“If that cap drops to 50bps,” says Henderson, “there will only be 15 basis points to play with, meaning passive only, and what will be the outcome for members?”
GOOD AND CHEAP?
The simple fact is, there are three tiers within DC defaults. At the top end is active allocation and active asset classes which will be priced at 60 to 90bps. Schemes therefore cannot use these solely as defaults, especially if member record-keeping is paid for by the members at a cost of 10 to 15bps. This means selling out of DGFs, going 50/50 with a lower tier or step-down product (something designed to look like a flagship fund but cheaper – and effectively a lower tier product).
That next tier is active asset allocation with passive management, at a cost of 46 to 60bps, and lastly passive allocation and passive management for 25 to 40bps.
All are trying to do different things but the value for money varies. “The third tier of passive/passive is the hardest to criticise on fees, and you can see you’re getting diversity, but it does not access as much skill,” says Nico Aspinall, head of UK DC investment consulting at Towers Watson. “If you can’t afford DGF at 75bps and are forced to move to 30bps, you have to ask yourself if you have halved the risk-adjusted return. The answer is probably yes and though it may not be harmful, it will leave DC further behind DB.”
Chinnery agrees, for while the passive offerings will give some diversification and come in under the price cap, they will deliver a higher dispersion of returns, he says.
Lustig puts it somewhat more colourfully: “Static asset allocation/passive is really cheap, but you are compromising on quality. If you pay peanuts, you get monkeys.”
THINGS MUST CHANGE
The charge cap may not inhibit only returns, but innovation, until there is certainty about where it will remain.
Kapur fears talk of moving towards defaults of passive fixed weight allocation as it is “inferior and backward-looking instead of forwards-looking and analytical”. He says trustees should reassess their approach to asset allocation, to focus not on general returns alone, but risk measurement too.
Trustees must consider what the fund is trying to achieve and realise they cannot consider it as a 40-year time horizon, as they might with DB. Any future reduction of the cap could have major consequences for scheme members, says Henderson.
“Equities are at an all-time high and interest rates are at an all-time low. We live in a time of real extremes,” he says.
How do schemes square that circle and can they pay for relative market trades instead of only taking beta? “It’s no problem with 35bps, we can work with that,” says Henderson, “but 50bps would mean a move back towards balanced funds.”
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