Defined-contribution pension plans “are in their adolescence” and one workable model for their maturity is public-private entities which use social networking to promote the confidence of their members, a world authority on pension funds says.National franchise DC funds should have both public and private sector features, according to Roger Urwin, global head of investment content at Towers Watson.
Pointing to the “relative success” of the Swedish and Singaporean systems, Urwin says mature DC funds should take “the best of both worlds: the utility characteristics of a public utility, plus the market characteristics of the private sector”.
Funds in the US, UK and Australia “have not reached maturity”, he says. Looking into the future, they must appropriate social technology and harness social networking to engender the confidence of their members.
“Over time, people do learn and will learn,” Urwin says. “The membership and the organisation itself (learn) incrementally, albeit slowly.”
He says more and more members have more sense how their fund is benefitting them.
“Social technology and social networking provide one of the models by which this learning can occur.
“The future vision is one where members trust their super fund, because it’s delivered good communications, it’s appreciated for recognising the member’s segment and circumstances and it can demonstrate that this segment is better served by a certain strategy,” he says.
Funds had to do a better job of delivering good returns to members, particularly in the default, where the vast majority of members are, he says.
US target-date funds had a chequered history because of the impact of the GFC, whereas the UK was having somewhat better results with its life-cycle products.
In Australia, the track record was mixed for getting members from first-level default into more sophisticated second-level member-choice options.
As well, Australia had “not found (it) too easy to harness the governance board and the executive team,” Urwin says.
“How do those two parts produce a complementary and value-enhancing team effort? In a strongly governed fund, the product of the two parts should be greater than the sum of the parts. But for most funds achieving this is still work in progress.”
According to Urwin the global financial crisis produced a problem on both sides.
“Expectations were set at a very high level. Australian funds had a good performance run and people began to trust too much in double-digit returns. These are not sustainable returns.
“The industry has had a difficult job communicating that these past results were unrealistic going forward.”
In Australia, costs were dragging down performance and there was a tendency “to see success as judged by your peer group”.
“We have to break this habit. Costs may be addressed through (Australia’s) SuperStream and MySuper. The over-optimism of the alpha industry is a drag-anchor which carries a lot of costs, and there is too much pursuit of alpha with little overall benefit to members.
Too many funds were pursuing alpha as an unrealistic expectation, and too many products were earning too many fees for a realistic value proposition to be delivered to members.
Urwin believes the way forward is for DC funds to combine good (public) utility features with good (private) market features, but that it is yet to be tried widely.
“It’s too early to judge,” he says, adding that many of the problems of pension funds were because they are sub-scale.
But his system criticisms are not directed at DC funds alone, turning to defined-benefit funds, he says in the US, the public DB funds had a measurement problem because the yardstick for solvency was “quite optimistic”.
“They are not run well from a sustainability viewpoint. They are relying on the future generations’ contributions: this is not sustainable and it’s not equitable.
“DB in most places is dead in the private sector, but the public sector is ‘more stuck with it. There is a big problem with inter-generational equity.”
In contrast, defined contribution dealt with the inter-generational equity issues because the individual was taking on risk individually.
“The question is ‘can a country’s government run a high-grade investment organisation?’ It’s certainly not impossible but it’s a bit of a stretch.”
Governance will be crucial in the future, Urwin says. Funds must step back and ask how they could organise themselves to take investment decisions quickly and effectively.
Urwin’s latest paper on DC funds, in conjunction with Oxford University’s Gordon Clark, is at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1652680