By Dale Critchley, Workplace Policy Manager, Aviva
The Pensions Regulator has commented on the industry’s focus on charges stating that “high fees, with nothing to show for it, erode pots cumulatively over decades to leave savers poorer. But it is impossible to invest, or even to consider investing, in a broader range of assets – which could provide diversification benefits and higher returns – if the ceiling for investment costs is, as some say, below 10 basis points”.
Although they don’t mention it, both statements point to behavioural biases, known as Prospect Theory. These biases mean decision makers will tend to value avoiding a loss more than making a gain, and value certainty, the gain from a small reduction in charges, over the prospect of much larger potential gains if investment performance improves. Asking decision makers to do otherwise is to set aside human nature.
Where professional advisers are involved, decisions about where to place a company pension scheme or how to invest contributions in a default arrangement, are more likely to be based on an analysis of data, risk and return, but we can see that Prospect Theory has still had a significant impact on the defined contribution pensions market.
Charges have been reduced over time, while default design and the prospect of higher returns, from active management or more expensive asset classes, have been downgraded in importance. We exist in a market where a 0.01% reduction in charges can been seen as important, yet many times that difference in past investment returns might be overlooked, and not a guide to future performance. With the value offered by service being difficult to gauge, it is little surprise that our instinct to simplify decisions comes into play, and there is a focus on the certainty of charges.
The value for money framework will perhaps offer the greatest challenge to the status quo. It will demand that decision makers within schemes look at what they are delivering for savers, compared with the largest schemes in the market. This will be a more balanced score card, and one that aims to address some of our behavioural biases by presenting comparable data across the three pillars of charges, investment performance and service.
Those governance committees and trustees who find that their scheme has underperformed, or is at risk of underperforming, will need to take action to improve the outcome for savers. In doing so, they will potentially need to overcome a slew of behavioural biases. One of the biggest challenges will be shaking off any bias toward the certainty of charges, to potentially embrace the uncertainty of investment returns, when it’s in their members’ long-term interests. They will perhaps need to avoid confirmation bias and accept that their views may not have been driving the best outcomes for savers, accept new thinking or investment in different asset classes. Trustees may even need to overcome ownership or endowment bias and decide that savers could be better served in another scheme.
The FCA has clearly recognised the potential for loss aversion to dampen opportunities while the Pension Regulator is recognising the downside of certainty bias. The new value for money framework will refocus the decision making of those who operate and oversee workplace pensions, but employers and advisers, who drive the demand side of the market, might also consider whether their decision making is entirely objective, and how taking into account behavioural biases might improve the retirement prospects of savers.
FCA - Our strategy 2025 to 2030
TPR - https://www.thepensionsregulator.gov.uk/en/media-hub/speeches-and-speakers/pensions-regulation-and-growth
https://www.economicsonline.co.uk/definitions/prospect-theory.html/
https://www.spw.com/wealth-lens/behavioural-finance-why-we-can-make-irrational-investment-decisions
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