Tuesday, July 17, 2007

Mandatory Provident Fund Fees Slammed

The South China Morning Post included an article describing the effect of fees and costs on the payout which retirees can expect from their investment in their mandatory provident fund (MPF). (For those not living in Hong Kong MPF is our mandatory retirement savings scheme.) The article was derived from a report from the Consumer Council.

The report essentially said that based on returns of about 5% per annum, fees of up to 3% per annum would effectively consume about half of the total return over a lifetime of saving.

This is not rocket science. It is not news. The absurdly high fees (even by the standards of the Hong Kong funds industry) go a long way towards explaining why so few people make more than the statutory minimum investment into their MPF plan ( I do not know of anyone). In fairness to the service providers, some of those fees are justified by the additional regulatory burden imposed by the regulations. How much? I do not know, but not much.

The MPF scheme is a poor one. In fact it is an awful scheme. In its defence, it has only three things going for it:

1. it is compulsory: while the merits of compulsion are debatable, as a tax payer I do not want to face rising tax bills in my old age to pay retirement benefits to those who did not save while working;

2. only a limited range of substantial institutions can offer schemes and assets must be held through an approved custodian: there is very little risk of scheme assets being lost as a result a manager or custodian failing;

3. it is a defined contribution scheme: much better in the longer term than defined benefit schemes.

The reasons why the MPF scheme is so awful are:

4. no choice: employees must use the scheme provider selected by their employer;

5. day to day fees and costs are outrageously high. Low cost index funds are unheard of;

6. the cost of switching service providers can cripple already poor returns. If you switch jobs and have to switch your service provider you will be screwed.

In effect, savers are assured of achieving returns well below market and even below what they would expect the average actively managed fund to achieve.

The MPF scheme should be scrapped and replaced with a more flexible mandatory scheme. Savers should have the option of setting up and managing their own scheme and given a much better range of investment options. Default options can be used for those who do not wish to (or fail to) take control of their own retirement savings.

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