It never ceases to amaze me the number of final salary pension schemes I still come across that use a pooled ‘managed fund’ as their investment medium.
It’s undoubtedly very easy to select one of these as a significant number exist and they represent an understandable home for clients in money purchase pension schemes who want to delegate their investment decisions to a specialist and achieve some form of asset class diversity in their portfolio. The managed fund will give them that and providing there is some form of protection in the form of ‘lifestyling’ to reduce risk as individuals approach retirement and the level of risk exposure in the managed fund is clearly identified it represents a simple solution.
In defined benefit schemes however such an approach seems to represent the worst of all possible worlds. You have an investment approach which reflects the risk attitude and approach of a fund manager which may be completely inconsistent with the liabilities held under the scheme and potentially at odds with the views and requirements of the scheme trustees. The asset classes held will bear no relation to the scheme specific liabilities held under the scheme. It is also impossible to switch monies out of specific sectors taking in to account market conditions.
Not only that, but many of these actively managed funds provide returns consistently below those which would be achieved by a passive manager at a significantly reduced cost.
These are the main reasons why so many schemes have moved to investing in individual asset classes, using specialist houses to manage these assets and to expand in to wider asset areas.
To date I haven’t been able to identify any other ways to get money in to pension scheme than via contributions or investment return. In simple terms if your investment return is poor and/or the expenses paid to achieve it high then any shortfall will be made up with increased contributions. This is a hidden cost to the scheme but one every bit as real as the direct level of fees levied but it is all too easily missed. Annual investment charges could easily range from 0.2% to 2% which on a £5m fund is a difference of £90,000. Factoring in underperformance of only 1% would equate to another £50,000. It could be pretty difficult to make administrative cost savings to this extent within any other area of the scheme.
Trustees need to be very aware of the risks they are taking and the associated costs. At a time when there is a strong focus on cost saving throughout the market this is an area which is worthy of greater focus.