I looked into this a few years ago and found the whole process incredibly frustrating.My question once more is whether any Irish pension provider can offer the small retail investor a better shake than this.
By my very rough calculations it would be several years before I saw any profit given the high costs associated with on-boarding a new client - yes, even one who “knows exactly what they want”
So naturally there has to be a fee paid upfront to reflect the time to meet these regulatory requirements but also to reflect the added value.
To turn the question around. If I can significantly reduce the ongoing charges why should all that benefit accrue to the investor?
So what would be a reasonable up front cost to pay to set up a pension with lower ongoing charges?
@Marc: I realize that actors in the Irish financial services industry incur high compliance and operational costs. Every machine has its friction, and the small size and fragmented nature of the Irish retail market doesn’t help. I’ve read pieces in the Sunday Business Post, the Irish Times, and the Irish Independent over the years in which you were interviewed, and I’m grateful to you for fighting for lower costs and more transparency. I guess that many people—not without reason—mistrust the financial services industry, and so even the good guys often get tarred with the same brush. Of course you’re entitled to get paid for your services; I explicitly said as much in an earlier post. And if you can significantly reduce ongoing charges for investors, then presumably some of that benefit should accrue to you too.
So, to your question “what would be a reasonable upfront cost to pay to set up a pension with lower ongoing charges?” It’s an interesting question, and the short answer is that for several reasons that I’ll do my best to spell out, I don’t know.
Firstly, there is an asymmetric information problem that creates an imbalance of power between industry insiders and their retail clients, and a consequent atmosphere of suspicion. I have only a fuzzy idea of the costs to the provider of setting up a pension, and so it’s hard to say what would be a fair retail price to pay.
In the abstract, the question of how to divide fairly the savings from reduced ongoing charges between the adviser and their client could be framed as a variant of the ultimatum game from behavioural economics, with which I’m sure you and many of the forum members are familiar. The proposer is given a sum of money (say one hundred euros) to divide with another player, the responder, who can choose to accept or reject the proposed division. If the responder accepts, then the money is shared as per the proposal; if they reject the offer, then neither player gets anything. Narrow economic rationality would suggest that the responder should accept any amount down to as little as a single cent, since any amount of money is better than none, but although experimental results vary widely, responders often reject proposals of under 30%, since they don’t like to feel they’re being exploited.
So perhaps the economically rational investor should be prepared to pay any amount up to one cent less than the reduction in charges (plus some small sum for the inconvenience of switching) to move to a lower cost provider.
Or, perhaps one could frame the question in terms of a fair distribution of spoils between capital and labour. Arguably, since the investor, in putting up the capital, is taking all of the risk, they should be the one who receives most of the reward.
Suppose, for the sake of argument, that a 50/50 division is fair. If investor X is paying company A €1,000 a year to manage their portfolio, when it only costs €500 a year to keep the lights on and the salaries paid, then in theory, company B could do the same job for €500. Company B could then offer to manage X’s portfolio for €750 a year, effectively splitting the savings 50/50. But there is still €250 of profit left on the table, so in a competitive market, company B would be undercut by company C, who could again offer to split these profits 50/50 with investor X, charging them €625, spending €500 on overheads and payroll, and making a profit of €125. And so on until in theory all the savings accrue to the investor in a perfectly competitive market...
I’m sorry if it seems like I’m podding through toy examples from Econ 101; I’m just trying to formulate a genuine response to the question you posed by thinking through simplified—but hopefully clear—cases, and going back to first principles to do so. From one angle, the provider should get almost all of the savings; from another, it should be the investor. But in a highly uncompetitive market like Ireland’s, the situation more closely resembles the ultimatum game: the pension providers and intermediaries hold most of the cards, and thus end up with most of the loot, which may explain the frustration of many posters on this forum.
More narrowly, the question of how much it would be worth to the client to pay upfront to reduce ongoing charges is a difficult one, because an accurate answer involves several variables, only one of which is known. It depends on (1) the initial balance, (2) the size of subsequent contributions, (3) the period over which those contributions are made and the associated ongoing charges reduced, (4) the rate of return on the balance invested and (5) the future availability of other options owing to regulatory changes and new entrants to the market.
As a first pass through, if one takes a somewhat arbitrary break even point of ten years out, then one might think it would be worth paying anything under €1,000 upfront to save €100 a year for ten years, but the future savings need to be discounted to allow for the time value of money.
So, if we fix (1), plug in guesstimates for (2), (3), and (4), and handle (5) by assuming that the regulatory and market environment will not change during the given period then the mathematical formula that should be used to answer the question would be that for the present value of a growing annuity. Let me try a worked example:
Suppose somebody on the median Irish salary of €37,775 has been investing for 15% of their salary for 14 years and has accrued a pension balance of €100,000. If they contribute €5,666.25 or 15% again this year and earn a 6% nominal return, then at the end of the year they’ll have €112,006, and with a Davy PRSA they’d pay a 0.75% dealing charge of €840.05. (The charge is on the average, not the year-end balance, but I’m using the year-end balance to keep things simpler.) Assume that their salary grows at a nominal rate of 3.75% per annum, and that they continue to contribute 15%, and make a nominal annual return of 6%. (I arrived at the salary growth rate as follows. Assume that a person at the end of a 40 year career earns double what they did in inflation adjusted terms when they started out. The rate at which a sum of money doubles over 40 years is 1.734%, so rounding up and adding back inflation of 2% gives 3.75%.). Then their pension balance, and thus their annual dealing charges will increase at a rate of approximately 10% a year. Plugging this in to the present value of a growing annuity formula, one gets:
PV = (P / (r - g)) x (1 - (((1 + g) / (1 + r)) ^ n)), where
P = first payment
r = rate of return per period (discount rate)
g = growth rate of annuity
n = number of periods
In the case above PV = (840.05 / (0.06 - 0.10) x (1 - (1.10 / 1.06) ^ 10) = €9,416
Strictly speaking, since the rate at which the pension fund balance—and thus the annual dealing charges—increases is not exactly constant, the present value of an annuity formula answer is only an approximation. To see this, imagine somebody who is just starting to save €5,000 a year. At the end of year 1, they have €5,000, at the end of year 2, €10,000, and at the end of year 3, €15,000. So the rate of increase from year 1 to year 2 is 100%, but from year 2 to year 3 it’s only 50% etc. But after a few years, when the ratio of the balance to the contributions is high, this effect is rather minor, so the approximation is quite close. I worked out the exact figure using a spreadsheet, and the present value came to €10,276.
So, for somebody on €37,775 with a pension balance of €100,000 who intends to keep contributing 15% of a salary that they expect to grow at a nominal rate of 3.75% making a nominal return of 6% on their investments and paying 0.75% in annual dealing charges, the present value of those future charges over the next 10 years is about €10,000.
Suppose a provider or an intermediary can offer a comparable selection of investment options (low cost broad index based funds) and can reduce the dealing charge by 50% to 0.375%. They’d save about €5,000 in charges over the following 10 years. If the professional and their client were to divine those savings equally between them, the professional could charge €2,500 to set up the pension into which the €100,000 balance was to be transferred, which is in the ballpark of what an expensive solicitor here might charge in conveyancing fees for handling a property purchase.
I’m not suggesting that this figure of €2,500 is reasonable or fair, or that a 0.375% dealing charge represents good value for money, and there are multiple assumptions I’ve made that could be challenged. I also agree strongly with @Qwerty22 ’s excellent points that people shouldn’t have to pay for what they don’t need, that there are too many intermediaries in the Irish system that are extracting rents rather than adding value, and that the Pan-European Pension Product can’t come quickly enough. But I just wanted to work through a possible scenario quantitatively in order to anchor the discussion in some actual numbers. I’d be interested to know what you think of my analysis @Marc...
@Investor
The (effective) 100% allocation only applied to the initial premium.
The €150 policy fee essentially "buys" a 20bps discount from the AMC that would otherwise apply. That deal made sense in my circumstances - it definitely wouldn't make sense in all circumstances.
The 70bps spread between the unit prices and the net return of the relevant underlying indexes is the (approximate) blended average that I have observed over the last few years. That spread would capture the AMC, policy fee and whatever other costs the life company decides to apply to my policy. It's not the spread between the unit prices and shares in the underlying State Street funds.
Again, I don't think it's a particularly good deal. But I have yet to see a better one in the Irish market.
I guess it depends what's agreed with the broker - there's no "standard" commission level AFAIK.@Sarenco: Thanks for the clarification! When you say that that 100% allocation rate only applied to the initial premium, does that mean that if somebody were to set up a similar pension plan with Friends First/Aviva into which they wanted to make continuing contributions, they’d face ongoing broker’s fees/contribution charges of 2% on each of those continuing contributions?
Thanks for taking the time to set out a logical argument and as my first degree is in economics I really appreciate the detailed analysis.
I also really like the conveyancing analogy.
I don’t expect my lawyer to live in my house with me but I do expect them to perform a professional service to complete the purchase for me and I’m prepared to pay a reasonable fee for what represents a very significant investment.
By this logic for many people their pension will also represent a significant investment of the same order of magnitude as the house purchase.
Whereas, by extension, a traditional adviser client relationship is more like a landlord and tenant relationship whereby there is a closer ongoing economic relationship between the two parties.
Some investors are happy to pay a rent (ongoing advice fee) others feel that they want to own their own house (pension)
Disintermediation in financial services has been ongoing for as long as I can remember with Big Bang in the city of London in 1986 and the demise of jobbers and the opening up of equity investment to more people.
I was able to trade my first shares in the late 1980s something that would have been virtually impossible before then.
Meanwhile the regulatory pendulum has been swinging back and forth and last year saw a raft of regulations intended to promote transparency and investor protection but naturally has resulted in a significant increase in base costs.
Our custody charges for example have increased from 0.09%pa with a non-MIFID II compliant custodian to 0.30%pa just to be able to meet the ongoing reporting obligations.
Something ironic in a regulation intended to make it clear to investors just what they are paying in annual fees directly resulting in a threefold increase in the fees that they are paying!!!
I think it should be possible to offer an independent, fee-only consultancy service to meet the regulatory requirements and allow DIY investors the opportunity to make their own investment decisions.
I had to laugh at the reference to Hargreaves Landsdown, one of the worst offenders in taking hidden commissions from investors by promoting “Best Buy lists” but I take the point.
I think it should be possible to offer a fixed fee to arrange a pension structure with an open architecture platform.
I’ll need to work through how orders would get placed etc but in principle it should be achievable.
There would need to be a comprehensive guide on the underlying structure to replicate the role an adviser would normally take so that investors didn’t try and make transactions against their own self interest - something an adviser should normally catch.
I think the pricing would be something like this
An initial consultancy fee - this would be subject to VAT - an unfortunate by-product of the intermediation in financial services status quo.
The best way to manage costs would be then to refer to another intermediary to implement since that fee could be charged to the pension account (except in the case of a PRSA) and since intermediation is not a VATable activity and could be paid from pre-tax assets (the pension) this would make the most sense for anyone except a VAT registered business.
On an ongoing basis I think it would make sense to offer two charging models to cover the cost of providing ongoing account servicing - this is not the same as ongoing investment advice which would not be provided but rather dealing with essential ongoing account administration like updating Anti money laundering documents etc.
1) an ongoing fee to cover activities like reporting and occasional ongoing admin that would be ordinarily required to operate an account. So maybe something on the order of 10 to 20 bps.
2) the cheap as chips option with no ongoing fee but with all ongoing adviser interventions charged at an hourly rate of say €100pa
My guess would be that it would be possible to offer a pension structure for 40bps plus the OCF of the funds selected
So an investor choosing the AUM service charge would get a contract for 50 or 60 bps rather than 75.
An investor paying per use would get their base pension cost down to 40bps or 50bps for a PRSA.
Dealing in funds would be at zero cost. Dealing in ETFs would be at an additional cost.
The only quirk is a PRSA can only include either zero ongoing or 0.25%
So that might need to be arranged by way of a separate service charge which may well be subject to VAT and would need a whole heep more thought.
Equally I think you’d be clinically insane to want to run your own ARF without an adviser, the risk of loss of mental capacity alone makes this an immensely complex product to try to DIY.
But following the same principles, it should be possible to have a base cost contract at around 0.30% plus an ongoing service fee.
I guess it depends what's agreed with the broker - there's no "standard" commission level AFAIK.
However, bear in mind that beyond a certain level annual costs levied on the fund become way more important than the level of commission on further contributions.
I recently helped a friend to set up a non-standard execution only PRSA with Davy Select, and was hoping to get some feedback on our implementation of the portfolio. (I’m not a fan of the Life Assurance companies, since so many of their funds are actively managed, opaque, and have all kinds of hidden costs.)
Here is the plan in outline:
STRATEGY
1. Euro cost average by making monthly contributions.
2. Commit to maintaining a diversified stock/bond asset allocation in low cost broad index based ETFs rebalanced annually.
3. Begin with an 80/20 stock/bond allocation, and reduce the stock allocation by 1% per year after reaching the age of forty-five when rebalancing the portfolio until the allocation is 60/40 at sixty-five.
IMPLEMENTATION
a. Stock ETF: Buy or sell Vanguard FTSE All-World UCITS ETF [ticker VWRL] denominated in euros on the Amsterdam Euronext Exchange once a year when rebalancing the portfolio. (Don’t buy it in sterling on the London Stock Exchange.) Since Davy charges a 0.10% fee and a €25 foreign transaction settlement charge per trade for each instrument listed outside the UK and Ireland, it is cost-prohibitive to buy VWRL monthly. So, as a workaround, buy iShares MSCI World SRI UCITS ETF [ticker SUSW]—a euro denominated global environmental, social and governance fund available on the LSE which tracks the MSCI WORLD SRI Select Index (which correlates quite closely with the MSCI World Index)—on the London Stock Exchange monthly instead, for which Davy levies no trading charges, and sell the entire position to buy VWRL stock ETF and/or AGGH bond ETF when rebalancing the portfolio annually.
b. Bond ETF: Buy euro-hedged iShares Global Aggregate Bond UCITS ETF [Ticker AGGH] on the LSE.
c. Perhaps consider diversifying further in the future when the portfolio has grown by assigning 10% of the stock allocation to a small-cap value ETF (for higher expected returns at the cost of extra volatility), 10% to a REIT (for inflation protection and added diversification), and possibly 5% to an Irish ETF (a little home bias may be behaviorally justified). There are not many euro-denominated choices available on the LSE, so the options to build a more complex portfolio are limited, and the ETFs listed below are small and thinly traded with large bid-ask spreads. Thus they’re not ideal, but there’s nothing else.
Small-cap value ETF: WisdomTree Europe SmallCap Dividend UCITS ETF EUR Acc [Ticker DFEA] (Note that this ETF tracks a fundamentally weighted index.)
REIT: SPDR® FTSE EPRA Europe ex UK Real Estate UCITS ETF (EUR) [Ticker EURE]
Ireland: WisdomTree ISEQ 20® UCITS ETF [Ticker ISQE]
d. Be prepared for a worst-case scenario loss of up to approximately 35%, but expect an annualized inflation-adjusted (i.e. real) return over time of approximately 4%.
NOTES
Assume a 70/30 stock/bond allocation. Then, ignoring ETF transaction costs such as bid ask spreads, market impact costs, and net asset value premiums and discounts, the approximate cost of ownership as a percentage of assets under management works out as follows:
(0.75% Davy annual dealing charge) + (0.25% VWRL ongoing charges figure x 0.70) + (0.10 AGGH total expense ratio x 0.30) = 0.955%.
The actual cost is a little higher because of the iShares SUSW ETF expense ratio of 0.30% and the once a year 0.06% + €25 Davy overseas charge to buy the Vanguard VWRL ETF, but the effect of these additional costs will diminish over time as the size of the portfolio and the bond allocation percentage increases. In short, over the lifetime of the PRSA, the cost of ownership should come very close to 1%, which is very high by international standards, but not bad for Ireland.
Any criticism of the above plan would be greatly appreciated...
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