April 06 Q2 (iv) - DC fund investments

[kathrynT]

Hi

I've got a bit of a query with the above question - I'm hoping someone can shed some light! It's how you allow for the expenses. In the question it says the expenses are:

"1% pa of DC fund value"

I took this to mean if the employer pays conts of 7% say, and the member pays 5%, that the total going into the fund would be 7% + 5% - 1%(for expenses)=11%.

How the institute answers have done it is to knock the 1% off the investment return assumption. So it says equities are assumed to return 7% pa, so you assume the fund returns 6% to allow for expenses.

I'm not that familiar with DC work, but I thought the institute's way was what happened in practice, but the wording of the question threw me into doing something different. I'm just confused because the wording of the question doesn't seem to fit the answer.

I'm probably just picking on a tiny point as an excuse not to study but it'd be nice if anyone has any thoughts!

Thanks

Kathryn

 

[Meldemon]

1% of fund value vs 1% of contribution value...

...without looking at the paper I would guess that "1% of fund value" means 1% of the accumulated assets rather than the incremental contributions. This is also consistent with the way in which investment managers tend to set up their charging structures (that is % of funds under management rather than % of cashflow in). What would happen in the case of net cash outflow?

Subtracting from the investment return assumption is based on the fact that at whatever rate the fund grows at in future, it will also reduce annualy by 1% as charges are taken from the fund. To nit-pick their formula, I would use (1+i)/(1-1%)-1 rather than i-1% as the net investment return assumption.

Admin costs calculated per member would be subtracted from contributions as it has no bearing on the size of the assets under management.