MPF future looks passive as HK opts for 'default' fund

The fund industry's arguments over active management have been dismissed by the Hong Kong government and the pension authority, paving the way for the introduction of a low-cost and largely passive default fund.
MPF future looks passive as HK opts for 'default' fund

Plans for a new low-cost, largely passive default fund for retirement scheme members in Hong Kong took a step closer yesterday, with the government coming out firmly in favour of the idea.

Fund groups’ complaints that a restrictive new regime would stifle innovation were largely dismissed with the government’s firm recommendation of a ‘core’ passive product for the majority of MPF members.

With legislation on its way this year, the new system is expected to come into effect in 2016.

A report issued yesterday by the Hong Kong government’s Financial Services and Treasury Bureau (FSTB) in association with the Mandatory Provident Funds Schemes Authority (MPFA) makes clear their intention to have MPF members migrated to new low-fee and closely-mandated investment funds.

Of particular concern to the fund management industry is the conclusion that management fees for the new ‘default investment strategy’, as it is to be called, should not exceed 0.75% of assets per annum. The current market average is more than twice that (1.6%).

The report predicts that the new fee and investment restrictions will naturally drive MPF funds to be managed passively in the future.

The latest moves are the result of mounting criticism of the MPF system’s failure to generate the right level of consistent returns for members, and for the perceived high charges on the underlying funds.

The original consultation paper from the FSTB and MPFA - ‘Providing better investment solutions for MPF members’ - was issued in June 2014. It proposed various strategies and invited comments on issues including the use of a ‘core fund’, based on standardised default funds used in other markets where pension saving is more developed, such as Australia.

Fund industry and employer representatives generally agreed, in their responses to the consultation paper, that a core fund would help address concerns about fees and investment performance, and alleviate the difficulties that MPF members faced in making investment choices between a large number of constituent funds.          

However, fund groups argued that an overly restrictive regime would stifle innovation. Their complaints have been largely dismissed in the conclusions issued yesterday.

The proposed default investment strategy “should adopt a balanced, mixed asset, globally diversified investment strategy which will automatically reduce risk as a member approaches age 65,” said the report.

For members under 50 years of age, the core fund portfolio would have target exposure of  “around 60% to higher risk assets (predominantly in global equities)”.

The investment strategy for contributions and accrued benefits for members who are 50 to 65 years of age would be regularly adjusted, with the exposure to higher risk assets reducing to 20% at age 65.

The future of passive management for MPF portfolios is clear from the report’s statement that, “While the industry should not be mandated to adopt passive management, the fee cap, the small size of the asset allocation buffers, as well as the application processes, disclosure and benchmarking will likely drive them towards adopting such an approach.”

The report even went as far as to dismiss the idea of active management for MPF contributions: “Notwithstanding submissions made to the contrary, we are not convinced that passive management will necessarily produce inferior returns.” Their research showed “that actively-managed MPF funds had not delivered better returns than passively-managed ones.”

Fund and retirement industry associations argued that, to foster competition among providers, investment managers should be given the flexibility to come up with their own default investment arrangements.

A few respondents went further to suggest that the ‘core fund’ and the concept of standardisation would work against the effort to educate the public on their responsibility for investment and retirement planning.

Again, this complaint was knocked back, with the report’s authors refuting the idea that a simpler low-cost approach would be detrimental to the encouragement of pension saving.

“We consider it critical that the many members who do not have the time or skills necessary to make an investment decision, are best protected by the development of better solutions than those existing at the moment,” said the report.

Investment managers and trustees were “almost unanimous in their opposition to the proposed fee levels, often citing the 2012 EY report in which it was stated that the cost of administration alone was 0.75%.”

But on fees, the report concludes, “We believe that the fee levels proposed are a reasonable starting point, having regard to the costs of operation of the MPF system, overseas experience and the aspirations of many respondents.”

Bruno Lee, chairman of the Hong Kong Investment Funds Association (HKIFA) said: “The cap on fees does pose challenges, but the industry would use our best endeavours to work towards the requirements, including but not limited to using low fee passive funds or other products that can help achieve the outcome.”

The MPFA and the government say they will continue to consult with the industry and technical groups on detailed aspects of the arrangements. The government aims to introduce an amendment bill into the Legislative Council within 2015 with a view to introducing the new default investment strategy in 2016.

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