Changes to stakeholder regulations are forcing investment trusts out of the stakeholder picture, says Debbie Harrison
The 1% cap on annual charges for stakeholder pension schemes has inadvertently eliminated investment trusts from the scope of most of these funds.
Robert Hall, a partner with the consultant Watson Wyatt, says: 'There is a problem for stakeholder schemes wishing to use investment trusts to obtain exposure to venture capital assets or to track equity indices that include investment trusts.
'Under Regulation 14 (of the original stakeholder regulations), the cap on charges must be calculated as 1/365th of 1% of the fund per day. This does not include stamp duty and stockbrokers' commissions on trading in securities.
'Under Regulation 2, the stakeholder rules specifically exclude investment trusts from the definition of securities. This means that dealing costs such as the 0.5% stamp duty charge must be included as part of the capped charges on a daily basis, which makes it extremely difficult for stakeholder-compliant funds to buy investment trusts. Many stakeholder providers have reached the conclusion that given the level of daily controls required to police the rules, investment trusts are simply not worth the candle.'
One such provider is Standard Life. Colin Ledlie, assistant general manager for marketing, says: 'This was a deliberate move by the Department of Social Security [DSS] when it drew up the stakeholder legislation. It was concerned that some providers might invest in their own investment trusts and effectively add an extra layer of charges. Unfortunately, by applying the regulation as it does, the DSS may be using a sledgehammer to crack a nut.'
The DSS is clearly determined to ensure providers do not breach the daily cap on charges. Regulation 12 requires scheme managers to make a declaration that they have adhered to the charges rules, while the reporting accountant must confirm this statement.
Where the stakeholder scheme appoints external managers as an investment option, it also has to ensure these managers are complying fully with the regulations. At present, Standard Life does not offer external links. Ledlie says: 'We are taking a cautious approach to this. We are in discussions with the DSS to ensure that any future external links comply fully with the rules. While it is comparatively easy to monitor our own funds for compliance, it is another thing altogether to check what external managers include in their funds on a daily basis.'
Venture capital route blocked
The absence of investment trusts from the stakeholder market can be regarded as a significant setback for the government, which is keen for pension funds to play a greater role in the venture capital market. This, after all, was the primary purpose of the Myners Report.
Hall said: 'The Myners Report was requested by the Treasury mainly on the grounds that UK pension schemes invested less in venture capital than US pension schemes. The most cost-efficient method to gain exposure to venture capital is through the large venture capital-oriented investment trusts.'
Paragraph 6.44 of the Myners Report states: 'The review recommends that defined contribution schemes should, as a matter of best practice, consider a full range of investment opportunities, including less liquid and more volatile assets. In particular, investment trusts should be considered as a means of investing in private equity (venture capital).'
The report suggests that for investors with more than 10 years to retirement, 'a holding of 3% to 5% of the portfolio (in private equity) is unlikely to pose any significant risk to retirement income.'
It goes on to say that it cannot be right to argue that an asset class is by its nature too risky to form any proportion, however small, of the scheme's overall investment offering. There is a danger here that just when more defined benefit schemes are coming to reject an investment strategy that ignores certain asset classes on the grounds that they are 'too risky' as irrational, defined contribution schemes may repeat similar mistakes.
Myners specifically cites investment trusts as the most appropriate vehicle for venture capital ' a sector dominated by the FTSE 100 company 3i, which at the time (March 2001) had a market capital of about £8bn. The total assets of the top 11 UK-listed investment trusts that focus on private equity were estimated at £11.4bn.
Given the providers' bid to keep investment costs down, it is particularly ironic that this charging problem affects the very index-tracking funds that have found so much favour with the government and Office of Fair Trading (OFT). While 3i remains the only investment trust in the FTSE 100, there are over 300 investment trusts in the All-Share. Passive managers can track the index exclusive of investment companies, but in doing so they reduce exposure to important venture capital opportunities.
Insurance funds are more efficient
The virtual ban on holding investment trusts within stakeholder funds represents yet another severe blow to the beleaguered investment trust industry at a time when it is trying to come to terms with the failure of the individual pension account (IPA) as a viable pensions vehicle for investment trusts. Ian Sayers, technical director at the Association of Investment Trust Companies (Aitc) says it was a great shame that the drive towards simplicity within stakeholder should result in the elimination of investment trusts just because they operate a fixed charging structure.
'The 1% cap on charges is very difficult for investment trusts due to the fact we have to charge stamp duty at 0.5% and other brokerage and dealing costs. These represent a one-off cost in the first year.
'However, over the long-term investment trust charges can be much lower than other collective investment vehicles and can fit well within the spirit of the stakeholder regulations. The unfortunate situation we have at present is that there is no dedicated investment trust IPA or stakeholder scheme,' he says.
Moreover, there are only a handful of investment trust personal pensions. Most investment houses that launched into the defined contribution market have done so by setting up a life office subsidiary. The brave few in the investment trust personal pension market include Foreign & Colonial, Edinburgh Fund Managers and JPMorgan Fleming (JPMF). The latest JPMF plan offers a simplified choice of three funds within a very competitive charging structure that can compete head on with stakeholders but cannot comply with the regulations.
Sarah Aitken, head of stakeholder products at Merrill Lynch Investment Managers (MLIM), says: 'When we looked at the defined contribution pensions market we examined the structures of all the pooled vehicles, including investment trusts, unit trusts, open-ended investment companies and pension fund pooled vehicles and decided that the most efficient method of delivery at this stage was the insurance pooled fund.'
One of the unique aspects of insurance funds is that the insurance company is the beneficial owner of the assets. The investors themselves are not beneficial owners ' they simply hold an insurance contract.
This, together with other features, means that insurance funds generally pay a lower level of stamp duty than, for example, unit trusts, while the charges are exempt from value-added tax.
MLIM is a leading player in the stakeholder market, both in its own right as a provider and as a third-party investment manager to several life office schemes. Those with long memories may recall that when Mercury Asset Management (now part of MLIM) came into the personal pension market in 1989, it did so through a life arm set up specifically for the DC market. This still forms the basis for MLIM's DC pension offerings.
Stakeholder charges make putting money in investment trusts virtually impossible
This bars stakeholder funds from venture capital, despite the recommendations of the Myners' report
Passive managers will be forced to exclude a huge chunk of the All-Share
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Investment trust savings scheme