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

The news last week that the £178 (€216) billion UK Local Government Pension Scheme is proposing to switch to passively managed funds brought up big numbers in the headlines – it comprises 89 smaller pension pots, is one of the biggest pension funds in the EU and a switch to passives would save an estimated £660 million per year.

But the real question is whether these proposals are a catalyst to change in the wider industry, across both private and public sector pension schemes. With the arrival of UK government legislation of a management fee cap on certain pension schemes at 0.75 percent, fund managers will be further encouraged to focus on low cost options. However, some critics say the process is slow moving and recent headlines are unlikely to transform the asset management sector.

Significant savings in passives

The road ahead is certainly long. According to the World Pensions Council, pension funds in the northern hemisphere only allocate around 12 percent on average to passive mandates and ETFs, which represents roughly 15 percent of their average allocation to equity and fixed income.

But it is evident that passive funds equal significant savings. The UK Local Government Pension Scheme is estimated to save £230 million per year in investment fees and £190 million in transaction costs by investing in passive bonds and equities.

The review came about after a commissioned report by pension consultants Hymans Robertson found that the £178 billion pension pot was underperforming in the longer term, and that switching to passives would not harm performance.

It also found that savings associated with passive fund management can be achieved quickly, within one to two years. The switch would cost £215 million; roughly equal to the savings achieved from reduced turnover costs in just one year. In fact, if all of the pension scheme’s equities had been managed passively in the financial year 2012-13, the taxpayer could have been spared £190 million of turnover costs.

In the public sector, all these costs are borne by the taxpayer.

Hymans Robertson looked abroad for backup. In the US, equity returns in defined benefit pension scheme funds are mostly explained by market movements and asset allocation policy, with active management “playing no role”.

Ros Altmann, pension policy expert and a former UK government advisor, said the findings push the public towards passives and the pension trustees have concluded that active management is “not worth paying for”.

“Indeed, the decision assumes significant cost savings just from moving to passive management,” she said.

This is not the first pension overhaul in the UK’s public sector: last year London’s local councils, which manage around £20 billion, moved to pool funds and reduce investment and administrative costs.

This is happening on a global scale. Japan’s Government Pension Fund introduced passive, smart beta funds last month to improve performance.

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Europe Blog

Robin Powell

Their empire remains strong yet they have weak competition, charge high fees and don’t produce the desired returns