This is among the headline findings of a new study into investment strategies commissioned by the Defined Contribution Investment Forum (DCIF).
Workplace pension charges have come under the limelight in recent months after the government revealed, in mid-December last year, that it will review the level of the charge cap imposed on auto-enrolment funds in its review of auto-enrolment.
Funds used in auto-enrolment schemes must be capped at 0.75 per cent under current rules.
At the report launch event, DCIF executive director Louise Farrand said: “Our worry is the race to the bottom in terms of cost.”
She added: “We are concerned that if every single master trust is competing on a cost basis, the Department for Work and Pensions will say: ‘Okay, fine.’ You can do this [run pensions schemes] for no money at all, but that is not necessarily in everyone’s best interest.”
“Buyers of master trusts aren’t necessarily that sophisticated and they are probably looking for the most affordable proposition. If I knew very little about investments and pensions in general, and thought of auto-enrolment as a compliance exercise, I would probably look for the cheapest thing for my members also. I think there is a real issue around buyers’ education.”
She added: “Everybody has different views of what value for money constitutes, so it is an incredibly difficult thing master trusts are trying to do here. We are not downing master trusts for what they are doing, but they are wrestling with some difficult issues and we are keen to help them on some of the more difficult questions.”
The study, authored by Nico Aspinall, defined contribution consultant, analysed a total of 17 master trusts: five consultant-led, six insurance-led and six independent with assets under management totalling £10.7bn.
The explicit focus on fees is to the detriment of asset diversification and results in the gravitation to passive solutions, according to the study.
Disclosures and interviews with the sample revealed the investment costs of many “very low-cost” standard propositions offered by master trusts are in the range of four and 20 bps. This leaves little scope for the allocation of pricier actively managed or illiquid assets.
The report features a quote from one master trust interviewee who pointed to the advent of a charge cap as a barrier to the inclusion of a sufficiently large proportion of actively managed assets that would have a meaningful effect on investment performance.
Meanwhile, several respondents argued active management could not add value with the exception of particular asset classes – most commonly emerging market equity, debt and high-yield bonds.
Ms Farrand said: “We are trying as a group to move away from the religious active versus passive debate and think of them as different types of tools to get you to a particular income replacement level.”
On smart betas, several respondents predicted that in the future these strategies would be more likely to become part of their approach than active management.
What is more, a wide range of illiquid investment opportunities are absent from most master trusts’ investment design, the report found. It highlighted the absence of infrastructure investment as a particular concern.
It said: “Given the long-term investment horizon defined contribution members have – particularly those enrolled into pensions for the first time – missing out on the long-term investment returns infrastructure offers feels like an unfortunate unintended consequence of the charge cap reforms, and essentially the level of sophistication provided by a start-up industry.”
Also speaking at the launch event, David Calfo, defined contribution specialist at Capital Group, said: “There is some frustration from the asset management side in engaging with master trusts and advisers on how to get better returns through master trusts. The rhetoric sounds good, but there has not been a lot of action.”
The study also identified a disparity when it comes to investment design on principal default funds and the pricier ‘self-select’ funds. Most master trusts only use passively managed funds in their default options, while self-select funds holds more actively managed assets in most cases, according to the study.
At present, master trusts have a legal obligation to assess and report on value for members (VfM) annually. The FCA has not outlined a single approach to an assessment of value so the onus is on providers to develop a method that reflects the circumstances of the scheme and its members.
The report denigrated the brevity and the lack of detail of the VfM statements it analysed as “striking”, in particular the investment design.
It added that most VfM statements reference the pricing of the component funds and state that the cost of funds is competitive. However, few explore whether different levels of spending on the investment proposition – incorporating more diversification or more active management for example – would bolster VfM.
The report said: “No VfM statements discuss how spending level was decided; the link between VfM and past and future returns; or whether permitting the employer to tailor investment designs (which adds an implicit or explicit governance cost) increases VfM. While VfM is an evolving subject, more needs to be done to help trustees to review and publish consistent information.”
The government did not tackle the issue in the Spring Budget, but announced it will update the tax regime for pension providers using the master trust model – bringing it in line with The Pensions Regulator's strict new rules. The measure was introduced to boost consumer protection and improve compliance, it said.
Ms Farrand berated the lack of uniformity when it comes to providers determining VfM as well as the measurement of investment performance which, she claimed, stifles the ability to compare against competing master trusts.
The DCIF has called on a consistent performance measurement across all master trusts, with them reporting quarterly on how a typical 25, 35 and 55-year-old invested in a default fund fared.
Ms Farrand said: “The government has a role to play, but we should be careful about suggesting that more red tape is a good thing. We can look at the pensions dashboard as an example of effective cross-industry collaboration. A similar approach is needed for things like VfM and measurement of performance.”
William Annison, director of Derbyshire-based HWWA Consulting, said: “I think there is a balance to be had. Producing products that have a very attractive price point because they invest in cheap assets could stifle innovation and is not necessarily going to yield the best result for customers compared to a more adventurous yet more expensive proposition.
“The media tends to put too much focus on cost, but should really give equal attention to potential returns.”
He added: “The main problem is the industry struggles to engage scheme members to save for retirement. Providers have a lot of online tools to help people understand the likely impact of their current saving habits at retirement, but these are being underutilised."
Myron Jobson is a features writer of Financial Adviser
Key points
Master trusts' focus on cost rather than value is not in the best interests of members.
The advent of a charge cap is a barrier to the inclusion of a sufficiently large proportion of actively managed assets.
There is a disparity when it comes to investment design on principal default funds and the pricier ‘self-select’ funds.
This article was amended on 30.3.2017 to remove a reference to Nest, which was not mentioned in the DCIF's report
