Recommendations

- The assets of the personal accounts scheme should be held internally.

- They should also be invested mostly or entirely, by the scheme itself rather than by external "managers".

- It should have a buy-and-hold investment policy, which implies an emphasis on fund investment rather than "management".

- The scheme should set up its own stockbroker.

- There should not be a choice of funds for members.

- Members should be able to cash in their savings at any time, without limits on transfers in or out.

- It should be possible for members to receive investment income on retirement rather than have to buy an annuity.

And the principles of my reforms are these: Government giving more power to Parliament; both government and Parliament giving more power to the people. ^x

He set up the FSA which gave power to the industry. There is a parliamentary EDM to provide consumer representation on the board of the FSA.

.. urges the FSA to ensure that suitable consumer representation is reflected on the board as a matter of urgency. ^x

"Power to the people" is also promised by David Cameron, ^x and there are various proposals, including the introduction of a petitions committee. ^x But personal accounts are being "delivered by the private sector", ^x which is giving power to the industry.

"Power to the people" implies people having control of their own money, rather than handing it over to the pensions industry. People should not be required to make their own pension arrangements. Pensions, that is income in retirement, should be provided by group schemes. But defined-contribution schemes are a problem, because they are a half-way house where savings are locked in limbo land, because they cannot be withdrawn, and have to be used to purchase an annuity. Defined-benefit schemes have the problem of early leavers and affordability. In short, pensions and the private sector are incompatible.

Congratulations to PADA for publishing the responses to its consultations. The discussion paper says:

We will summarise your comments and publish them along with a response to this consultation. This will occur within three months of the close of the consultation period.

This is a contrast, for example, to the consultation Freedom of Information Act 2000: Designation of additional public authorities of the Ministry of Justice, which was published 25 October 2007, with close date for responses 1 February 2008, to which the government responded 20 July 2009. That is nearly 18 months later. The responses have not been published (at the time of writing 20 July 2009). Although it says on the Ministry of Justice website: "Responses published: 16 July 2009". ^{x x}

Unfortunately the responses to government consultations are usually not published. It seems that they would be if more people made Freedom of Information requests to see them. I have written about this on: www.comparativetables.com/follow.htm. ^x This non-publication is not giving "power to the people". ^x Responses to consultations should be published. There are frequent calls for a national debate on different topics. Non-publication does not facilitating national debates.

The full name of the respondents to consultations should be requested, to reduce the possibility of spoofs. The full name is not requested, and is not always given in the published responses to Building Britain's Future, and there may be spoofs. The maximum permitted length for responses is 1000 characters, and it is impossible to enter more. ^x But some responses are considerably longer than 1000 characters. ^x I asked for the email address of one of the respondents, without a reply (at the time of writing ^x ). So I have no way of checking they are real.

The Building Britain's Future website says: "Your voice is important. Contribute to the discussion and help shape the future of Britain!" ^x This seems to be a rerun of The Big Conversation, which Tony Blair described as "an honest, serious debate about the future of Britain". ^x

2. "Ethical basis"

How does the PADA reply to someone, such as a contributor to a discussion?

Why you should NOT invest in a pension at all, ever. ^x There is no longer a sufficient ethical base in the UK to do so. .. So it ran fine as a company for 183 years, but was then over 20 years taken over by, successively, AMP in Australia, HHG and Pearl, and may now finish up part owned by some shark in the Cayman islands! ^x

Or for example, a letter in The Guardian:

As one scheme after another has collapsed, he has not only done nothing to help but has spurned legitimate claims for compensation - even defying the parliamentary ombudsman in the case of Equitable Life. So who is going to feel like locking away any of their hard-earned cash when they've witnessed billions of pounds of their fellow workers' pension savings vanish? ^x

What is the ethical basis of the personal accounts scheme? Requiring people to make an embarrassing decision whether to stay in, or opt out of the scheme, does not seem very ethical. This decision is embarrassing because it is a gamble on: future investment returns, the annuity rate at retirement, the rate of inflation during retirement, whether they will actually need an income in retirement from the scheme. They might decide in later years that they made the wrong decision.

According to the legislation:

The trustee will have 9 - 15 'members' appointed for a term of up to five years renewable once. It may also have employees. The Secretary of State appoints the initial members; thereafter the trustee appoints its own members (from a PADA Industry Day ^x)

The Trustee Board members should be appointed by outside organisations, otherwise this is a self-perpetuating oligarchy, as Equitable Life was described in the Penrose report. This does not seem much of an ethical basis. Self-regulation is causing problems with MPs expenses and financial regulation. ^x

The PADA paper Securing a retirement income seems to have a hidden agenda - to promote the sale of annuities. It is pro-annuity in comparison with the income drawdown option, as discussed for example in the IMA discussion paper Enabling choice for retirement. ^x The money's worth values in the paper cannot be checked by being able to see the calculations. It quotes values from Survey of Annuity Pricing by Cannon and Tonks. ^x But when giving money's values, this paper does not at the same time give the annuity and interest rates used in the calculation, so these values are impossible to check.

Designing an investment approach seems to have the same hidden agenda - providing business for the City. The use of external fund managers combined with a choice of funds for members, could result in personal accounts turning into yet another kind of personal pension. ^x Personal accounts are a third bite at the cherry. So there is a loss of credibility, because the government did not get it right with personal pensions and stakeholder pensions.

3. A City orientation

This consultation seems to be giving power to the City. It proposes that fund management is "allocated" to the City, and perhaps also investment funds. The PADA paper Securing a retirement income also has an industry orientation. It is promoting the sale of annuities, by not even mentioning inflation, or for example, discussing the relative unpopularity of annuities abroad. When members retire they will have to purchase an annuity or be "transferred out" of the scheme for income drawdown:

If a member wants to take out an income drawdown product, they will be able to do this by transferring their funds out of their personal account to another registered pension scheme. ^x

Having a scheme covering the whole country seems rather ambitious, rather than starting it in part of the country, and then extending it. The personal accounts scheme seems too centralised. There should arguably be several organisations, for the English regions, Scotland and Wales.

Should PADA not be doing more itself rather than procuring so much from outside companies? Contracts are being signed which will be expensive to change or back out of. Using outside contractors has been expensive in other areas, such as the development of NHS computer systems. ^x PADA says in an Industry Day:

What is PADA procuring?

• Contract Set A - a range of goods and services contracts in order to support the Trustee Corporation

• Contract Set B - a single contract for Scheme Administration Services

• Contract Set C - single contract for Fund Administration Services

• Contract Set D - the selection of a number of funds

• Contract Set E - a number of contracts for Annuity Purchase Services ^x

4. The total expense ratio

Annex five says:

The TER provides investors with a clearer picture of the total annual costs involved in running an investment fund.

But how clear? For example, is the stakeholder cap on charges on the TER or only on the management charge? Regulation 13 of the stakeholder regulations suggests the latter, because "expenses, commission" are in the heading whereas the cap on charges is defined by regulation 14. ^x

5. Unnecessary deals

The City makes money from "deals". The FSA is concerned with promoting "deals":

promoting efficient orderly and fair markets;

helping retail consumers achieve a fair deal; ^x

As pointed out by Lord Myners there is much unnecessary share dealing going on. ^x This is fund managers passing shares between each other. The discussion paper gives the portfolio turnover for actively managed funds, 58 per cent (page 145). London Stock Exchange statistics show that the number of bargains and shares traded per annum has risen steeply since 1997.

6. Portfolio turnover

The discussion paper says:

To address some of these issues for collective investment schemes, the Financial Services Authority (FSA) introduced a requirement for collective investment schemes to calculate a Portfolio Turnover Rate (PTR).

This PTR was introduced as the result of the Third UCITS Directive. ^x This PTR has to be in the Simplified Prospectus of UCITS-approved funds. The FSA has resisted making the declaration of portfolio turnover compulsory for all funds, as it is for mutual funds in the US. The FSA's Consultation Paper Informing consumers: product disclosure at the point of sale (2003) says:

We have concluded that portfolio turnover would, as some respondents suggested, be very difficult to interpret in a useful way. We accept that it would be over-simplistic to interpret low turnover as a good thing. We also accept that for the information to have any validity a correlation would need to be demonstrated between past turnover and future turnover. We have not yet determined such a correlation exists. For those reasons we have decided that we will not bring forward proposals to require the disclosure of portfolio turnover. ^x

The PTR referred to by the FSA is not the usual US definition of PTR, which is the minimum of the total purchases and total sales of securities, divided by the average value of investments during the year. ^{x x}

The UCITS definition of PTR is unsatisfactory and confusing. ^x Let X be the total of all investment transactions, that is all purchases and sales by the fund during the year, and Y be the same for the units (or shares) of the fund then:

PTR = 100 x (X - Y) / (average assets during the year) %

This could be negative, since there could be turnover of the units of the fund without any turnover of its investments. That is the money obtained from the purchase of units is used for redemptions. The adoption of this formula has resulted from feeble representation of investors at the European level.

This is an example an "ill-conceived or badly designed new regulation .. from abroad ". ^x The Conservative Party White Paper From Crisis to Confidence (2009) says that the industry should be protected from such regulations. What about investors? This definition of portfolio turnover is a disadvantage for investors.

The personal accounts scheme should specify the portfolio turnover of its funds using the more comprehensible US definition.

7. Stockbroker commission

The discussion paper says:

It is this lower cost of trading that allows pooled funds to offer efficient diversification to investors who may not be able to achieve it cost effectively on their own.

But it is easy enough for trading to be reasonably "cost effective". On-line trading costs typically about £10 per trade ( Fastrade ^x) and certificated trades by telephone should not cost more than twice as much. Dealing costs depend on frequency of trading, which is higher for pooled funds, partly because of soft commissions.

The personal accounts scheme should specify the broker's commission and stamp duty of its funds. This is part of the charging structure, although not discussed in the PADA report Choosing a charging structure.

The discussion paper does not mention "stockbroker" or "soft commission". The personal pensions scheme needs to ensure that its fund managers are not using stockbrokers in return for "backhanders":

Backhanders, or 'soft commissions', are also allowed by the regulators. 'Soft commission arrangements are common between fund managers and stockbrokers," said Justin Urquart Stewart, a director of Barclays Stockbrokers. 'Basically, it is payment in kind in return for the fund manager giving the broker his business.' ^x

Broking houses are clearly willing to make substantial payments out of their commission income - either to fund managers in the form of soft-commission, whereby the fund manager receives goods and services free of charge, or whereby pension funds and other clients secure substantial rebates through commission-recapture programmes. ^x

The personal accounts scheme should have its own wholly owned stockbroker, to avoid the problem of soft commissions. ^x The FSA has developed new rules for soft commissions, which can now only purchase "research": .

The new rules stipulate that only research and execution-related goods and services can now be purchased with commissions. ^x

But this is vague. It includes advice on which shares to buy - leaving fund managers with little to do. That is fund managers are offloading their work onto stockbrokers.

Research is a broad category and survey respondents found it easier to classify their expenditure in this way now, rather than representing a very significant change in the goods and services actually purchased from commissions. ^x

Soft commissions are provided in return for a certain amount of dealing - which promotes high portfolio turnover.

8. Buy-and-hold

The discussion paper says:

An important decision for the trustee corporation will be the balance of passive and active management used to invest the scheme’s assets.

A more important decision is arguably whether or not they have a buy-and-hold strategy, that is low portfolio turnover:

Research in the US has shown a positive correlation between high turnover and poor performance.

Should the trustee corporation offer branded funds as part of the fund choice offered to members, and if so why?

"Branded funds" are external. This is asking whether funds should be internal or external. They should be internal. Branded funds should not be permitted. The response to this question will depend on whether the respondent is from the industry which likes branded funds, or has been infiltrated by the industry. The FSA is continually doing the wish of "most respondents" to its consultations. ^x This sounds democratic. But "most respondents" are always from the industry, so it is acting for the industry.

The consultation seems to be trying to introduce branded funds:

Overall, however, participants would generally be willing to consider branded funds alongside ‘own-brand funds’, and to consider which provides the ‘best deal’ when making a decision.

"The best deal" is impossible to determine because charges vary with time, and there will be hidden charges.

10. "Funds will be passed on"

The white paper Security in retirement (2006) ^x says that funds are "passed on" to these external managers:

Funds will be passed on to professional and independent fund managers as in current industry practice. (1.76) ^x

"Passed on" implies that the funds become external. But does "allocating" in the discussion paper: "allocating assets to investment managers"? "Contract Set D - the selection of a number of funds" suggests that the funds are external. An external fund manager can manage internal funds. For example, St James's Place has internal funds managed by external managers.

We do not employ any in-house investment managers, instead we carefully select a number of external managers of outstanding ability to manage our range of funds. ^x

Someone has given me the password to their on-line Fastrade account. They are not my shares or account. I trade on their behalf, and cannot transfer anything to my account. No funds have been passed on to me, though I am acting as a fund manager. The funds are internal to this person. But I am an external fund manager, because I am not an employee.

If funds are external, a change of manager implies a change of fund, which is costly:

Manager change can be a costly process. It requires a search for a new manager and the transition of the assets from the old to the new manager often requiring a transition manager. This will incur additional trading costs. ^x

When a manager is changed there are no direct consequences for the fund itself, which remains as it was. It is simply that the responsibility for managing the underlying assets has been handed over to a new investment professional who will then make their own adjustments to the portfolio. ^x

This does not seem to be "a costly process", though "additional trading costs" can result from "adjustments to the portfolio" resulting from different views. This is a problem with external fund managers.

The personal accounts scheme should have an in-house capability. Pension funds are sometimes managed in-house by internal fund managers, to a greater or lesser extent - such as the Universities Superannuation Scheme. ^x The personal accounts scheme should have custody of its assets, with its name on share registers and share certificates. They should be internal and not be "passed on", if this means they become external. There is no mention of "custody" or "custodians" in the discussion paper.

"Fund management" implies buying and selling, in comparison with "institutional investor". But initially, as the personal accounts scheme expands it should be (almost) entirely buying. Its funds should be invested by the personal accounts scheme itself, that is by employees who could be called "investors" rather than "managers".

11. Corporate governance

The discussion paper says:

A high level of corporate governance can be achieved in three ways:
• fund manager selection
• corporate-governance overlay
• in-house capability

Shareholders of companies are expected to take part in corporate governance, by voting on resolutions and attending AGMs. The investment funds of the personal accounts scheme should be internal so it is a shareholder and can take part in corporate governance. This will help develop an "in-house capability". Leaving this to external managers seems unreliable. "Selecting fund managers with a more committed approach to corporate governance", and "require fund managers to closely monitor and research the companies they have invested in" seem vague. "Corporate -governance overlay" seems to be passing responsibility to someone else. In short, I am in favour of the third option.

12. "Diverse needs"

The discussion paper asks:

Should the personal accounts scheme offer choice beyond the default fund?

No it should not, for various reasons listed in Appendix 1. The discussion paper says:

respecting the diversity of members .. to avoid individuals or groups feeling excluded, alternatives to the default fund are required to cater for a wide range of members with different needs, aspirations and values. .. limited choice may lead to increased opt-out from the scheme if the fund choice available does not meet the diverse needs of the target group.

People do not have "diverse needs". This is the "suitability" myth. Howard Davies said to Treasury Select Committee The mis-selling of personal pensions (12th November 1998):

The whole learning experience of the last few years has taught us I think, that suitability is at the core of the problem which investors face, whether this is a suitable product for you.

Investors want a good return on their investments. This is not "diverse needs" or "suitability", which imply that investors have needs other than wanting a good return. The industry - that is the industry regulated by the FSA - likes choice, because no choice no industry. Governments like choice because it enables then to offload responsibility for decisions onto the public. So they make up reasons for choice such as "religious views", which is a vague concept to apply to fund selection.

13. Level of risk

The discussion paper says:

Pada investment director Mark Fawcett said the fund would be designed on the basis that most members would be risk-averse and have lower-than-average financial understanding. But he said other funds would be available for investors seeking additional risk. ^x

People should not have to think about the appropriate level of risk for saving towards a pension. This should be the responsibility of the personal accounts scheme. Risk appetite can rapidly change, and levels of riskiness are difficult to assess, moreover:

There may be a mismatch between our members’ perception of investment risk and what investment risk is appropriate for them, particularly in the context of long-term savings.

"Investment funds with greater or lesser risk could also be made available for those who want to seek higher returns or greater security."

Similarly, members should be able to receive investment income instead of having to purchase an annuity. This income is not "guaranteed", but likely to increase for those "seeking a higher return". But there is no such option in Securing a retirement income:

We believe that a lifetime annuity will be the most appropriate product because:

lifetime annuities provide a guaranteed income for life.