Pension expert calls for co-op format

(December 3, 2004) The headlines in recent years have certainly been attention grabbing, as reports of pension shortfalls left many in the workforce wondering if their retirement plans would survive.

Plan sponsors have been planning changes that could alleviate the pressure, including conversion of defined benefit plans to defined contribution plans, limitingtheir liability. But perhaps the biggest threat to pension health lies outside of the sponsor’s control.

“I see a global financial intermediation industry with a serious ‘value for dollars’ problem,” said Keith Ambachtsheer, president, KPA Advisory Services. “On average, customers pay too much for too little.”

Speaking at a luncheon hosted by the Toronto Society of Financial Analysts (TSFA) on Thursday, Ambachtsheer conceded the audience probably would not like what he had to say.

“Free market capitalism is supposed to produce value for dollars for its customers, but it doesn’t. We should know why, so we can fix the problem,” he said. “If you know there are millions of ordinary people out there paying too much for too little, shouldn’t you do something about it?”

He says most plan members are unaware of the contingencies involved in their DB plans and that their contribution levels and benefits can be subject to change. Ambachtsheer said the term “defined benefit” is a misnomer, designed to make the plan member feel secure. A more appropriate name might be “risk sharing arrangements.”

According to Keith Ambachtsheer, the two main problems facing pension funds are agency issues and governance. The basis of both of these problems is informational asymmetry — where service providers have such an advantage over members and sponsors in understanding the plan that they can charge fees greater than what their returns warrant.

“People don’t know what they don’t know,” he said. Because both plan members and sponsors rarely understand the product, they often overpay their service providers.

He said the compound cost of fees over the life of plan participation can slash potential returns in half. And the assumption that investors can expect returns equal to the market, less fees, is not quite accurate.

“If you look at the difference between time-weighted rates of return in the mutual fund sector and dollar-weighted rates of return, the dollar-weighted rates of return are 2% lower than the time-weighted rates of return.”

While there are some pension managers who do offer good value for their fees, Ambachtsheer said they tend to be those which are out of reach for most pension fund sponsors, such as the Ontario Teachers’ Pension Plan.

“These are dedicated organizations, designed to do dedicated things for dedicated groups, so they’re not out there soliciting,” Ambachtsheer said.

These organization benefit their plan members because of their dedicated structure, which he suggests other pensions should use as a template. These pensions not only deliver stronger returns with lower fees, but tend to be more transparent to their members.

“Pensions are extremely complex risk-sharing arrangements between multiple stakeholder groups,” he said. “The best we can hope for is to be even handed in how we deal with the interests of these various stakeholder groups. The ‘sole interest’ notion makes no sense at all in pensions.”

He points to Vanguard founder Jack Bogle’s thesis that such organizations should be co-ops, owned by the beneficiaries, which eliminates the conflict between the need for the management firm to make a profit and the investor’s need for value creation. Just as Bogle applied this thesis through the creation of Vanguard, Ambachtsheer said it should be applied to the pension fund industry.

“Agency issues and governance issues are the most fundamental drivers of value creation in our industry,” he said. “There’s about a 1% per annum differential between high-scoring investment organizations, in terms of good governance, and those that score poorly.

“Good governance perpetuates good governance. Unfortunately, the reverse it also true.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(12/03/04)

Steven Lamb