So the call from shadow pensions minister Gregg McClymont for strict price controls on the new wave of 'drawdown' products being created by the financial services industry, seems sensible. The government is introducing cap of 0.75 per cent on workplace pensions schemes in April 2015, but the new cap does not include income drawdown schemes.
Attempting to compare drawdown providers is already difficult, as we found earlier this year, when we tried to identify the cheapest offerings for investors.
However, in response to McClymont's proposal, Hargreaves Lansdown protests that low-cost drawdown is already here: "We offer a drawdown plan today that only charges only a one-off fee of £90 including VAT, far below any possible price cap." Yes, that looks cheap, but Hargreaves death charge at £295 +VAT is much higher than many of its rivals. And that is not the 'only' charge. The real costs are incurred on additional layers of charges - for example, on the underlying funds that you will be investing in to produce a retirement income.
Here, most investors need a simple all-inclusive charge comparison. The FCA Consumer Panel has recently handed out guidelines in which it said it was 'unacceptable' that full fund costs are not disclosed to consumers and the Investment Management Association (IMA) which represents the open-ended funds industry says it has developed a new pounds and pence disclosure measure. But even if we eventually get a satisfactory and true total cost of charges figure, it still won't swing the balance of interests in favour of the investor.
A report by Cass Business School "Heads we win, tails you lose" found a clear 'incentive mismatch' between the best interests of investors and managers. It recommends that fund managers should consider adopting a fee structure that better aligns investors' and managers' interests by sharing losses as well as gains.
"The most common fee structure in the UK funds market, a fixed fee as a percentage of assets, is generally the best structure for managers and the worst for investors," said Professor Andrew Clare, co-author of the report.
Ideally, he says fees should go up if a fund outperforms, but they should also go down by an equal proportion when the fund underperforms. According to Morningstar, a few countries, like Norway and the US, require fund companies to employ this symmetrical structure for performance fees.
In the US, mutual funds by law must use a form of an incentive fee known as a 'fulcrum fee'. The specifications of the fulcrum fee were laid out in a 1970 amendment to the Investment Company Act of 1940. US funds have a base fee that acts as a fulcrum around which the performance fee rises or decreases based on the funds performance against its benchmark index. Increases in fees for performance above that index are matched by decreases in fees for performance below the index. In addition, in practice the incentive component of fees always has an upper limit and a lower limit on size.
Capping charges is fine, but what UK investors really need are fee structures that are skewed more in their interests.
