WHITEPAPER

December 13, 2015

The hidden trade-off between DC pensions

By Zuhair Mohammed

DC investors are making a costly trade-off that many are completely unaware of. The focus on daily liquidity in DC pension products might provide members with the ultimate flexibility governments want them to have, but the vast majority of members neither use that flexibility nor realise the hidden cost at which it comes. Research points to a potential gain of five percent or more if DC pension pots were allowed to invest in illiquid assets. As the pensions environment and demographic changes place ever more pressure on individuals’ retirement savings, governments can no longer afford to ignore this issue and must launch consultations on the sense behind both daily liquidity and charge caps. Savers deserve to know about the compromises they are being forced to make. It is time for a serious rethink.
  1. Is daily dealing really necessary?

The move towards daily trading has no basis in sound reason from a typical member’s perspective. It was born of competition between administrators who differentiated themselves from their peers based on the speed at which they invest/disinvest member contributions. This meant a shift from monthly to weekly and, ultimately, daily trading.

The perceived greater efficiency this created lured people into believing it must be good. Regulators, keenly focussed on promoting flexibility in pensions arrangements, certainly seem to have adopted this view, which is clear in the liquidity constraints placed on mutual fund structures such as UCITS funds and in how they regulate the pension provision market.

But in the rush for ever-more rapid trading, people were not thinking about the impact that trend would have on investment outcomes.

In reality, most people don’t make use of the flexibility today’s DC pension framework affords them. And if flexibility means lower returns, then that should also be explained to savers given the compromise they are being forced to make.

The vast majority of pension scheme members would probably find monthly trading acceptable. Evidence from around the industry suggests few trade more frequently than this, even when markets are behaving in a manner that should create considerable concern.

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