The Dutch and the Swedes are the tallest people in Europe. The average Dutch male is 1.843 metres tall, just over six foot. Swedes are a tad shorter at 1.815 metres. Other than being able to look down at vertically challenged Brits and Americans, this additional size comes with few tangible benefits. The same is not true of the respective Dutch and Swedish pensions systems.
David Knox, through the Australian Centre for Financial Studies, has developed a global pensions index. It ranks the retirement savings of different countries according to the benefits paid, their sustainability and the overall integrity of the system. No country receives the top A grade, but both Sweden and the Netherlands achieve a B. Just as in the tallness stakes, the UK and US trail, with a C ranking.
What the Dutch and Swedish pension systems have in common is size. Sweden’s four AP-Fonden, designed to buffer and top up state benefits, are among the 30 biggest pensions plans in Europe. Combined, they would rank third behind two big Dutch funds: ABP (for civil servants) and PFZW (for healthcare workers). These two Dutch funds cover 4.8 million workers, more than 30% of the entire population of the Netherlands.
Size is not the sole determining factor for pension success. But where it counts most is at the sharp end: fees. Pension construction, strategic asset allocation, alpha and all that fancy frippery matter for nought if when a worker retires the income is insufficient to fund a reasonable lifestyle. The biggest driver of this is cost.
Fees charged by household-name personal pension providers in the UK can cut in half the pension pot of a saver. Total charges of over 2% are common. Yet savers often ignore the biggest driver of retirement income. In the US, the Transamerica Center for Retirement Studies found that only 25% of 401(k) plan participants surveyed had any idea of the fees they were paying, 25% were not sure and 50% had no idea at all.
Keith Ambachtsheer reckons that approximately every one percentage point of fees and other costs reduces the ultimate retirement pot by 20%. That is why bigger is better. ABP charged participants €90.90 in 2009. This equates to a little over 10 basis points. ATP, Europe’s third-biggest pension fund, charges Danish members approximately 20bp.
Alexander Dyck and Lukasz Pomorski at the University of Toronto’s Rotman School of Management recently published a paper looking at newly available data from CEM Benchmarking. The study finds that pension plans managing more than $50 billion outperform those with assets of less than $1 billion by between 30bp and 40bp a year, largely through cost savings. Compounded over 40 years of retirement saving this is a substantial sum.
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Every one percentage point of fees and other costs reduces the ultimate retirement pot by 20% |
Higher returns are the corollary of lower costs. Personal pension plans are so expensive because asset managers are commercial organizations run for profits. No corporation runs a pension fund with profit maximization as a goal. The interests of the sponsor and the plan member are broadly aligned. Empirical studies in both Canada and Australia have borne this out. Pension fund portfolios that had almost identical investment mandates as mutual funds outperformed by 1% to 3% a year after fees. Having large, well-managed pension funds is good news for society as a whole, something sadly underestimated. A pension is a means to an end: a well-funded and comfortable retirement. The more money there is in pension pots, the less of a burden retirees will be on the state. Encouraging people to save more and finding ways for them to maximize their post-work income should become a policy priority.
Fortunately there are some very simple steps that can be taken. The pooling of defined contribution plans should be permitted and encouraged. Small corporate pension funds should get together and take advantage of economies of scale. Belatedly, policymakers appear to be coming round to the necessity of pension reform. In the UK, Lord Hutton’s interim report on public sector pensions, which disburse £25.4 billion annually, is looking at the Swedish and Dutch DC systems.
The National Employee Savings Trust (Nest) launches quietly next spring and officially in 2012. It is a supplementary personal pension account scheme, which will become the default option for UK employers who do not put in place alternative provision that is at least as good. Employees will be auto-enrolled and 8% of salary will be deducted. It is estimated that it could raise £8 billion annually, so it will soon join the ranks of the super-sized.
Nest will initially charge 50bp, which includes a 1.8% surcharge on contributions but this will fall to 30bp. Sadly the maximum annual contribution is £3,600. These are the kind of pension funds that should be available to all, rich or poor, tall or small.
Andrew Capon is editor-in-chief at State Street Global Markets, the research and trading business of State Street Corp. He was formerly senior editor at Institutional Investor and has won numerous awards for journalism on fund management and investment issues. The views expressed are the author’s own
