Turner Opportunities
1. The speech of Adair Turner to the Investment Management Association
"Turner Opportunities" seems a suitable name for "opportunities" suggested by Adair Turner, Vice President of Merrill Lynch Europe and Chairman of the Pensions Commission, in the speech which he made at the annual dinner of the Investment Management Association on 25th May. x They are rather vague at present. When they are more clearly defined I hope that "opportunities" does not turn out to be a euphemism for "products", because the financial industry views every "reform" as an opportunity to introduce new "products", that is savings contracts. After the stakeholder reforms we had stakeholder products. After the Sandler reforms we now have Sandler products.
Adair Turner seems to have in mind something similar to the Swedish Premiepensions - myndigheten (PPM) scheme, x x and to a lesser extent the proposals of George Bush in the US for retirement accounts and the new KiwiSave scheme in New Zealand.
Entrepreneurs are forever seeking new opportunities, but not pensioners. The word "opportunity" implies there is a need to do something, that is grasp the opportunity. Whereas in my opinion when it comes to pensions everyone should have to do as little as possible.
2. "improve pension saving opportunities"
The Turner Opportunities are intended to "improve pension saving opportunities" for "persons of average income or below". In the last paragraph of his speech he says:
"My overall message is clear. One of the criteria by which we should judge different policy options is how they will improve the pension saving opportunities of the person of average earnings and below."
It was the intention of stakeholder pensions to improve the saving opportunities of people of average income and below. These have been unsuccessful leading to Sandler products and an increase in the cap on charges from 1% to 1.5% for the first 10 years. Because of this lack of success, the Pensions Commission was established especially to consider compulsion rather than opportunities.
But if you are compelled to save, this can hardly be described as an "opportunity". Compulsion to save in a particular way is surely more of an opportunity for the industry than for investors. So that Turner Opportunities may turn out to be opportunities for the industry, that is members of the IMA, and investors will have enforced duties rather than opportunities.
3. "cost-efficient opportunities"
Turner Opportunities will be earnings-related:
"And the reasons why governments, including robustly free-market governments, have tended to embrace earnings-related objectives are a mix of two rationales
- First, a belief that people cannot or will not, if left entirely alone, make the long-term savings decisions which are in their self-interest.
- Second, that there is a segment of the market which will only enjoy cost-efficient opportunities to save if the state intervenes in some way or another."
"Low-cost products" has become a rather discredited term because of stakeholder pensions. The new buzzword could be "cost-efficient opportunities". In his speech to the IMA, Adair Turner discusses the second argument which is concerned with "cost-efficient opportunities": "It is on the second of the arguments that I will concentrate tonight." This suggests that he will discuss the first argument on a future occasion. The press release of the Pensions Commission, about the speech is headed:
"Cost-efficiency a vital criterion in judging pension system reform."
and in his speech Adair Turner says:
"What is striking is how different are the administrative costs involved in different types of pension provision."
This is a welcome emphasis on costs. But administrative costs are not the only kind of cost. What about the cost of the time and worry investors have to endure choosing between hundreds of almost identical funds, and following their performance like in particular members of the Swedish PPM scheme?
4. Turning their back on the market: the PPM scheme
Administration
Adair Turner mentions the possibility:
"The government acting as an efficient money collector, and bulk-buying fund management from the wholesale fund management industry. This is essentially what happens in the premium pension tier of the Swedish system."
Who is this money being collected for? Where does it go? Who looks after it? The idea that the UK government should act as a money collector for the industry is surely a non-starter. Adair Turner seems to suggest that in the case of the PPM scheme this money is looked after by the Swedish government rather than by the industry, because he says that it is "bulk-buying fund management". But individuals pay for this fund management individually.
"The government acting as an efficient money collector" is a sound general idea. But only if it then goes to institutions which can be trusted. Which are motivated to look after it rather than being chiefly interested in making money for themselves their shareholders and salesforce, by imposing charges.
Adair Turner also refers to the President George Bush proposals for retirement accounts in the US x x and the new KiwiSave scheme in New Zealand. The work in running a saving scheme can be divided into:
1) gathering in savings,
2) corresponding with unit holders,
3) keeping records of the units they possess,
4) investment.
PPM is concerned with 1), 2) and 3). It deals with the funds making bulk payments. It has existed since 1999 following legislation in 1994. So that we have a track-record, such as:
"The ten worst performing funds in the first year of the Swedish premium pension - all stock funds with a technology focus - lost a staggering 76.6% of their value." x
He describes the proposal to increase the retirement age for graduates to 70 as "unreasonable, utterly unworkable and the Pensions Commission have not spent one second considering it". Equally unreasonable is the proposal to introduce something similar to PPM, especially because there are so many funds. Contrast the website of PPM x with that of TSP. x
Charges
Adair Turner does not mention the very cost-efficient Danish ATP scheme x which has existed since 1964. This was in my submission to the Pensions Commission in January.
The PPM website says:
"PPM claims back a portion of the fees in the form of a rebate (price reduction) that fund managers extract from the funds. The size of the price reduction depends on the size of the fund's fee and PPM's total fund holding.
When PPM receives the rebate, the money is distributed to the pension savers. Since rebates are individual, the money is distributed to all pension savers that have invested in the fund from which the money comes. PPM claims back a portion of the fees in the form of a rebate (price reduction) that fund managers extract from the funds. The size of the price reduction depends on the size of the fund's fee and PPM's total fund holding. x
The size of the reduction is given by a rather complicated formula on the PPM website. x It gives an example:
"For example, in the case of a fund with a gross fee of 1.2 per cent, the personal discount is 0.20 per cent." x
"PPM's fee of 0.3% is also additional." x
In this particular example the fee is then 1+0.3 = 1.3%. So has actually increased from 1.2%. In return for 0.3% PPM has negotiated a reduction of 0.2%. Adair Turner says: "They are targeting a long-term RIY of 0.3%."
The government in this country tries from time-to-time to control the charges of savings products by caps on charges, with only limited success. PPM has a discount instead of a cap. It seems unlikely that our government will be any more successful with discounts, than it has been with caps which are preferable in some ways:
"In 2004, for example, Skandinaviska Enskilda Banken increased fees on its money-losing PPM generation funds from 0.5 to 1.2 per cent... In a system in which most account holders do not pay close attention to their accounts after making the initial selection, there is a significant temptation for fund managers to raise fees after the initial round." x
In 2003: "The average fund fee after rebate was 0.43%". x Adding the 0.3% PPM fee we obtain 0.73%. There are similar figures in x and higher numbers in. x But the latter does not take the PPM rebate into account.
Choice of funds
Requiring people to choose between a large number of funds is a choice between near identical alternatives without adequate criteria to make a choice: The PPM scheme x replaces stock and bond markets by a fund market. People do not like having to choose between the hundreds (600+) of different funds:
"Despite including a wide range of domestic and international fund choices about 85% have left their money in the default 'non-choosers' fund." x
"The problem is that more and more people are refusing to make a choice." x
The default fund is a public sector fund, the Seventh National Pension Fund (AP7). Why have a choice of funds? Perhaps because some people do not trust the public sector?
"In fact, only 8.4 percent of new enrollees pick their own portfolios, from an offering of some 600 funds. .. . Is it worth spending the extra money to offer choices? When partially privatizing U.S. Social Security, they ask, why bother to offer even three funds? Why not offer only one well-designed, low-fee index fund?" x
They have turned their back on the market. Some 90 percent of new members are choosing or defaulting into the default fund. This has comparatively low fees:
"Those who have selected their own portfolio have considerably higher fees than participants in the default." x
The default fund has had a comparatively good investment performance:
"The fund that attracted the largest market share, aside from the default, was Robur Aktiefond Contura, specializing in Swedish technology and health-care stocks, whose value soared 534.2 percent over the five years preceding the PPM launch. Three years later, however, it had lost 69.5 percent of its value. Overall the mean aggregate portfolio was down 39.6 percent after three years. The default fund, on the other hand, was down significantly less, 29.9 percent - not too terrible given that markets were falling worldwide." x
Giving people a choice of funds has thus been counter-productive. Those people who thought they were being enterprising by not just flopping into the default fund, have lost out. What is the point of the 600 + funds? Why have a market?
Professor Edward Palmer of Uppsala University gave evidence to the Select Committee on Work and Pensions. It says:
"You paint a picture of thousands of houses up and down Sweden discussing whether to invest in Japan, in South-East Asia or in America." x
Do these thousands of Swedish households appreciate the importance of hidden charges, and how they damage fund performance? Professor Palmer was a member of the Working Group perhaps responsible for PPM:
"He was an expert in the Swedish Government's Working Group on Pension Reform 1992-1994. The Working Group formulated the new Swedish pension reform passed in Parliament in 1994. Since 1994 he has been a member of the implementation group for the Swedish reform." x
He therefore does not want to criticise his own work. In addition to the country/continent/hemisphere investors have to choose a sector such as those with a "technology-focus" mentioned above, which lost 76.6% of their value in the first year:
"A significant percentage of those making an active fund choice may go for sectors which are very specialised and risky." x
In his talk to the Select Committee Professor Palmer gives 0.65% of capital as the "normal amount" of fee for administration, to which the PPM fee is added making 0.95%, which is about the same as stakeholder pensions. A scheme like PPM would be rather like compulsory stakeholder pensions, and might even be described in due course as a new kind of personal pension.
5. Promoting procrastination
One of the findings of the Pensions Commission (First Report page 208) is that "people procrastinate". The more people are required or encouraged to do things, the more opportunity there is for procrastination. Yet Adair Turner is discussing new schemes which will arguably promote procrastination. There are surely enough such schemes already such as:
"80% of all stakeholder pensions schemes are empty shells." x"Less than a third than of eligible children have had trust funds opened on their behalf. Although 1.7m were sent out, only 499,000 have been cashed... Gordon Brown hoped the scheme would be popular with parents, but he has simply been met with a wall of apathy... A quarter of parents said they didn't even know what they had done with the £250 voucher to open their child's account." x
"Half of eligible parents yet to open child trust fund." x
"Child Trust Funds generate little interest for busy families." x
"Parents lose £60m of their children's money" x
"Only A Third of Parents Open Child Trust Funds." x
"70% of child trust funds ignored." x
"Child trust fund vouchers lying idle." x
"62 per cent said they hadn't got round to it yet." x
"Apathy towards child trust funds has grown to its highest level ..
.. rapidly turning into a scandal." x
"Third of teens ignore education grant." x
"7m people owed unclaimed council tax benefits." x
"Unclaimed benefits could be costing pensioners £500 each." x
6. Conclusion
As mentioned above the work in running a saving scheme can be divided into:
1) gathering in savings,
2) corresponding with unit holders,
3) keeping records of the units they possess,
4) investment.
Some key questions seem to be:
1) Whose name is on the share certificates of the underlying investment?
2) Who appoints the fund managers?
3) Who keeps a record of who has which units?
Adair Turner seems to be hinting at the possibility of a new national organisation to do 1), 2) and 3), but leaving 4) to fund management companies chosen by scheme members. In my opinion it should also do 4) or at least choose fund management companies itself, otherwise the Turner Opportunities seem to be opportunities for these companies and only responsibilities for savers and investors.
June 2005