In this series, we address and challenge common misconceptions that have led to the increased prevalence of passive investments in defined contribution (DC) schemes.
To help trustees and corporate advisers weigh the pros and cons of active management, we perform a reality check on each misconception, referencing fiduciary principles and market and member survey data.
This installment addresses the misconception that passive investment options reduce fiduciary risk, defined as the risk that the scheme services and funds do not achieve value for money.1
There is no denying that passive investments offer market returns at an attractive cost. Exhibit one shows that the average passive fund tends to cost about 21 to 59 basis points less than the average active fund for asset classes commonly offered in DC schemes.
Unintended consequences of the charge cap
A charge cap of 0.75% for default funds used for auto enrolment was introduced in the UK in April 2015 to ensure pension scheme members are 'protected from high and unfair charges and are saving into schemes that are well run.'1 This charge cap spurred some schemes to implement low-cost investment options within the default fund. While it was not intended to do so, the introduction of the charge cap changed the investment selection paradigm for scheme trustees by focusing more on cost in isolation than on 'value for money'.
"What is ‘value for money'? Value for money is about finding the right balance between economy, efficiency and effectiveness, and cannot be assessed through only one of these dimensions in isolation." - Organisation for Economic Cooperation and Development (OECD)
Issued in the UK by MFS International (U.K.) Limited ("MIL UK"), a private limited company registered in England and Wales with the company number 03062718, and authorised and regulated in the conduct of investment business by the UK Financial Conduct Authority. MIL UK, an indirect subsidiary of MFS®, has its registered office at One Carter Lane, London, EC4V 5ER.