Fund returns set to fall

The 1% stakeholder cap will be a bigger drag on absolute returns than has so far been recognised due to lower long term returns on investment, predicts pension asset managers Phillips & Drew.

The group's report, Pension Fund Indicators, states the cumulative effect of the flat rate, coupled with the downward trend in investment returns, particularly on long-dated bonds, is likely to be substantial.

Andrew Maclaren, director at Phillips & Drew said on current rates over half the real return from long-dated index-linked gilts would be swallowed by charges.

He warned the same fate could be shared by riskier asset classes, such as equities.

Maclaren said: "With index-linked gilts that have yields as low as 4% the effect of the cumulative 1% charges could be to wipe off up to half of the real returns.

"Most people would say they would probably do better with other assets like equities, but they are riskier and it is possible that you might even do worse than with gilts."

Equities advanced at rates far in excess of economic growth and falling inflation in the decade from 1990 to 1999 according to Phillips & Drew, with the ratio of stock price to peak earnings rising by 150%. Looking forwards the report concludes long-term returns on equities are likely to be much lower.

Maclaren said: "Clearly this picture is based on forecasts. It is easy to see why when you see that the return on index-linked bonds and long-dated gilts is much lower than it has been in the past.

"On equities you cannot be so certain, but most people would accept that equities are very highly rated in comparison to the past.

The best you can hope for would seem to be they maintain their current level of performance but it does seem likely that those returns will be lower."

The firm suggested the increasingly tightly defined UK pension scheme mandates may need to be broadened to exploit anomalies outside of their current investment universes.

Pension fund consultants could help schemes by shifting benchmarks away from low yielding assets.

Maclaren said the stakeholder charging framework would particularly hurt the less affluent saver, as opposed to savers in big institutional schemes.

He said: "Although competition for large group stakeholder plans will result in their charges coming down below 1%, smaller schemes and individual pensions will likely be near the 1% ceiling.

"They will be the kinds of schemes available to relatively poorer savers."

Maclaren said the difficulty in remaining competitive in the stakeholder market could result in a universe of only four or five main players, with other pension providers taking up niche positions.

Given these factors, a stakeholder scheme may not be the best solution to the saving needs of the poorest 50% of the UK population.

For them stakeholder pensions would appear to be less attractive than keeping cash on deposit or in low-cost Isas, he said.

He added building up a pension fund would be difficult for many and in a lot of cases probably not an intelligent use of funds, particularly if it is likely to reduce future state benefits.

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