The Department for Work and Pensions has just launched a new campaign to explain the new single-tier state pension.
The new single-tier state pension, which will replace both the basic state pension and the state second pension (S2P) is now only 16 months away. While the focus of late has been on increased flexibility for private pensions, the state pension reform is in some respects more significant, if only because it will affect many more people.
The Department for Work & Pensions (DWP) has launched what it describes as a “new multi-channel advertising campaign” which it hopes will “ensure everyone knows what the State Pension changes mean for them.” That may be a tall order to judge from some research results which the DWP published alongside the press release announcing its new campaign. That research showed:
• 42% of people yet to retire admitted that they needed to find out more about saving for retirement;
• 38% conceded they “try to avoid thinking about” what will happen when they stop working;
• Only 60% of those surveyed realised it is possible to take action to increase their State Pension; and
• 37% of those aged 65 or over thought (wrongly) that the amount of their state pension will change as a result of the reforms. Although the DWP did not ask the obvious question, the chances are very few in that group were expecting a cut in payments after April 2016.
The DWP’s ministers “are urging everyone – and the over-55s in particular – to look at what the changes will mean for them and to secure a detailed State Pension statement so that everyone can plan accurately for retirement.” It is a recommendation we thoroughly agree with. However, be warned that if you have ever been a member of a contracted pension scheme you could well find that your projected state pension is less than “around £150 a week”, which is commonly quoted – even by the DWP in its press release.
The price of crude oil has fallen around 40 per cent since a recent peak in June this year. This has a profound effect on economies and markets around the world as the cost of manufacturing and transporting goods falls along with oil producers’ income and the currencies of oil-rich countries.
The theory goes that consumer spending will rise because people have more disposable income; that inflation will fall as the price of goods eases; and that companies with high energy bills will become more profitable. If lower prices hold, the effect might become political and environmental as the balance of world power shifts from oil exporters to oil importers, and the impetus to develop cheaper clean energy wanes. Oil seeps so deep into the global economy you might think that to be a successful investor you need to have an accurate view on its price and its impact on asset prices. But you would be wrong.
No-one with an opinion about oil knows whether their view is right or wrong, and only the changing price will confirm which they are. Market prices are a fair reflection of the balance of opinion because they are created by many buyers and sellers agreeing on individual transactions. As an investor you can take a view of whether that balance – that price – is right but, like all other people with an opinion, you have no way of knowing whether you are right or wrong until the price moves.
Knowing this, it seems irrational to take a view (or a risk) on something so random as the direction of the oil price. In fact, why would one take a view on anything related to the changing price of oil; the US economy, for example; or the price of Shell; or Deutsche Post; or anything else?
The rational approach is to let capital markets run their course and to have a sufficiently diversified portfolio that allows you to relax in the knowledge that, over time, you will benefit from the wealth-generating power of your investments as a whole; without risking your wealth on a prediction that might go one way or the other.
Most investors are aware that their funds levy annual charges against their funds. These comprise the Annual Management Charge which ranges from 0.1% to around 1.8% or more for UK mutual funds. In addition the funds are required to publish certain additional fund charges such as custody and legal costs. These two items make up the Total Expense Ratio (TER).
Many investors are unaware of the fact that, in addition to the TER, funds incur costs in two other ways. One of these, the Portfolio Turnover Rate (PTR), is caused by the costs which fund managers incur when the buy and sell stocks. The more they do this, the greater the PTR. In the UK the estimated cost of a sale and purchase is around 1.8%, when Stamp Duty is taken into account. The average UK fund turns over its portfolio by around 100% a year, thus adding around 1.8% onto investors’ costs. Many funds have PTRs of twice or more this level.
A further area in which investors can incur costs is the price at which funds are able to deal in their shares. Generally shares are offered for sale or purchase by market makers in batches of say, £250,000 or £1Million. On dealers’ screens the best priced batches are generally shown at the top of the list with prices getting worse further down the list. A fund needing to offload £10Million of a particular stock could therefore find its self selling via a number of market makers and not all at the best price available on the market. This can be a substantial hidden drag on fund performance, especially for very large funds or those which trade actively.
So what can be done about this? Bearing in mind that the method of access to the market (fund selction) is very much a secondary decision, well behind Asset Allocation, the optimum way to keep fund costs down is to invest in passive or tracker funds. These can be expected to provide returns in line with the performance of the market at low cost. In addition certain passive funds engage in dealing strategies designed to optimise the price at which deals are carried out.
Hidden Costs of Investment
Passives and Index Trackers are vastly cheaper than Active Funds. It is not just a question of the Total Expense Ratios but also the cost of turnover.
Take the UK All Companies Sector as an example. Most actively managed funds have an Annual Management Charge of 1.5% pa. In addition they have other expenses declared of typically another 0.1% to 0.2% pa. Let’s be nice to them and say, on average, the combination known as the Total Expense Ratio (TER) amounts to say 1.6% pa.
Compare this with say Fidelity Money Builder UK Index Tracker with an AMC of 0.1% and a total TER 0.28% pa. Before even considering portfolio turnover costs the average Actively Managed fund has to deliver a further 1.3% or so per annum without taking any more risk than the index as a whole in order to simply match a tracker. Of course, there is no point in paying extra simply to break even with what you would have got if you just tracked the index.
Let’s now look at Portfolio Turnover Rates (PTR). These describe the proportion of the fund that has been turned over due to sales and purchases and is calculated according to a formula prescribed by the FSA. It is now a requirement for these to be published for UK unit trusts and OEICs within the Simplified Prospectus. You still have to hunt around for these figures as they are often quoted separately to other cost data. I am collating details of these prospectuses and will publish links in due course.
In the FSA Occasional Paper on the Cost of Retail Investments http://www.fsa.gov.uk/pubs/occpapers/OP06.pdf and, in particular on page 28, the average cost of a deal in a UK fund has been estimated at 180 basis points (1.8% to you and me). To find the cost of turnover you have to multiply the above cost by the PTR.
If you take the average PTR of an Active UK fund of 70%-90% (page 47 of the FSA paper) you end up with costs in addition to the TER of between 1.26% and 1.62%. If you take the Fidelity Special Situations Fund PTR of 137% you get an overall portfolio turnover cost of 2.46%. Quite a few active funds have PTRs of over 200%.
To get the total annual cost you have to add the PTR cost to the TER. This means that the actual annual cost of the average Active UK Fund amounts to between 2.86% and 3.22%. In the case of the Fidelity Special situations Fund you get total annual fund costs of 3.96% pa.
Contrast this with some trackers. The F&C FT All Share Index Tracker has a PTR of 0% and a TER of 0.39% and the Fidelity Money Builder with a TER of 0.28% and a PTR of -2.3%. These mean that the average active fund has to outperform them without taking any more risk by up to 2.94% per annum.
The sad truth is that most active funds can’t even achieve index levels of returns let alone beat them. So, why would you pay extra for that?