The £117bn left in ‘Failing’ Pension Funds
Penguin Wealth’s website, increaseyourpension.co.uk talked to the Times this month about our research on ‘failing’ pension funds. The findings are quite shocking! Here is the article…
Four million UK savers will lose thousands from their pensions because their hard-earned money is languishing in giant underperforming funds. These £1 billion-plus funds are effectively shrinking people’s pension pots by producing very low returns, leaving millions facing a less comfortable retirement, according to a report.
Increaseyourpension, the online retirement savings specialist, singles out 34 giant funds, worth a total of £117 billion, which have been serial poor performers — and many are run by some of the most famous names in the pensions industry.
Craig Palfrey, of Increase your pension, says: “What the report shows is that millions of ordinary pension savers are putting their money into funds that have proved to be serial failures yet are notching up millions of pounds in juicy fees. If you take a poor-performing fund worth £3 billion then, assuming an average holding per person of £30,000 — an industry estimate — that would mean it was held by about 100,000 individuals. With a typical annual fee of 1 per cent the fund group would be receiving an annual income of £30 million — a huge reward for producing little of value.”
The disclosure comes as the chancellor prepares another raid on pension tax reliefs in the budget on March 16. He has already made cuts to the annual and lifetime allowances, which take effect on April 6.
These consistently disappointing funds made up just over one third of the 90 giant funds studied in the research. A further 45 were classed as borderline, registering barely average performance, while only 11 — less than one in eight — were rated good. The message from the report’s authors is: you need to check whether your fund is a consistently poor performer and, if so, whether now might be the time to switch to one with better prospects of delivering good returns.
If you stand to be hit by the new restrictions on pension tax relief you should also be checking whether you are making the most of your existing contributions allowances.
The report findings
The authors looked at the funds’ track records over the past five years. For each of those five years they gave a score from one to four, depending on which quartile of its sector a fund was ranked in. A fund that was consistently first quartile over the five years would score the top mark of five, while a fund that was always fourth quartile would score 20 — the worst mark. Any fund scoring 13 or more was ranked poor.
Scottish Equitable, now owned by Aegon, had seven funds rated “poor”. Aviva and Friends Life, now merged as one company, had six, BlackRock had four and Standard Life and Scottish Widows each had three.
At the other end of the scale, of the 11 funds ranked “good”, BlackRock had four and Standard Life three. Zurich and Scottish Widows had one each.
The three funds with the lowest score of 18 were Scottish Equitable Global, Zurich Equity and Scottish Equitable Balanced Passive. They returned 32.3 per cent, 31.4 per cent and 26.2 per cent respectively over five years.
The difference between investing in a poor-performing fund and a good one can make a huge difference to your standard of living in retirement. For example, while the Scottish Equitable Global fund produced an average return of 6.3 per cent a year for the past five years, the rival Baillie Gifford Global Alpha fund returned 12.1 per cent.
While the Scottish Equitable fund produced an overall return of 32.3 per cent over the five years, the Baillie Gifford fund returned 74.1 per cent. This kind of difference compounded over the lifetime of a pension can easily amount to a very sizeable sum.
Why is this happening?
On the savers’ side many people simply entrust their money to a large insurance company with a reassuring brand name and imagine that, because it is large and well known, it will manage their money effectively. Sadly this is often not the case and ordinary investors are paying for big companies’ failure to scrutinise performance.
The report’s authors describe it as “the phenomenon of inertia” among customers and note that it is not unique to the pensions industry. Bank customers who receive poor service and savers who get woefully low rates of interest have shown themselves equally reluctant to switch to better-performing financial groups.
On the insurers’ side the report says many financial groups appear to devote a disproportionate amount of time to the question of how they sell their services to investors.
The authors observe: “Companies are more likely to build multibillion-pound funds if they get their distribution strategy right than if they get their investment management right.”
Patrick Connolly, of Chase de Vere, the independent financial adviser, adds: “In some cases pension funds that grew big because they delivered good returns find that their style goes out of favour or the managers can’t handle the extra money that success draws in.
“But a more common reason for poor performance is that these funds have either been promoted by the banks or are the in-house funds offered by pension companies. If you started your pension some time ago this is especially likely to be the case, because there was much less choice then.”
Why financial groups favour big funds
The rewards for building giant funds speak for themselves. A company managing a £1 billion fund is going to receive roughly ten times as much in fees as one running a fund containing £100 million.
Yet economies of scale mean that the actual costs of running the larger fund are nowhere near ten times as high. Once basic costs are accounted for, much of any extra income flows straight through to the bottom line. So by growing a bigger pension fund, a financial group creates much greater profitability, which of course then grows exponentially, and the outlay is much the same.
Do smaller funds fare any better?
If large funds have mostly delivered poor or mediocre returns to investors, you might think that smaller funds would have a better track record. Unfortunately they don’t, according to the report’s authors. They say: “We scanned the wider pensions market to assess the performance of all funds, regardless of their size. What we found, to our astonishment, was that about 75 to 80 per cent of all funds fail to perform at an adequate level.”
They say that their research reflects other studies which show that actively managed funds (of all sizes) tend to produce lower returns, on average, than market indices, reflecting, among other things, the impact of fund charges on returns.
This is especially true of pension funds, where the negative effect of charges compounds over a long time to great sums.
They add: “We recognise that there are some very good active funds out there. What we are saying is that it makes no sense for active funds — especially very large active funds — to charge hefty fees for below average performance.”
The industry’s response
An Aegon spokesman says: “We have made a number of changes to the management of these funds, and are seeing these improvements reflected in three-year performance figures. We will continue to monitor these funds and believe they can deliver good longterm returns.”
Aviva says: “We constantly review the performance of all our funds, on all our platforms, and take immediate, proactive steps to address any emerging concerns in order to protect our customers’ investments.”
BlackRock says: “Three of the four BlackRock funds highlighted are index-tracking funds. They are designed to mirror the returns of an index, which they have done. To compare them favourably or unfavourably with a sector average which includes active fund managers may confuse investors.”
Scottish Widows says: “Two of the funds highlighted are index trackers and have been successful in closely tracking their benchmark index, which is their primary objective.”
Standard Life says: “We agree that pension investments should be regularly reviewed, however this should be in the context of all relevant information and appropriate financial advice should be sought.”
Zurich says: “The Zurich Equity Fund has performed favourably over the past five years. We work closely with fund managers to get the best possible value for our customers. At the same time, we are happy to see another of our funds ranked highly.”
What can investors do?
You should review the performance of your pension funds and consider switching if you find any serial underperformers. Craig Palfrey, of Increaseyour pension, says: “ The performance gap can be dramatic and could, if continued into your 60s, make a huge difference to your lifestyle in retirement.”
He took two people aged 40, with pension pots of the same value — £40,000 — and examined how large they would grow if one was generating returns of 3 per cent per year while the other produced 6 per cent. By age 50 the fund with the lower returns would have grown to £53,756 while the higher return fund would be worth £71,633. By age 60 the two funds would have grown to £72,244 and £128,285 respectively — a gap of more than £56,000.
He says: “We offer a free review of your pension funds at increaseyourpension.co.uk and people can also view our report on our website.” Other advisers also offer free reviews.
Connolly says one possibility is to see if your existing pension company has some better funds to switch into. “If not, you may have to switch to another pension product and you should check whether there are any penalties involved in doing so.
“If you move out of your existing pension you will have to set up either a new personal pension or self-invested personal pension [Sipp] into which you can place your new funds. You would then have to pick your funds. Those who are confident enough could do this themselves, possibly using a fund platform, many of which provide a lot of information and fund research. If you don’t feel confident enough to do this then you should consult a financial adviser.”
Justin Modray, of Candidfinancialadvice, says: “ Those with occupational pensions will almost certainly find that their employers will not contribute to funds that lie outside the company’s own scheme. If you do create your own pension portfolio it makes sense to hold a selection of funds across different investment types to avoid being overly exposed to any one area.”
Experts picks for pension funds
Justin Modray, of Candid financial advice, the online adviser, suggests CF Woodford Equity Income, Fundsmith Equity and Vanguard FTSE Developed World ex UK Index.
He says: “The Vanguard fund is a cheap way to get global stock-market exposure and a good ‘buy and hold’ fund you shouldn’t have to worry about monitoring too closely.
“Neil Woodford has proved to be a safe pair of hands, making his fund a good long-term bet. Income can be reinvested to boost growth prospects.
“Fundsmith’s Terry Smith comes from the Warren Buffett ‘buy and hold’ school of thought. That is: buy well-run companies with good longterm growth prospects then
sit back and wait. This could nicely complement a tracker fund.”
Iain Scouller, of Stifel, the stockbroker, picks three investment trusts. He says: “Foreign & Colonial has been a solid long-term performer. It invests in more than 500 companies in 35 countries.
“Witan invests internationally and has delivered good returns this year.
“Caledonia Investments takes a very long-term investment view. About 30 per cent of the portfolio is in unquoted companies — this segment has delivered some good profits.”
DOWNLOAD OUR RESEARCH REPORT ON PENSION FUNDS HERE