'DC consolidation could widen gap between the good and bad'

The partner at Hymans Robertson says consolidation can lead to greater value for money for members if the larger provider offers better technology and greater choice. But it can also lead to a loss of value if aspects such as administration go wrong.

Train says most of the smaller trust-based schemes will have moved to a master trust in future and she says the most important thing for employers is to ensure they actively work with the provider to improve services.

In a Q&A with FTAdviser In Focus she reflects on upcoming regulatory changes and the effect these will have on pensions. 

There is a chance that we will see an opening of the crocodile’s jaws in terms of those schemes that deliver value and those that don’t. 

FTA: What’s your view of the Edinburgh reforms overall? 

RT: The ambition behind the Edinburgh reforms is a good one – “for the UK to be the world’s most innovative and competitive global financial centre”.

Sitting behind this is a number of initiatives to deliver this, including the productive finance working group, which we fully support.

Further detail is required in some areas to bring the ambitions properly to life and deliver on them. We recognise some of the planning is still in the early stages, but we very much welcome the evolution.

FTA: What effect will greater open banking integration have on pension saving?

RT: Open banking will mean that pension savers will be able to see all of their pensions and savings in one place, allowing them a more holistic picture of their finances.

This is to be welcomed, as it will help members to view their pension savings as ‘their’ money, rather than something that is many, many years away over which they have little visibility.

This could potentially lead to greater engagement in, and ownership of, their pension assets and could impact the level at which they contribute into their pension going forward. 

FTA: What’s your view on the government’s plans to allow pension funds to free up funds for illiquid assets?

RT: We firmly believe that there are clear benefits to DC pension schemes of investing in illiquid assets, while also recognising the risks and limitations that may apply for some schemes.

We’ve already seen several master trusts access illiquid assets, and we see the opportunity for schemes to invest up to 20 per cent of assets under management in illiquids over the medium term.

We’ve been talking for a while about our principle of 10/10/10 – by this we mean: paying an additional 10 basis points in fees, to get a 10 per cent allocation to illiquid assets within a scheme’s default assets, in order to achieve a 10 per cent improvement in member outcomes.

We believe a global approach should be taken to identify the best possible investment opportunities.

There are lots of opportunities in private markets, including in the equity, debt and green infrastructure markets. 

As long-term investors too, we believe DC savers should also have the opportunity to benefit from the good long-term returns these assets can provide, as well as the 'green' credentials of many of the investments within this universe, while being able to mitigate some of the risks around being invested in them.

The requirement from October this year for schemes to state their policy on illiquid assets in their statement of investment principles will put this firmly on trustees’ agendas. 

FTA: Will the government’s illiquid assets plans work or will the risks likely outweigh the rewards? 

RT: There’s been lots of talk about the government wanting to use pension fund assets to fund investment known as 'productive finance', such as UK infrastructure and green energy supply.

From a pension scheme’s perspective, while these types of funds have attractions from an investment point of view, a sole focus on the UK would mean opportunities for investment overseas would consequently be limited.

At the end of the day, trustees of pension schemes have a fiduciary duty to consider what investments will deliver good outcomes for members.

Over the past 10 years, we’ve seen a move away from significant exposures to UK equities within pension portfolios as global markets have offered wider opportunities and, in many cases, better returns than could be achieved by UK companies.

We believe the same principles should apply to investment in private assets, ie a global approach should be taken to identify the best possible investment opportunities.

The risks of investment can be mitigated to an acceptable level like other asset classes, which should mean the government’s vision for investment in illiquid assets should be achievable and reap reward for pension scheme investors.

FTA: What share of total pension assets could end up in such assets in practice?

RT: As highlighted above, we believe around 20 per cent of DC pension scheme assets could, over the medium term, be invested in illiquid assets.

There is potential over the longer term for this to go further, as seen in other markets like Australia where investment by the super funds is in some cases in the region of 30-40 per cent.

FTA: What are the opportunities for pension funds to take a leading role in the fight against climate change?

RT: We believe that pension schemes have a pivotal role to play as the stewards of assets in driving a just transition, given the far-reaching impact of climate change both in terms of physical risk (to the environment around us) and transition risk (the risks associated with transitioning to a green economy).

By recognising that, for example, climate change may pose risks to where people can work, the access to resources for that work, eg water, you identify the risks posed to companies and therefore the potential impact of climate change on investment returns.

Indeed, the introduction of climate change reporting for the first time in October 2021 for many pension funds helped to highlight the various investment risks and opportunities that climate change brings.

Understanding these risks and opportunities will help schemes engage with their asset managers to understand how the companies in which they are invested are planning to change and evolve.

With pension schemes managing trillions in assets, it’s a big opportunity to effect change to result in positive investment outcomes long term, by building sustainable companies, holding laggards to account, and consequently improving the impact these organisations have on the world we live in.

FTA: The government wants to accelerate DC scheme consolidation. Do you foresee any risks, particularly when it comes to value for money for members?

RT: The DC own-trust-based marketplace is expected to decline in future years with a move of schemes to master trusts. In future, we see a range of large DC trust-based schemes, group personal pension and master trusts remaining, with most of the smaller trust-based schemes having moved to a master trust.

These larger own-trust-based schemes will generally be schemes with paternalistic employers, with strong in-house teams that favour a best-in-class offering for their members or those with scheme complexities (such as guaranteed minimum pension underpins).

In many cases, these schemes are already larger than many of the master trusts and have implemented sophisticated investment strategies. 

There are a number of benefits as well as risks that scheme consolidation brings. Benefits include access to potentially lower cost default options, better technology and greater choice, which all contribute to better value for money for members.

Risks of consolidation include areas such as administration. If admin goes wrong in a master trust with millions of members, not only could this have a significant financial impact on the master trust itself, but it could shake members’ confidence in their pension vehicle.

Clearly, poor administration leads to poorer member experience and arguably poorer value for money.

From a company’s perspective, many have seen the outsourcing of their DC pension arrangements to a master trust or group personal pension arrangement as reducing their governance burden, which is the main driver.

In no other part of their business however, would they invest thousands if not millions of pounds a year into something they don’t interact with regularly on an ongoing basis.

We work with a range of governance committees of master trust and group personal pension arrangements where they actively work with the provider to improve services (and appropriate fees) on an ongoing basis.

If companies are not doing this on a regular basis, there is a chance that we will see an opening of the crocodile’s jaws in terms of those schemes which deliver value and those that don’t. 

carmen.reichman@ft.com