Each tenth of a percentage point shaved off a deposit every year represents the loss of several tens of thousands of crowns for a pensioner
The level of fees that second-pillar pension funds will be able to charge for managing deposits will have a big impact on depositors. As little as one-tenth of a percentage point shaved annually from a deposit represents a loss of tens or even hundreds of thousands of crowns for a future pensioner.
The think tank Institute for Democracy and Economic Analysis (IDEA), a project of the Economics Institute of the Academy of Sciences of the Czech Republic (EI), has released a study showing the rates submitted for public discussion by the Ministry of Finance at the beginning of March are out of line when compared with plans from abroad. The main priority, though, is to configure the system properly.
The concept put forward by the ministry contained four possible ways of calculating fees:
as a percentage of the assets under management (0.9 to 1.5 percent depending on the type of fund, with a drop of 0.2 percentage points from the sixth year onward);
a combination of a percentage of the amount invested and a percentage of the assets under management (a fixed percentage, plus 0.7 to 1.3 percent annually, again with a drop of 0.2 percentage points from the sixth year onward);
a combination of a percentage of revenues and a percentage of the assets under management (5 percent of revenues per annum, plus 0.7 to 1.1 percent of the volume of deposits per annum);
a combination of a percentage of revenues and a percentage of the assets under management with a higher revenue component (10 percent of revenues per annum plus 0.4 to 0.8 percent of the volume of deposits per annum).
The IDEA report found that experience abroad with the operation of pension funds and regular open-end investment funds indicates that the level of fees proposed by the Ministry of Finance for the more conservative funds is too high. “In an environment with low or zero marketing costs, the expenses of conservative funds is something in the order of 0.5 percent of the volume of assets or even lower,” the report states.
Cheap Swedish funds
For instance, administrative expenses in the Swedish system represent 0.13 percent of the volume of assets and 0.23 to 0.24 percent in the case of non-equity funds. In the case of the “most expensive” equity funds, administrative costs in Sweden are only 0.45 percent of the volume of assets under management.
You don’t have to look far for a comparison. Even on the Czech capital market effective asset managers are already offering the regular investment of relatively small amounts more cheaply than the original fee proposal submitted by the Ministry of Finance. Equity funds charge a 3 percent entry fee, which over 15 years of saving corresponds to an annual administrative fee of approximately 0.5 percent of the volume of assets. As far as bond funds are concerned, the rates are a lot lower at around 1 percent of the amount deposited, i.e. the equivalent of 0.2 percent per annum of the volume of assets. ‘The political agreement on 0.3 percentage points … is still below the level of best practice.’
Last week, Minister of Finance Miroslav Kalousek (TOP 09) said that the coalition had agreed on a 0.3 percent fee in the case of a fund investing exclusively in state bonds. This would represent the lowest limit, since administrative costs are higher in the case of other funds. “The political agreement on 0.3 percentage points of the assets in funds investing in state bonds is still below the level of best practice, though the difference is not as great as that contained in the original proposal,”the report said regarding the latest proposal by the center-right coalition government of the Civic Democrats (ODS), TOP 09 and Public Affairs (VV).
The IDEA report claims that if highly competitive conditions could be set on the pension fund market, the regulated level of fees would simply act as a safety net against isolated cases of unfair practice, for instance the setting of excessively high fees that might dupe inexperienced consumers.
At the same time it would make sense to concentrate on regulating fees for funds with low volatility and low administrative costs, such as funds investing in state bonds, money market funds and similar liquid assets. Much less significant is the regulation of more aggressive funds investing mainly in equity. Any regulation put in place should not only cover the level of fees but also the information that funds would be obliged to provide on them.
A benchmark managed by the ČNB
However, the IDEA report claims that finding the right structure for the pension system is more important than the specific level of fees. “Regulating the level of fees is of less significance than other aspects of the institutional framework within which pension funds will operate,” authors Ondřej Schneider and Libor Dušek stated in the report. ‘Regulating the level of fees is of less significance than other aspects of the institutional framework.’
They believe that the crucial thing is whether pension funds will know the identity of their clients, i.e. whether they will be able to lure them from their competitors at great cost, whether one pooled fund will be created and organized by the state, and how the investments of funds will be regulated.
Schneider and Dušek favor account anonymity. This means that funds should not know the identity of their clients or those of their competitors. They would also not be against the creation of a state lifecycle fund, which could begin operations immediately if it were to be managed by the Czech National Bank (ČNB), for instance.
Such a fund could have low operating expenses and could become a kind of benchmark for private pension funds. Its investment policy would abide by the rules of international diversification, i.e. more of a focus on equity for younger savers and investments exclusively in bonds over the last five years. Though revenues could not be guaranteed, the combination of investment horizon and investment profile would offer higher, stable revenues than pension funds offer at present. The model regarding fees could be the main Swedish public fund, whose administrative costs are 0.15 percent of the volume of assets.