The work being done on the design of personal accounts is shining some much needed light into dark and murky corners.
Take the paper published this week by the Department for Work and Pensions on guaranteed investments and their suitability for inclusion as an investment choice within Britain’s new national pension scheme.
Written by David McCarthy of Tanaka Business School and based on economic modelling, it concludes there is zero demand for guaranteed investment products where guarantees are priced using financial techniques commonly used by banks that sell financial guarantees.
On the other hand, where investment guarantees are free, investors prefer them to all other investments, according to the model. But in most other circumstances, demand is low regardless of financial education levels or wealth.
This is based on a typical five-year guaranteed capital bond offered by high street banks, which pays out the greater of the initial capital invested or the return on the FTSE 100 index. The seller of the guarantee typically gets the value of the dividends, which amounts to 15-20 per cent of the initial capital invested, according to the paper.
“In many cases the extent of these costs is probably not transparent to the buyer,” it adds.
Mr McCarthy concludes there is no case for making short-term capital guarantees the default investment choice for personal accounts. He suggests there may be no grounds for making them available as an option either. But he concedes: “There may be some individuals for whom guarantees do represent value for money.” But they would need clear information to make a sensible trade-off between the cost and the benefits.
Long-term guarantees are not a viable option either, according to Mr McCarthy. He suggests a good alternative would be to make the default fund more conservative than it would otherwise be – a route the Personal Accounts Delivery Authority appears interested in following judging by the discussion paper on the investment approach for personal accounts issued today.
Guaranteed products may look superficially attractive, but a close look under the bonnet reveals costs that make them “too expensive to be attractive to most people”.
That is a conclusion that makes sense to me.