Nest will fail its members by pandering rather than educating

I am not opposed to the idea of employers and their employees of modest means and/or financial acumen being given a shove towards setting aside funds for retirement. But I feel strongly that NEST and quasi-compulsion are not the right way to go about it, and certainly not the best.

Advice, both to employers and employees will be essential, but NEST's charging structure contains no margin for advice.

Already, NEST entails a choice of four different definitions of pensionable pay, with different percentage contribution levels for each.

Most ordinary people with no experience of investing don't understand the difference between a gilt and an equity.

Pension funds are still taxed (as they never used to be). Income levels in retirement are still shackled to annuity rates (which is in urgent ned of reform). Retirement contributions cannot be insured (as used to be the case). Unspent funds on death in retirement still cannot be passed down to the next generation free of tax (as many people consider they should be). Having the adminstrator in India (Asian call centres are widely disliked, even though the UK's favourite cuisine is Indian) and the investment manager in Massachusetts for a UK scheme is hardly confidence-inspiring. Auto-enrolmenmt may overcome inertia, but it will also engender resentment.

It could all have been done so much better and so much more simply. So far, I remain decidedly unimpressed with the coalition government's pensions simplification.

This thoughtful article sheds light on one of the key issues facing Nest - how to select, devise, monitor, appropriate funds for the target members - supposedly a large percentage of the UK working population, if the scheme is to meet its original objectives.

A With-Profit style fund still seems the best way to provide a low risk, longterm, fund for many risk averse employees/working people. To be realistic, many of these will be in low paid, sometimes casual work, doing long hours, changing employer frequently for no fault of their own. Many will not have surplus income to invest in sophisticated funds, will be risk averse, demoralised as many are to day, to see that their hard earned contributions often go down, despite adding new contributions.

Successive governments have chosen not to support the mutual principle, to undermine and allow With Profits style funds to wither, be sold on to consolidators, with no viable alternatives to protect modest investors. So, the least they can do is to devise a long term, low cost, no frills style of fund which will be there for millions of low and middle income earners when they need It most, at retirement.

We specialize in socially responsible investment, but we recognize the valuable role that WP style funds can perform, to provide an element of stability in very unstable, as well as more optimistic times. If the Prudential can, having demutualized, still run a With Profit fund with enviable performance while removing volatility then we need to hear some good reasons why UK government cannot either devise or underpin a similar model.

There has been so little evidence of common sense, protection of the wider public interest, how advice is delivered by both regulator and government in recent years, that I have no expectations that either Nest or RDR will serve them this time round.

The minority, those who have sufficient income to save well, make choices, inherit or acquire above average assets, select an IFA, will be fine, but it is surprising and worrying that the interests of the majority neglected, with attendant grave consequences for the UK economy, tax revenues, benefits system, in years ahead.

NEST will fail its members by being totally inadequate.

Stuart- what a good article. The Glide Path is a flexible beast and the more assets a target dated fund has within it, the greater the glide path flexibility. Glide paths for DB plans have been constructed around the fairly complex cahsflow profiles of each scheme. By comparison, the liability profile of target date funds should be easy to define. The default fund's default liability cashflow profile is 25% cash and 75% CPI linked lifetime income payments.

As you point out "it is theoretically possible to have all internal prices, and the exchange rate, perfectly indexed for inflation". The Glide Paths of DB schemes attempt to get rid of unrewarded risks (such as inflation) by swapping out these risks at the right time. This use of "swaps" is standard practice among larger DB plans and there's no reason that NEST shouldn't use market opportunities in the same way (providing the funds are of a proper size and there continue to be organisations who want to do the swapping- counterparties).

In theory, target date funds could become "whole of life" funds provided that a counterparty could be found to insure the longevity risk. Put in everyday language, the target date fund could simply distibute a quarter of its value on the target date then morph into a deaccumulation fund paying out regularly to its membership (with the final payment being made to the last survivor). I'm sure there are people in NEST who have considered this!

Brigid- I'm not sure this idea is that far from the original conception for with profits pension funds - (mutuality being replaced by a reliance on the financial markets).

As regards the "wreckless conservatism" of an under-volatile accumulation fund, there is a trade off that needs to be created between highly volatile high return characteristics- (that scare members along the way) and lower volatility low return funds (that deliver below reasonable expectations).

The fund managers "philisopher's stone" is the fund that provides equity like returns without the volatility- which is a great marketing phrase for DGFs . It relies on the free-lunch of diversified uncorrelated returns. I am sceptical about alchemy and about DGFs but I think there's mileage in NEST exploring that concept too.

I'm interested in my pension but I'm not interested in managing the investments (I drive a car but don't often open up the bonnet). If NEST can offer me a target date fund that is better managed, better governed and not overly-priced- I'd seriously consider transferring my personal pension pots into it (assuming they open for "transfer-ins" post 2017)

Agree With Dave G, simples.

However, it does provide us IFA's with a golden opportunity to advise employers and get a proper scheme in place.

Every cloud and that!

Martin and Dave

What aspects of NEST do you find inadequate?

Hi Henry, the fact it's in the papers and it is "hot topic" at the moment provides us IFA's with a good opportunity to raise the importance of having a suitable scheme in place.

It's probably topic of conversation down the pub, employers talking about their GPP schemes. Great excuse for me to get to the pub and "work"!

I'm still not sure what you see as wrong with NEST. I can see many people finding the contribution levels of Auto-Enrolment inadequate - but NEST itself ?

Henry, your own suggestion as to the nature of the liability actually gets to the heart of the problem for NEST's default option. You say

'The default fund's default liability cashflow profile is 25% cash and 75% CPI linked lifetime income payments.'

But that itself make some arbitrary but critical assumption about the way the Pension Commencement Lump Sum will be taken and applied and therefore its duration and liability characteristics. It is only cash-like if i) applied fully to early years in which case the annuity is deferred and has a longer duration or ii) not even applied to pension (I dread to think what people are doing at present, such as using it pay down mortgage debt). If applied to the same liability stream, it's 100% 'CPI linked lifetime income payments'.

Whilst the liability is inflation linked, the whole point about current practice is that the vast majority of people buying an annuity at retirement do not buy inflation protection. I agree with you that inflation risk is unrewarded and so a bad use of the risk budget. But it could be that what people actually want is a tapered real income, as they value more spending power early in retirement and are willing to push declines in spendign power out to later years - when they may be dead or if not think they will then tolerate better 'the simple life'. Because they can't get an index linked annuity with this time profile (and nobody currently dares to deliver the solution by drawdown for small sums because of compliance risk - itself upside down thinking) they let inflation do the tapering for them. There's a kind of utility matching but its horribly inefficient.

NEST's consultation paper barely touched on these issues and did so in a perfunctory manner as if lifted straight from a selection of text books. There is no sign of intellectual leadership or insight - compared, say, with the best of LDI thinking, which you are obviously familiar with.

Stuart

So long as the cash sum is "tax-free- it is a no brainer for most people to take it (I'll leave alone dodgy commutation factors in some DB schemes!).

What people do with their cash is their business, what they link their income to is again their choice- I agree with you that not linking income to inflation is a dodgy move and most people underestimate the corrosive power of inflation and go for "jam today".

We are talking about default positions and "inertia" here and if "inertia" or "the laxy concensus" as I heard it called today, has a positive, it is that it allows fiduciaries to influence behaviours by establishing a "norm".

Let's suppose that a mature target date fund - (2020 onwards) has £250m in it. Occupational rules state that the trustees can pay pensions from the fund- a fund of £250m is large enough to support some fairly sophisticated cashlfow management techniques (including the purchasing of longevity swaps).

I'm looking for NEST's investment team to be looking at managing the deaccumulation without "buy-out" into individual annuities. EU Solvency II makes insured annuity contracts unattractive - let's use our collective clout to lobby hard for a collective drawdown option akin to the "end-game" solutions in play at most mature DB schemes.

Henry:

What is inadequate about NEST?

It is much easier to turn that around and ask what is adequate about it?

On that basis, it is making an attempt to force people to save for their retirement. Not in itself a bad idea. But it has been done before (and failed) with stakeholder.

The failures with Stakeholder included the crass stupidity that every employer with 5 or more employees had to designate a Stakeholder scheme unless an adequate alternative was available. But nobody had to actually JOIN the scheme. NEST appears to be trying to add that element of compulsion.

But if the scheme is flawed, then it is FLAWED. No element of compulsion can ever change the basic flaws.

It has been costed at a pathetically low rate - sounds as if the Consumers Association have yet again had the ear of the so-called government.

My question is simple:

Is it better to have a scheme that averages an annual growth of say 5% per year, with costs of less than 1% per year?

OR

Is it better to have a scheme that averages growth of say 10% p.a. but at a cost of less than 3% p.a?

In asking that, we all know that no growth rates are GUARANTEED. But in the longer-term, are actively managed stockmarket based funds likely to outperform deposit style and largely unmanaged funds?

We all know that they are LIKELY to.

But the whole scenario reminds me of the story of a farmer who had a horse, and that horse was eating over a bale of hay per day. This was costing the farmer a lot of money, so he resolved to reduce this amount, and from a monthly total of around 30 bales of hay he managed to get it down to 29, 28, 27 and so on. He was telling a farming friend that he had just manged to get he horse down to 2 bales of hay per month when the beast keeled over and died on him!

Does that summarise my thoughts sufficiently, or am I just a cynic?

Adding to what the likes of Dave Greenhill has said, it also appears the we are always in the position of advising with the reality of real returns on real client plans from proven systems, Brigid mentions the likes of Pru with profits as one example, against the theories of failed ideas which in theory should not have failed.

Or at best when they did fail did not reduce client's money as much as more expensive ideas which also failed.

Hardly a success.

It does not appear to occur to anyone that if the easiest mosty succesful systems in this industry were simply the cheapest, we could all just go an select the cheapest funds, watch the client's money grow and turn up each year for a big pat on the back and a few pound for reviewing and doing well for them.

In to the bargain I could save myself nearly £5k per year on software as it would not be required and a few thousand on access to more complex and costly systems.

If NEST is going to be so good then transferring out should be an option as well as having a small range of approved reasons for doing so without a potential claim, giving the client the option to get out.

Otherwise if this idea fails like the others have done it is little more than a cobweb trapping the most vulnerable people in society.