The perfect blend
Unsurprisingly fund managers argue that additional investment sophistication, and indeed higher charges, can make all the difference to the member’s saving experience. Many of todays’ strategies focus on risk management and limiting volatility using diversified growth funds (DGFs) and target date funds (TDFs).
However, fund managers are still beholden to the typical 50bps fee threshold, so they blend cheaper passive global equity strategies with pricier DGFs to achieve a more predictable outcome.
Andy Cheseldine, partner at consultancy Lane Clark and Peacock, points to the Blackrock ALMA diversified growth fund, which is included in the government’s National Employment Savings Trust (NEST) default TDF. “Only a small proportion of the target date fund goes into the Blackrock DGF; the rest will be in passive global equities or passive bonds. They construct the investment strategy by looking at areas where asset allocation is most important and where active fund management more important and spending the cost budget there,” Cheseldine says.
For example, few managers believe they can outperform UK equities so this portion is run passively and at low cost. In the emerging markets, on the other hand, active management may be more effective and therefore worth paying for. However, the active proportion makes up a small amount of the overall fund and therefore keeps total charges low.
As with the NEST/Blackrock example, AllianceBernstein uses a passively managed component alongside a ‘proactively and dynamically managed’ strategic asset allocation.
“Clients and prospects have been told that TDFs are expensive but when you look at solutions that are 30 basis points or less I don’t think we can call that expensive,” Banks says. “The rationale is simple; if 80 to 90% of the risk and return comes from asset allocation then that is where you should spend the cost budget.”
NEST chief investment officer Mark Fawcett says fees are one of the key factors when looking at more sophisticated strategies.
“The fee structures have got to be fair. I struggle to pay a management fee on cash which hasn’t been invested, just committed, and then a high performance fee on top of that,” he says. “Ultimately whenever we are paying management fees we have to be really conscious that, that is being taken out of members’ pots, and therefore we have got to believe we are getting good value for that. Accounting for performance fees is challenging in DC, so hedge funds and private equity are a lot harder for us than listed equities. But at the same time you would have said that about infrastructure two years ago, but we have now got the realistic possibility of an infrastructure fund with no performance fee, a relatively low management fee.”
While members and employers may be unwilling to pay much above 0.5% for investment sophistication, the future cost of DC could rise as members make more demands for guarantees. Since downside protection does not come cheap members might see fees creeping back towards 1%. However, Cheseldine warns that although guarantees can look attractive they might not be worth the money.
He says: “If [a fund manager] offers a choice between a 0.5% AMC without a guarantee or a 0.9% AMC but with a guarantee or promise, lots of people will go for the second option even though it may not be good value.”
Stephen Bowles, head of DC at Schroders, anticipates a spectrum of fees along which different types of product and solution will sit. Consumers can then select the best option and corresponding fee structure for them.
“Certain schemes will be prepared to pay more in fees than others and we are seeing that already in aspects of DC. You could pay 75bps but I am not sure if that is reflective of a better solution. It’s more about where on that spectrum you want to sit and what you want to achieve,” Bowles says.
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