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UK Govt Leading Way For Pensions Using Passives
By Rachael Revesz | 07 May, 2014


New cost cap encourages low cost options

But why this rush to lower costs in the UK this year?

In April UK pensions minister Steve Webb introduced a management cost cap for defined benefit pension schemes of 0.75 percent. This will apply to any scheme that an employer chooses for his employees – known as auto enrolment – and will come into effect in April 2015.

Consultant Altmann said it is likely that the annual management charge (AMC) cap will drive the market towards passive management.

“There is likely to be further downward pressure after 2017, but in the meanwhile the DWP [Department for Work and Pensions] is reviewing the various charges with a view to capping more than just the AMC.

Auto enrolment started in October 2012 and has still to include smaller employers, but it is gaining ground and according to Adrian Boulding, L&G’s pension strategy director, only about 10 percent of employees have opted out of the scheme.

Many providers have already scrambled to make way for the change, while some providers already have it sorted. Legal & General announced in its first quarter results this week that it charges 0.5 percent for its pension scheme.

L&G’s Boulding said he advocates a tighter cap of 0.5 percent, something which the Labour government has declared it would support.

“We will see more pension schemes moving to a core and satellite approach with a core of passive index tracking funds and supplementing by a small number of specialist active funds where it makes sense for certain niches to operate more efficiently,” he said.

An era of austerity and low yield

Another reason for the rush to low costs is the world of austerity and low yield that we live in today, according to Nicolas Firzli, director general of the World Pensions Council. He said management fees were not seen as so important during the era of high returns between 1980 and 2007.

“[The auto-enrolment cap is] part of a much broader, deeper, move towards more “low-cost” retirement benefits across the board,” he said.

It is true that recent government-led changes in the pension schemes that our employers pick for us, or ones that financial advisors study on behalf of their clients, means that an increased focus on cost is on the cards. This does tend to swing in favour of passive management as we have seen with the UK Local Government Pension pot.

However, those proposals do not advocate switching 100 percent to passive management. They state that for asset classes like property, infrastructure or private equity, they could continue to be managed actively through a separate common investment vehicle.

The World Pensions Council’s Firzli said pension funds are increasingly adopting this strategy for extra returns. Sophisticated US and Canadian pension funds CIOs know that active asset allocation and the measured inclusion of alternative assets such as private equity, infrastructure investments, property and hedge funds could yield substantially higher returns than intra-asset class “stock picking” or “investment style”,” said Firzli.

At November’s conference several industry experts argued why pension funds won't allocate 90 percent to passives, as people still believe that active and intelligent managers can make profitable decisions, and we are still ruled by investment consultants who might not be overly familiar with passive funds.

Indeed, the UK Local Government Pension Scheme proposals contain four options for the public to consider, including: all holdings to be in passive funds; requiring the scheme to allocate a certain percentage to passive; and adopting a “comply or explain” approach where the scheme can choose an active manager but must justify the reasons behind it.

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