McFall: We need code of practice for pension fees

Flawed mathematics unfortunately

While it is undoubtedly very important for investors to control costs, I would have a lot more confidence in pronouncements of this type if the author managed to demonstrate at least a passing familiarity with basic mathematics. Considering the scorn which Lord McFall and his colleagues in the TSC heaped upon bankers who appeared to lack qualifications for the roles they held, it is somewhat disturbing to see him make claims of this sort regarding the impact of costs (that a reduction from2%pa to 1%pa gives rise to a fund 50% larger) which are demonstrably untrue. By way of illustration, let us consider an investment of £10,000 over 25 years at a gross return of 5%pa. After costs of 2%pa, so net 3%pa, the fund grows to £20,938. Halve the charge to 1%pa (net 4%pa) and the value increases to £26,658, 27% more. It is actually rather difficult to get up as far as 150% and at growth rates between 0%pa and a highly unrealistic 40%pa, the range is consistently between 20% and 29% more for the lower cost version. Indeed, the only way to get to Lord McFall’s 50% figure is to assume a gross (pre-costs) return of -36.8%pa. Any investor experiencing a return that poor over 25 years would arguably have ore to worry about than whether the charges were 1% or 2%pa. Cost is one of the few things that investors can control (along with their relative exposure to risky and defensive assets) so it is important that they pay attention to their impact and seek to minimise the amount that is being taken from their fund to benefit third parties rather than themselves. It is therefore welcome to push for costs to be reduced further than they have been even since the 1990s. However, it is unhelpful for public figures to make pronouncements on such matters if they themselves have failed to grasp the mathematical fundamentals which determine the ultimate benefits that investors actually receive.

Posted by: Robert Lockie FIFP CFP