Work and Pensions CommitteeCorrespondence from Mr Peter Halligan

I thought it might be helpful to compile two “real world” worked examples of the impact of charges on the investor/pot holder (tin of beans) belonging to the investor. I attach two spread sheets with the detail of the relevant calculations of the charges and their impact on the final balance with which the investor/pot holder must buy an annuity/pension. I constructed these worksheets over the last hour or so and I urge you to get your technical staff to verify the calculations!

The first example is for an investor/pot holder with a £100,000 starting balance invested in 25% Emerging Markets Equities, 50% in Corporate bonds and 25% in Property who saves £1,000 a month (in these proportions). The time period is 10 years.

The second example is for an investor/.pot holder who invests in the same markets as the first, but starts with zero and invests £1,000 a month for 30 years.

The assumptions for the fees for investment management, IFA. platform and transaction costs, investment returns and annual change in the value of funds invested are also shown.

In the first example, the opening balance of £100,000 and contributions of £120,000 grow to c. £319,000, but charges remove c. £39,000 and the opportunity cost of charges (dropping the amount invested) removes a further c. £9,000, leaving the investor/pot holder c. £48,000 worse off. This equates to around 15% of the investo/pot holders’ money over the ten year period and an annuity/pension reduction of c. £48 a week/£2,400 a year.

In the second example, contributions of £360,000 grows to c. £840,000, but charges remove c. £159,000 and the opportunity cost of charges removes a further c. £113,000 leaving the investor/pot holder c. £271,000 worse off. This equates to around one third of the investors money over the thirty year period and an annuity/pension reduction of c. £271 a week/£13,500 a year.

The assumptions can easily be varied for an individual’s circumstances.

I recommend that a good industry standard would be that each investor is presented with a spread sheet for their own personal circumstances. I think the “Summary” worksheet would serve to highlight the impact of investment return assumptions and fees in a way that is lacking in the industry that is motivated to hide the long term implications of charges since it is the bedrock of their business models. 

I show the summary of the 30 year example for ease.

	30 year period
	Gross	Net	Variance
Opening balance	0	0	0
Contributions	360,000	360,000	0
Gross returns	480,840	368,275	-112,565
Charges	0	-158,818	-158,818
Closing balance	840,840	569,457	-271,383
Variance %	-32%	-48%

For investment managers, IFA’s and platform providers, the stakes are very high.

27 January 2013

 

I have just read the uncorrected transcript of the oral evidence presented to your committee as reported here:

http://www.publications.parliament.uk/pa/cm201213/cmselect/cmworpen/uc768-v/uc76801.htm

I have sent this to the cc email address also.

Congratulations on covering a lot of ground thus far. You are certainly giving me a lot of faith that the Committee is getting to grips with as much as it possibly can. I appreciate that you are working with a host of actors in this play. I have no vested interests other than my own personal ones. For interest, I have a self directed SIPP that invests directly in shares and pay just 0.2% on my accumulated capital in total costs. I will be moving it to flexible draw-down on my 55th birthday (28 July 2013). I also have two defined benefit pensions at Crown Agents that start paying at 60 and 65 which are both linked to RPI inflation.

I offer my quick thoughts that I hope you find constructive. Please let me know if you would rather discuss this in another way, rather than via email. I am not working at the moment, pending an (early slef provided!) retirement.

NEST

Firstly, I would like to let you know that I worked with the NEST trustees to select investment managers (bond and diversified growth funds) in the last few years of my time at Aon Hewitt and have some idea of how NEST operates.

NEST charges an all up fee to the members that includes investment management fees, custody fees and other costs for the underlying products used by the platform providers associated with investments.

Other providers exclude investment management fees, custody fees and other costs and charges for underlying investment products and, instead, these fees and charges are taken out of the unit price of underlying investment product unit prices which are only then shown net to the investor/pot holder.

Transparency and Accountability

The baked bean analogy used by Steve Webb is not quite right. The investor/pot holder buys the beans and only then has to figure out (with help) the cheapest and best way to keep them in “good” tin, supplied by a provider. The beans belong to the investor/pot holders, not the platform provider of the DC scheme. Over the course of the (potentially 50 years of contributions and 20 years in retirement) for a total of 70 years), the investor/pot holder is having beans removed from the tin by via the financial services industry. As an example, assume that the sole activity of the investor/pot holder is to buy shares in Vodafone. The investor would buy a number of shares each month, crossing a bid/offer spread, paying stamp duty and brokerage.

During the 70 years, the platform provider takes some beans out of the tin, investment managers/custodians/brokers take some beans out of the tin and then an annuity provider takes more beans out. These beans do not belong to anyone but the investor. It is the number of beans put in and the number of beans taken out that needs to be “transparent”.

Q325 from Glenda Jackson highlights the crux of the matter and hence, my proposal that the GROSS return (before all investment management fees and charges AND platform fees) is shown to the investor/pension pot holder with a reconciliation of charges to the NET return as his (currently non-taxable) investment earnings.

Q326 from Graham Evans started with a very good point. Economies of scale are not being passed on either at the fund manager level or the platform level. It is one of the disappointments of my career that my peers in the fund management industry simply seek to make more money rather than reducing their fees as technology has lowered the cost of doing business by a huge factor.

I confess I had not factored investment advisory fees into the spread sheet I sent you, mainly because I would have thought that IFA’s can only provide the most generic advice that is better provided by a quality standard. More exiting beans! From Q334. I also did not factor in transaction costs by the investment manager, whether these are bid/offer spreads when dealing in shares, bonds, commodities or FX or stamp duty or transaction brokerage. I seem to recall that the Turner report had something to say on this matter. These (beans?) should be very small for passive stock market index matching products (that mirror, say, the MSCI Global Equity Index) and can be very high for actively traded products like Standard Life GARS.

As far as I know, investment management transaction costs ARE ALWAYS EXCLUDED from fee caps, including NEST. These brokerage costs ARE IN ADDITION to the investor/pot holder costs of buying or selling units in investment managers’ products that they have invested in.

I would point out that different (large) platform providers negotiate different management fees for the same investment products with the supplier (investment manager) of that product.

I remain of the view that the detail of (a) and (b) below should be available to each investor/pot holder or should be shown for representative investors (eg 30 year old with five years savings of £10,000 or 40 year old with 15 years savings and £30,000 etc).

(a)Gross investment management product returns (already supplied by investment managers as standard) less investment management fees and other investment related expenses like custody costs, legal fees and administration fees PLUS, platform fees and costs, (plus brokerage and stamp duty paid on transaction within the product).

(b)Platform fees and costs, bid/offer unit price spread costs as a percentage of investor/pot-holder contributions (plus IFA fees and other consultancy charges).

Portability

I agree that the pot should follow the investor/pot holder upon migration to another platform, provided that THE POT DOES NOT BELONG TO THE PLATFORM PROVIDER. There should be no requirement to cash up your investment manager product when all you want to do is lock in a better deal on another platform. If a platform providers “badged” product has previously been used, you have a whole can of worms to unravel in the form of much higher “switching” charges as shown in both (a) and (b) above.

I consider that the key is that PLATFORM PROVIDER products must be allowed to be “unbundled” (beyond an economic threshold of £2,000?) into the constituent investment manager products and delivered to the new provider. This implies a new quality standard for the industry. To do this you need “authorised investment manager products” that must be handled by all “authorised platform providers” (including NEST). Additionally, this will go some way to avoiding the higher charges for smaller amounts that cashing up and reinvesting smaller pots will otherwise incur.

I happen to believe that NEST is the natural repository of small amounts. Perhaps the amount is £2,000 and up; I don’t recall the current statutory number where smaller amounts can be paid out in cash on retirement.

Pensions and Annuities

I use a rule of thumb that says each £1,000 saved results in a pound a week of pension (£1,000 x 5% = £50 a year or around £1 a week). This money is very important for those on lower incomes.

I note that the costs to the pot holder/investor of the annuity (equal to the profit made by the insurance company in providing the annuity) were not addressed at this meeting. I am rapidly coming to the conclusion that we need a Government provider to de-NEST!

25 January 2013

 

I am writing to you in your capacity as Chair of the Works and Pensions Committee. I apologise for the email address and the direct approach.

By way of introduction and background, I am a 54 year old male of independent means who has spent more than 35 years in the investment industry as an investment manager, stockbroker, trader, consultant and, for five years until August 2012, I was employed (CF30—FSA designation) by Aon Hewitt as a researcher of fund managers of (mainly) DB pension schemes. In this capacity, I advised pension fund trustees about investment performance, pension fund liability matching and negotiated investment fees for global fund managers such as Blackrock, Goldman Sachs, M&G Investments, Aviva, Royal London Asset Management and Insight Investments, to name but a few.

I note that you will be meeting again on 14 January 2013 to discuss Governance and Best Practice in Work Place Pension Provision.

I have been looking through the 400 pages of written evidence submitted to your committee (including that from Kevin Wesbroom of Aon Hewitt) and I make the following observations.

There is no attempt by those submitting evidence to you, to quantify the total amount of likely charges and expenses of all sorts taken over the course of the accumulation of contributions to DC pension schemes, neither is there a representation of the cost to the individual of the annuity provided.

It would be good (as is done by the news media for the implications of the budget on changes to taxation) for, say, six representative contributors who accumulate pension pots of, for example, £10,000, £50,000, £100,000, £250,000 and £500,000.

Charges and expenses are persistent and make up a substantial reduction of the pot available to the investor and the pension annuity, compared to the size of the pot were the investor to self-direct his investments in a SIPP for example.

By way of illustration, I attach a spread sheet that shows the accumulation of 45 years of contributions for an individual with a starting age of 25, salary of 25,000 (appreciating at inflation of 2% with no promotions) and a net investment return of 4% per annum, who lives for 25 years in retirement.

I have several points that I think are releant to your Committee.

1.There is no written evidence submitted to you that showed “Gross Investment Returns” earned by the contributor, only “Net Investment Returns”. Gross Investment Returns are defined as the investment return earned before management fees, custodian fees and administration expenses of the investment vehicles(s) used by the DC scheme member. It is not possible to view the costs to the scheme member without sight of both of these items. It is true that if the investment return is high, it matters less, but it still matters since this highlights the risks taken. For example, an 8% gross return has a risk of around 16%, whilst the implication of a 5% net return is a risk of only 10%.

2.There is no total cost over the full period of the DC plan expressed as a percentage of contributions made. On the spread sheet, I show that a 4% p.a. net return to an investor would result in a final pension pot of £182,899. However, were the scheme member to earn the gross return of 5% p.a., the final pension pot would be £237,378. The difference represents a cost to the scheme member of £54,479 over the 45 years of contributions which, in turn, represents around 19% of the value of contributions made.

3.There is no representation of the cost to the scheme member of the provision of an annuity. If you assume the same net investment return of 4% p.a. during retirement, the annual drawdown (cost free annuity) that would result in a zero balance at death at age 95 (25 years post 70), is an amount of £11,484 per annum. Annuity provider’s rates are generally around 5% per annum, resulting in an annuity of £9,150 per annum and a cost to the scheme member of £2,334 per annum and £58,362 over the 25 year life of the annuity. This £58,362 represents 79% of the value of the contributions made over 45 years.

In short, I estimate that the cost to this “example DC scheme member” are around £50,000 during the pension pot accumulation process and £60,000 during the decumulation process. I do not think that you are being provided with this evidence and I respectfully submit it to you for consideration.

10 January 2013

		year 1	year 2	year 3	year 4	year 5	year 6	year 7	year 8	year 9	year 10
	opening balance	0	-2,358	-5,159	-8,439	-12,233	-16,580	-21,519	-27,096	-33,356	-40,349	-
25.0%	em equities	0	-759	-1,681	-2,781	-4,078	-5,589	-7,334	-9,335	-11,615	-14,199
50.0%	corp bonds	0	-958	-2,081	-3,380	-4,866	-6,548	-8,439	-10,550	-12,894	-15,484
25.0%	property	0	-641	-1,398	-2,278	-3,290	-4,443	-5,747	-7,211	-8,847	-10,666
	check total	0	-2,358	-5,159	-8,439	-12,233	-16,580	-21,519	-27,096	-33,356	-40,349
	average balance
	em equities	0	-759	-1,681	-2,781	-4,078	-5,589	-7,334	-9,335	-11,615	-14,199
	corp bonds	0	-958	-2,081	-3,380	-4,866	-6,548	-8,439	-10,550	-12,894	-15,484
	property	0	-641	-1,398	-2,278	-3,290	-4,443	-5,747	-7,211	-8,847	-10,666
	check total	0	-2,358	-5,159	-8,439	-12,233	-16,580	-21,519	-27,096	-33,356	-40,349
	returns p.a
7.0%	em equities	0	-53	-118	-195	-285	-391	-513	-653	-813	-994	-4,016
4.0%	corp bonds	0	-38	-83	-135	-195	-262	-338	-422	-516	-619	-2,608
5.0%	property	0	-32	-70	-114	-164	-222	-287	-361	-442	-533	-2,226
	total	0	-123	-271	-444	-645	-875	-1,138	-1,436	-1,771	-2,147	-8,850
	gross closing balance
	em equities	0	-812	-1,798	-2,976	-4,363	-5,980	-7,847	-9,988	-12,428	-15,193
	corp bonds	0	-996	-2,164	-3,515	-5,060	-6,810	-8,777	-10,972	-13,410	-16,103
	property	0	-673	-1,468	-2,392	-3,454	-4,665	-6,034	-7,572	-9,290	-11,200
	total	0	-2,481	-5,430	-8,883	-12,878	-17,455	-22,658	-28,532	-35,127	-42,495
									final year costs		-5,632
									final year balance		-48,128
							difference between gross and net				-48,128

	30 year period
	Gross	Net	Variance
Opening balance	0	0	0
Contributions	360,000	360,000	0
Gross returns	480,840	368,275	-112,565
Charges	0	-158,818	-158,818
Closing balance	840,840	569,457	-271,383
Variance %	-32%	-48%
Average 30Y balance	309,043	239,913	-69,129