These days, the Capital Market Authority is promoting changes in the existing investment routes in the pension funds, as part of a reform designed to allow them to charge savers higher investment management costs. Thus, the authority will allow each fund to offer the saver a variety of products – some expensive, some cheap.
If until now you thought it was difficult to make decisions in everything related to your pension money, following the reform you will have to make new and more complex choices from now on.
Current situation: What routes exist in the market?
Pension funds currently offer a number of investment routes for pension funds. If you have not actively chosen a route, then you will automatically join the “Chilean model” route, where the percentage of shares will decrease over the years as you approach retirement age. In addition, each fund has additional tracks, some more aggressive than the default track, some more defensive. Thus, a saver who wishes to take a higher or lower risk than the default set by law, can do so.
At the same time, the saver pays management fees to the pension fund for investment management. The management fee is collected from each monthly deposit as well as from the accumulated balance, and is limited by the ceiling. Today, there are two types of pension funds on the market: “selected” funds – which are supposed to be the “cheaper” funds for the saver because they were set in a tender held by the state, and “regular” pension funds – in which management fees are collected after negotiations with the client.
In addition, if the fund had expenses for making “special” investments, for example – transferring the investment to a body that specializes in this specific type of investment, it may charge savers these costs, called “direct costs”. Today, the collection of these costs is limited to a ceiling of 0.25%, with the main idea underlying the proposed change being to remove the ceiling over these expenses, and allow pension funds to roll over to savers the full expenses.
The first change: segmentation of default routes
As stated, the purpose of the reform is to give the permit to charge savers direct unlimited costs, which affects the default routes. Therefore, according to the reform, at the beginning of each year each fund will have to publish how much it will charge that year from the saver.
In addition, the manner of managing investments in these routes will change. The default routes in which the level of risk decreases until retirement age will become more segmented in order to reach a high level of accuracy in adjusting the risk for the saver. That is, if there are currently tracks that are up to age 50 and above age 50, the new tracks will be in five-year ranges from each other, so that every five years the investment track will be adjusted to the retirement horizon of the saver.
The logic behind the move is that the capital of a 30-year-old saver will not be managed like the capital of a 47-year-old saver, and the segmentation will make it possible to raise the level of risk among younger savers. Therefore, anyone who chooses to stay on these routes should be aware from now on not only if the return is optimal compared to the management fee he has chosen to pay, but also if the cost of “special” investments in his fund leads to the same attractive result – every year.
The second change: the establishment of investment clusters
Along with managing age-dependent investments, a number of special investment clusters will be established, in which it will not be possible to charge costs directly. Moreover, if today the management fee is dependent on bargaining, but in a uniform structure, in these clusters there will also be a different structure to the management fee.
The first cluster proposed in the draft circular is variable management fees. As noted, currently the management fees in the pension funds are collected from the monthly deposit and the accumulated amount only. The Capital Market Authority is interested in reviving a model that existed in the insurance market in the 1990s – the changing management fees. The fund will be able to charge management fees from the return it achieved for you, in the years when the return was positive. For example, in old executives’ insurance, the management fee was 0.6% of the accrual and another 15% of the real annual profit.
Now, according to the draft circular, the pension funds will also be able to charge variable management fees, but as stated, will not additionally charge expenses for special investments. The amount of the variable management fee that the authority will allow the pension fund to collect is not yet known at this stage.
The second model for collecting management fees is a negotiable cluster. The investment in this cluster will only be in actively tradable assets, ie the governing body chooses which asset to invest in and how much, but will not direct money to “special investments”. This way, savers in this route will pay management fees from deposit and accrual, but will not bear direct expenses. Within this cluster there will be a number of investment routes – more and less aggressive, and in combination with these routes the saver will reach the desired level of risk, when the level of risk will not decrease over time as in age-dependent routes.
Another cluster proposed in the draft circular is a passive cluster. In this cluster, investment management will track only tradable indices, and will offer followers the return on the index, in exchange for management fees, and without “special investment” costs. Here, too, there will be different routes at different risk levels, the combination of which will lead the saver to the level of risk he is interested in. Since the cost of passive investment management is lower than the cost of active investment management, it will be interesting to see if the management fees offered by the funds in this cluster will be lower relative to other clusters.
Alongside these clusters will operate specialized clusters, such as halakhic investments adapted to Jewish halakhah, halakhic investments adapted to Sharia, environmental investments according to the UN’s sustainable development goals and the IRA for personal management.
It is important to note that within each cluster the saver will have specific tracks according to the level of risk he chooses for himself: bond tracks, stock tracks, etc. It is important to note that the reform requires the saver to make additional decisions. The body that will manage its investments according to criteria such as return and management fee – now it must also decide on the cluster in which it wants to be that will influence the money management model, its costs for managing money and the return.
The third change: reducing risk to only two years
Another change in the draft circular is the limitation of the investment period in the financial investment route, ie investment without risk. The transfer of funds to these routes will be for two years only, and then – if the saver does not make an active decision again – they will be transferred to a retirement-age-adjusted route. The purpose of the change is to prevent crisis situations in which many savers transfer their money to routes that are not affected by the capital market, forget to return them in the long run, and thus hurt themselves in return.
The problems in the reform: The issues that have not yet been answered
On paper, the reform that is expected to be launched next year provides additional choices for savers. However, the cost component varies over a relatively short period of time (annually), making long-term considerations difficult.
In addition, the pension world is a complex world, and even today, when the choices are more limited, savers find it difficult to make decisions, and the main reliance is on the main distribution channel in the field – the pension marketers. Attempts by the Capital Authority to bring about change in the field of distribution channels, including the promotion of the objective agent reform, ie an agent who receives the same remuneration from the entities regardless of his recommendation – have so far failed. In such a situation, increasing the decision-making required of customers, does not necessarily play in their favor but may be a trap for those who are less sophisticated.