Charge disclosure or ESG considerations, which is more important?
Dale Critchley looks at what trustees should consider.
Trustees find themselves having to make two big changes to their scheme reporting this year. Their Chair’s Statement has to include details of all charges and the scheme’s statement of investment principles (SIP) needs to be updated to include how Trustees have incorporated ESG considerations. Both have to be posted online, within 7 months of the scheme year end for the Chair’s Statement and by 1st October for the SIP. Meanwhile, the FCA are consulting on whether Independent Governance Committees (IGCs) should have broadly similar responsibilities.
My guess is that few members will follow the signposting in their benefit statements and access this information, but it provides for cost effective oversight by the Regulator, and ensures Trustees give both of these aspects due consideration.
The focus on charges is nothing new. Auto-enrolment pension schemes are capped at 0.75%, although the market, and improved governance, has driven average charges much lower than this.
On the face of it this is great news for members, but there are downsides to the almost relentless focus on cost. A race to the bottom has resulted in providers being squeezed for every 0.01% discount but few schemes are seizing the opportunity to include more costly investments in pursuit of the prospect for higher, and more diversified source of, returns. Even where provider charges are very low there’s still a focus on low priced passive funds, with advisers and trustees happy to bank the discount rather than use the headroom within the charge cap to seek higher net, real returns.
It’s easy to see why there’s a focus on charges, it’s a more definite article, which means it’s easier to evidence. It won’t be long until we see someone publish a league table with the ‘winner’ being the scheme with the lowest charge.
The winner should be the scheme with the highest sustainable net return. It’s much more difficult to measure but that’s what the focus on environmental, social and governance (ESG) factors is trying to achieve. Charges, especially in default funds, where transaction charges are microscopic, have reached the point where the law of diminishing returns is well and truly established. When the total charge is 0.5% you can’t achieve a huge increase in growth by hammering charges. To make a real difference to outcomes governance bodies have to look at contribution levels and real investment returns.
The new regulations around ESG considerations are designed to encourage Trustees (and potentially IGCs) to think long term, and ultimately drive better returns for members, by investing in those companies that can adapt and respond to the risks posed, and opportunities created, by issues such as climate change, labour standards and corporate behaviour. These additional returns aren’t guaranteed, but they aren’t capped either.
A reduction in annual management charge from 0.5% to 0.3% might deliver an additional 5% in pension benefits for a 22 year old retiring at age 68 . In contrast, a 1% increase in investment returns could provide a 30% uplift to our 22 year old’s retirement pot, given the same initial assumptions.
Both new requirements are important, as what matters are returns net of charges. But like most things in life it’s not the easy bit that will deliver the biggest benefit. If trustees are looking to allocate their time based on the potential benefit to members they’d do well to prioritise their time on ESG considerations and how they can enhance long term investment performance, as this is where the potential to make a real difference truly lies.
Dale Critchley, Policy Manager for Workplace Savings and Retirement, is an expert commentator with over 30 years’ experience in a variety of roles within the workplace benefits market. He is an Aviva spokesperson specialising in issues relating to workplace pensions and is regularly featured in the media.