Weekly Roundup, 8th August 2022

We begin today’s Weekly Roundup with CDC pensions.

CDC pensions

The government has announced the launch of Collective Defined Contribution pension schemes (CDCs) in the UK, as an alternative to DB and DC schemes.

• With CDCs, both employers and employees make contributions (as with DC) but into a collective fund.

The fund makes regular predictions about what kind of income the pot will produce on retirement, but there are no guarantees.

The recently reinstated Minister for Pensions, Guy Opperman, said:

CDC schemes have the potential to transform the UK pensions landscape. We have seen the positive effect of these schemes in other countries [largely the Netherlands] and it is abundantly clear that, when well designed and well run, they have the potential to provide a better retirement outcome for members, and can be resilient to market shocks. I have no doubt that millions of pension savers will benefit from CDCs in the years to come.

People won’t be able to choose the CDC option for themselves – that decision lies with the employer.

• Royal Mail is the only high-profile firm to commit to using CDCs so far.

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CDC is being pushed as “safer” and “lower risk” than DC:

1. Longevity risk is pooled amongst members, who need not (cannot) take a view on how long they will live and invest accordingly
2. Investment decisions and drawdown methods are taken out of the pensioner’s hands, so they can’t get things wrong

I think these are simplification measures, rather than safety features.

We looked at CDCs when they were first proposed, and came out against them.

• CDCs have one true advantage for the pensioner – scale, which should in theory lead to efficiency, lower fees and greater diversification.

There’s also the advantage for the operating company that CDC schemes are unlikely to fall into deficit.

They have numerous disadvantages:

1. You have no control over the underlying investments
2. You’re forced to take the income on offer, which is like a return to the annuity system
3. The income is no longer guaranteed (as in DB) and is potentially variable
   • Annual increases are at risk depending on investment returns.
   • Recessions and market crashes could lead to benefit reductions
4. Retired members can receive more than the current natural income (with future investment returns making up the gap)
   • This is the same problem that made DB pensions unaffordable

There’s also the issue of how any existing schemes (particularly DB) could be converted to CDC:

• Can accrued rights be removed from DB members?
• Might trustees of an underfunded DB scheme engineer a further decline in its funding position to incentivise the member to convert to CDC?

FCA regulation

In FT Adviser, Sally Hickey reported on FCA plans to “protect” investors from “high-risk” products.

• The Financial Conduct Authority thinks that people are investing without understanding the risks involved, and the products concerned do not reflect the risk appetite of the investors.

A policy document released last week will require clearer and more prominent risk warnings.

• Incentives to refer friends and new joiner bonuses (widely used by fintech startups) will be banned.

The classification of high-risk investments has been simplified (though I haven’t seen the new definitions).

• Peer-to-peer lending and equity crowdfunding appear to be the target sectors.

FCA director of markets, Sarah Pritchard, said:

We want people to be able to invest with confidence, understand the risks involved, and get the investments that are right for them which reflect their appetite for risk. Our new simplified risk warnings are designed to help consumers better understand the risks, albeit firms have a significant role to play too.

Where we see products being marketed that don’t contain the right risk warnings or are unclear, unfair or misleading, we will act. This is even more important now because increases in the cost of living could prompt people to chase higher investment returns which may prove risky.

Crypto assets are not included, as the FCA is waiting for legislation to bring crypto marketing under its authority.

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Sally’s second article looked at the FCA’s proposal to open up Long Term Asset Funds (LTAFs) to more retail investors.

• LTAFs were dreamt up in response to the recent liquidity crisis in open-ended funds (OEICs) that invest in assets like property.

They have a 90-day notice period for redemptions and are designed to be used for infrastructure, private equity, venture capital, forestry and real estate.

• They must have a minimum 50% allocation to unlisted or long-term assets.

The structure was approved last October, but no LTAFs have been launched so far.

• I can’t see the point of them myself – we already have investment trusts, which seem well-suited to the task.

Anyway, the FCA is planning to allow “restricted” investors to buy LTAFs.

• Restricted investors self-certify to say that they won’t invest more than 10% of their assets into illiquid stuff.

The category was invented in 2019 for peer-to-peer lending, so presumably, the 10% allowance will now be split between P2P and LTAFs.

(Self-certified) high net worth and sophisticated investors can already buy LTAFs (though I don’t know why they would want to).

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The third article from Sally looked at industry criticism of the lack of detail on whether LTAfs can be included in ISAs.

Lora Froud, a partner at Macfarlanes, said:

The tax incentive would encourage individuals to lock up their savings for a longer term with a better prospect for investment returns. However, the FCA indicated that HMT and HMRC are responsible for the matter. We hope that they will move ahead with this.

No mortgages on second homes

In FT Advisor, Ruby Hinchliffe reported that Leeds Building Society will no longer offer mortgages for second homes.

CEO Richard Fearon  said:

Second homes reduce the number of properties available for people to live in at a time when housing supply in the UK is inadequate to meet demand and needs to be increased. We want to direct more of our efforts to other sectors, especially first-time buyers.

We don’t think second homes are compatible with our purpose, which is to put home buyers first. Any home other than a main residence usually lies empty most of the time, which does not serve the local community or contribute to the local economy.

New homes are significantly undelivered. So one way of tackling that is by making use of existing housing stock.

The UK has around half a million second homes.

Leeds will still offer mortgages on holiday lets, which need to be available for rent for 24 weeks of the year (and let for 10 weeks).

• And it will also lend to buy-to-let investors.

Drawdown tax

The bi-annual survey of 190 UK financial advisors by abrdn has been published.

• Arguably at the top of their wish list was the removal of emergency tax on pension drawdown income – 26% of respondents put this at number one, and 59% had it in their top three.

That would certainly suit me, as waiting months until the end of the tax year to reclaim the overpayment (via an early self-assessment submission) is a pain.

• If you can’t wait that long, there’s a form on your personal tax account to request repayment, but it still takes weeks.

The abolition of the pensions lifetime allowance (LTA) was even more popular, with 36% of IFAs putting it at the top of the list.

• I’d be even keener on this, and not just because it would save me a lot of tax – the LTA penalises good investing, and it makes no sense to have an input cap (the annual allowance) and an output cap.

I don’t hold much hope for either of these changes, since they affect small numbers of people in a demographic that is unloved by the wider public.

Interactive investor fees

Interactive investor (part of abrdn) has cut its trading fees for its 400K clients from £7.99 to £5.99.

• Amongst the established players, this brings it into line with X-O (Jarvis) and a lot closer to iWeb (Lloyds).

Many of the new trading apps are much cheaper or even free, but I doubt that many people have a lot of money with these firms.

Interactive investor also has a free monthly trades on many of its plans.

• This is staying but now has to be used each month, rather than within a three-month window.

ii CEO Richard Wilson said:

Investors can’t control the markets, inflation or interest rates. But they can control their investment costs – and over the long run the savings can be huge. 

I agree, but ii is still not quite cheap enough for me.

Augmented advice

A fourth article by Sally Hickey in FT Adviser looked at Hargreaves Lansdown’s plans to offer “augmented advice” in 1H23. The full-year results announcement said:

Our augmented advice proposition will establish a brand new experience for clients, incorporating insightful tools like financial well-being dashboards and calculators with nudges and coaching to provide an enhanced level of insight that supports them in hitting their financial goals.

We have made an experienced hire to lead both this initiative and our face-to-face advice business.

It will be interesting to see where that hire comes from, as the planned offer doesn’t sound quite like anything available in the UK at the moment.

HL also reported much lower profits (down 26%) but has managed to increase its client list by 92K to a record 1.74M.

• New customers are aged 36 on average and have £15K on the platform.

AUM is down £9% against a backdrop of falling markets.

Quick Links

I have just two for you this week, both from Alpha Architect: (( The Economist took a week off ))

1. Alpha Architect looked at Avoiding Momentum Crashes
2. And investigated whether Stocks Efficiently Predict Recessions.

Until next time.