC: survey

“The charge cap is due to be reviewed in 2017. It always excluded transactions costs, and this omission will be considered in the review. There’s a call for better disclosure of transaction costs as a minimum, and potentially being included in the cap charge if a simple and consistent method can be identified.”

Jennifer Paterson is the managing editor of Benefits Canada.

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