The Financial Inclusion Centre has submitted a response to the Financial Conduct Authority (FCA) consultation CP24/16, The Value for Money Framework which has just closed. The submission can be found here: FCA VFM framework Financial Inclusion Centre response
The overall intention is to enable better scrutiny of value for money in workplace pensions which come under the FCA’s remit. There is a similar initiative for pension schemes which come under The Pensions Regulator (TPR).
Pension arrangements will assessed using this new VFM framework and rated red, amber, or green (RAG).
We fully support the intention to ensure people saving for a pension get the best value for money possible. But, we have some serious reservations about the FCA’s approach.
Investment past performance does not predict good future performance
We are concerned about the importance placed by the FCA on investment performance, particularly past performance, in the proposed VFM framework. The FCA must know that past performance is no guarantee of future performance.
Yet, we can model the impact of high charges on peoples’ pensions and investments. We know that ceteris paribus higher charges and costs reduce the value of the final income. The higher the charges and costs, the more a consumer has to contribute to their pension/ investment to produce the same future fund value.
Of course, better investment performance may well end up offsetting higher costs and charges. However, if better investment performance does result, this will not have been down to any ex ante prediction of investment manager skills by IGCs, trustees, consultants, advisers, and other intermediaries. To be blunt, it will have been primarily down to luck.
It is very important for the FCA to recognise that investment based services are not like consumer products where future quality, reliability, and performance can be determined from observing past performance of exsiting products or consumer testing of new products.
By allowing investment past performance to be the core of a VFM assessment, the FCA risks misleading pension savers and distorting the market.
The VFM framework over-emphasises investment past performance and distracts from the impact of costs and charges
There is real risk that the VFM proposals will cause Independent Governance Committees (IGCs) and pension trustees (who are meant to represent the interests of pension savers) to over-emphasise the importance of investment past performance.
This could result in IGCs and trustees making or approving suboptimal investment decisions due to flawed interpretations of past performance data.
Moreover, overemphasising the importance of past performance will divert attention from the most important factor that is within the control of IGCs and trustees, the impact of charges and costs on pension values.
Yet, the FCA does not intend that costs and charges be analysed and rated separately in the RAG rating scheme.
It also risks causing more pension assets to be invested in high cost, complex, opaque, poorly regulated and governed ‘alternative’ investment assets and vehicles with questionable past performance track records and future prospects.
The proposed VFM framework risks reversing progress made in the pensions market and distorting competition
The FCA states that: ‘We are clear that value for money is not only about a focus on costs and charges – the cheapest schemes to run will not necessarily deliver the best performance in the long term for consumers. Other factors are relevant including the quality of services provided, investment performance and customer experience. The outcome of the proposals that we are consulting on today is to ensure that there is a focus on all of these factors, not only costs and charges.’
The FCA says it wants to: reduce the number of savers with workplace personal pensions that are delivering poor value; and drive better value for money across the workplace DC market through greater scrutiny and competition on long-term value rather than predominantly cost.
We have made significant progress in driving down charges and costs in the UK pensions and investment industry including through the use of the workplace pension charge cap. The weakening of the workplace pension charge cap and now this VFM framework threatens to reverse this progress.
The VFM framework with its emphasis on investment performance will just allow investment managers, consultants, advisers, and other intermediaries to divert attention from the importance of costs and charges and actively promote and sell high cost, complex investment strategies which actually offer little added value but introduce greater risk.
The assumption underpinning the general VFM framework seems to be that this will allow trustees and other governance bodies (IGCs), consultants, advisers, and other intermediaries to drive an improvement in investment performance (and therefore pension outcomes) through the dynamic of competition. Yet, there is no evidence to support this hypothesis. Given that past performance is no predictor of future outperformance, it is difficult to understand why the FCA (and the TPR) thinks the VFM framework will have the desired effect.
Moving the focus away from costs and charges will not promote more effective and efficient competition. It will just allow firms and various intermediaries to use potentially misleading data to promote costly investment strategies. It will promote competition on spurious factors.
Surely, the government, FCA and TPR must recognise the risk that this approach will just create new opportunities for consultants, advisers, and other intermediaries to sell more costly advisory services to schemes as well as a recommend more costly alternative strategies and funds. Rather than enhance value, the combination of more costly assets and advisory services is more likely to reduce pension values.
Use past performance data to improve accountability, not attempt to promote competition
To be clear, we do not challenge the need for investment firms and various intermediaries to report on past performance. This is an important element of accountability. Investment managers and intermediaries should be required to justify poor past performance and the charges and costs involved.
IGCs and trustees should be encouraged to demand lower charges and costs and switch providers where advantageous to drive value for the pension scheme members they represent. IGCs and trustees should be required to justify clearly to scheme members/ investors why they decided to use higher cost investment solutions when lower cost solutions such as passive strategies and funds are available.
We do support the collection and publication of performance data as an accountability tool. A database with performance and charges along with the name of the investment manager and adviser/ consultant should be published by the financial regulators.
The important point is that past performance should not be allowed to influence attitudes and beliefs about future performance and, therefore, the overall VFM of an arrangement. Past performance must be detached from and not be allowed to influence VFM decisions. Costs and charges must be at the core of any VFM assessment.
We do not see any harm in allowing a separate rating of quality of service to be shown alongside clear information on charges and costs. However, rather than hope that this will encourage scheme members and governance bodies to drive competition, it would be much more effective if FCA and TPR used this data to more robustly intervene to drive up standards.