Advisers may be wondering what this focus on the charge cap means for the advice they give to employers. For example, if a provider was to offer a higher cost solution, is that justified because of the high returns that members might enjoy or should advisers be looking for the lowest cost solution and thus steer away from higher costs?
It has long been said in the industry that DC investment strategies seem at odds with the long-term nature of DC member savings. With many DC members not likely to retire for potentially another 50 years, there is a question mark around why the industry needs daily pricing, daily valuation and so much liquidity and flexibility.
This leads to the next question: Why are DC schemes not making more use of illiquid or private market assets?
Recent pressure on DC schemes to invest in private markets has come from the recommendations of the Productive Finance Working Group, which includes the Bank of England, the Treasury and the Financial Conduct Authority.
The report covered ways to remove the perceived barriers that are stopping DC schemes from investing in these alternative assets. It makes interesting reading, going as far as to say that advisers should “endorse the objectives of this work” and highlights that they should be integrating allocations to these assets "when appropriate".
The report was backed up by chancellor Rishi Sunak who said that: “Now is the time for institutional investors to seize the moment and invest in longer-term UK assets.” Great news for those advocating private markets for DC schemes.
Then came the Autumn Budget announcement on reviewing the charge cap. We expect to see this consultation at the end of the year, and to those advisers who thought the charge cap was a blunt instrument to control costs and charges, and a key driver for ‘lowest cost is best’ across the industry, it sounds like an early Christmas present – although we will have to see how far this consultation goes.
While this important report and the announcement of the charge cap review are a good way of putting the issue under the spotlight, we think there are a number of other perceived barriers to investing in private markets that have not been addressed and are holding many schemes back.
As such, we do not expect sudden changes in the broader market, and in particular master trust arrangements, on the back of any easing of the charge cap – even if we do believe illiquid assets offer a helpful addition to member portfolios.
The first of these barriers is due to the key characteristic of these types of assets; illiquid investments are by their very nature not valued as frequently as liquid assets. The current structure of the DC market means that members contribute, transfer and trade in and out of the default fund on a daily basis. So what approach should be used that is fairest to members?
Do schemes use a ‘stale price’ for the in-between period, which has long been considered an inadequate way of pricing an investment, or do they use a real-time proxy that is prone to misalignment with the illiquid asset? What happens in a major market downturn?
Fundamentally it raises questions of fairness and whether some members will end up benefitting at the cost of other members, given the lack of pricing regularity.
Transparency is another big issue. There is unease and fear in the industry about the lack of transparency in unlisted investments and the issue of ‘gating’. The power of managers to stop any trading in or out of the fund has already caused upset for schemes using real estate assets.
None of these are total barriers, but they provide plenty of reasons as to why there is nervousness about integrating these into DC strategies. This is even before higher costs for these more complex and sophisticated investments are added into the mix.
Of course, private market access is already available. The DC market is innovating rapidly and private and illiquid markets form a growing part of that. Back in 2016, Partners Group opened their Generations Fund offering access to private markets. It is already possible to invest directly into real estate and DC-friendly managers such as Aviva and Schroders are now offering access to new sustainable private market solutions.
We know from our experience working with clients that this requires a lot of time working through the detail and understanding how an asset allocation would impact the running of the portfolio and wider scheme strategy.
As such, going back to basics and making it easier for schemes who want to try investing in different areas through existing approaches seems to make most sense.
While developing new fund authorisation regimes such as the Long-Term Asset Fund (LTAF) and reviewing the charge cap structure gets the market talking, it does not address some of the more fundamental barriers that DC schemes who want to take the plunge are facing.
With Christmas round the corner, a big present to the industry would be practical guidance from industry bodies such as the Investment Association about how some of these more specific issues around implementation can be sorted.
Trustees and advisers need more guidance and reassurance to know that investment in private markets will ultimately help to improve the long-term outcomes for members.
Steve Budge is partner in the DC team of LCP
