While UK defined benefit pensions have experienced rapid change in recent years, in the world of defined contribution political ambitions have created a confusing agenda.
The political plan for DC has been driven by an emerging cross-party consensus to encourage pension schemes to invest in UK plc.
Politicians’ urge to raid the pension pot piggy bank is understandable. Public finances are tight, economic growth is on its knees and other stimulatory choices such as joining the EU, building an industrial plan or reforming planning are either politically unpalatable or difficult.
With the realisation that there is little incentive for legacy DB schemes with the most assets to invest in so-called productive finance, the government’s attention switched to DC schemes unveiling the Mansion House reforms last year.
Now 10 large pension providers have said they will aim to invest in 5% of the portfolios in unlisted equities by 2030. Government’s hope is this will improve investment in UK plc.
Muddled thinking
There’s a reason I’ve said a confused agenda has developed. The Mansion House reforms are aimed at improving investment in the UK. It’s debatable whether it’s up to workplace pensions to help a government to invigorate a mismanaged economy.
Hiding under this political agenda is a more important question for the nearly 11 million UK citizens now enrolled in a DC workplace pension scheme – are these schemes giving them value for money?
If you think cost is a proxy for value then the overwhelming answer is yes. While the imposition of investment charges might have been the initial catalyst to drive down costs, cost is now the tool used by pension providers to secure market share.
As administrative expenses are difficult to reduce below a certain level, investment charges have been squeezed. The net result has been many DC default funds heavily invested in passive equities during the growth portion of the portfolio.
That’s caused concern about a lack of diversity in portfolios. The Mansion House reforms can be thought of killing two birds with one stone – they will encourage greater investment in the UK as well as diversifying portfolios in alternative assets.
Will fixed income be the real winner?
There are, however, questions about what type of alternatives should be included in these portfolios and at what price. The re-emergence of higher interest-rates creates two interesting conundrums for providers of assets like private equity and debt.
Firstly, as fixed income is once again offering decent yields, there are good reasons for DC schemes to include this asset class in their default portfolios. This can be done cheaply using similar passive products to equities.
The second is higher interest rates call into questions the economics of private debt and equity. Higher interest rate costs mean that deals which once made sense could no longer add up. And with many companies needing to refinance, some will see financial gearing rapidly increase.
Opportunities for asset managers
With 10 of the UK’s largest pension providers signing up to the Mansion House compact there could be a chance for asset managers to offer access to private equities and other listed assets to these pension providers.
The issue is many of these pension providers are large insurance companies which often manage their assets in house. There are, however, opportunities for best-in-class managers to offer access to an asset class those insurers would find it difficult to do well.
There may, however, be a greater opportunity among the master trusts which tend to outsource more than insurance giants.
Value for money
But perhaps the biggest opportunity for asset managers lies in the outcome in the value for money consultation.
Aware that cost had become a proxy for value, the government carried out a value for money consultation in early 2023 looking to shift that point of the view to a greater consideration of long-term value for scheme members.
The government said The Department for Work and Pensions, The Pensions Regulator and Financial Conduct Authority are all working together to deliver a consistent regulatory framework.
This framework will be introduced in stages and will require legislation which will occur when parliamentary time allows. If this doesn’t happen before the next election, we’ll need to see if the incoming Labour government will continue to pursue this agenda.
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