Sunday, 21 October 2007

Getting default funds right

Now that we are well and truly moving into a defined contribution world, surely it is time that the labour movement started thinking about the way these pension funds invest?

Just as a reminder, plenty of studies show that around 90% of DC scheme members end up in the default investment option. This is important for two reasons. First, it blows a hole in the idea (mainly propagated by people interested in selling services, but also a few politicos) than many people actually want choice, which obviously has wider ramifications. Often advocates of choice argue that if you ask people if they want it they overwhelmingly say yes. That is true. But if you look at actual practice, in DC fund decisions, the overwhelming majority choose not to choose. (I suspect you would find similar results in other non-financial areas where commercial interests have argued that choice is necessary, but that's for another day).

Secondly, clearly this means that the bulk of DC assets are going to end up in the default fund. So those of us with an interest in capital stewardship need to focus our attention there. The incoming Personal Accounts scheme looms large here. It will in time become the UK's biggest pension fund, and its default fund will therefore be a significant investor. Therefore we should be lobbying that it exercises its ownership responsibilities properly (ie voting and engagement with investee companies). I think it is important that the Personal Accounts scheme offers some niche investment options, maybe even a screened 'ethical' fund, but certainly some SRI option and a Sharia fund. But the really important issue is the default fund. Already some work is being done on this from a maindtream perspective - this report is worth a read - but there is not much discussion (to my knowledge) in the labour movement.

Given that the trustees of the Personal Accounts scheme will be aware that most people end up in default funds, they must also acknowledge that therefore they are making investment decisions on behalf of millions of savers. Those decisions encompass not only maimstream factors but also whether social and environmental issues are taken into account. Put in those terms it seems hard to argue that the default fund should NOT take any account of them.

I suspect that this is going to be a hard-fought argument, as almost certainly some on the Right (and maybe some commercial interests without SRI capability) will argue that this is playing politics with people's money. But personally I think they will be on shakier ground - why should the trustees assume that people don't want such issues factored in? In addition we need to be very wary of the 'integration' pitch from some fund managers. Many will these days argue that they already intergrate analysis of social and environmental issues into their analysis but in my opinion only a handful have the resource and competence to do this. The recent Fair Pensions report has some good stuff on this point. This issue is simply too important to let commercial interests dictate the outcome.

Finally just some random thoughts about DC investments and short-termism. As I've said 90% end up in the default option, but what about the other 10%? A lot of fund managers' DC marketing is aimed at this segment, and encouraging trustees to ensure they have enough fund 'choices' for members. Bear in mind too that fund managers routinely plug their funds on the basis of performance. This suggests to me that a significant amount of fund switching (ie between funds) in DC schemes is likely to be performance-driven. And it will be easier for individuals to switch funds than for trustees to switch mandates (for example it took years before PDFM really felt the commercial impact of its bearish stance). This in turn suggests fund managers will see more rapid fund outflows in response to poor fund performance (although perhaps on a small scale). So will that in turn increase the short-term pressures on managers, which they in turn will pass up the investment chain? On the other hand we have the 90% of assets sitting their in the default fund pretty much regardless of performance so would the pressure actually ease off as DC (and therefor DC default fund) assets grow?

I'm really not sure about this. I raised the issue in a conference once and one fund manager said short-term pressures would increase, whereas the other said that there was no evidence that it would (although I got the impression that he wanted to disagree with me because of my union affiliation!). Although the weight of assets point is compelling I wonder whether (like banks) fund managers basically know they have a lot of customers who won't switch because they a) aren't interested/informed enough to make the switch and/or b) can't be bothered. Therefore it makes sense for them to focus on those few stroppy customers (who are probably more financially literate, and better off) who might switch. So for fund managers that might mean a focus on the fund switchers, and therefore on the performance that causes it to happen. It's probably an area that needs some research. Would be interesting, for example, to see if there are different perceptions about short-term pressures depending if a fund management house is more retail or more institutional. One to think about some more!

No comments: