A consultation on value-for-money disclosures for DC pension funds has been opened by the Department for Work and Pensions, The Pensions Regulator and the Financial Conduct Authority – a move aimed at improving transparency and efficiency of auto enrolment pension provision.
The proposals, which were unveiled on 30 January alongside other reforms, require DC pension schemes to disclose the value for money their schemes provide, based on investment returns, costs and quality of service.
Paradigm shift
If adopted, it could mark a paradigm shift in DC investing, which has so far been dominated by a focus on costs with the majority of DC default funds being invested in mainstream asset classes through index-based strategies.
In the 10 years since the introduction of automatic enrolment, DC assets have grown rapidly, they now stand at close to £53bn invested on behalf of nearly 20 million members. But industry voices are warning that the low contribution levels of automatic enrolment mean that DC savers will build up insufficient income to provide them in retirement.
Earlier this month, the government has rejected calls to increase contribution levels, citing the challenging economic environment. Instead, the government has turned its focus on enhancing investment returns.
Performance gap
Speaking at a PLSA event to introduce the consultation, pensions minister Laura Trott (pictured) highlighted the impact of differences in investment returns on retirement outcomes, with the gap between the highest and lowest performing schemes amounting to nearly 50% over a five-year time frame. A difference which Trott described as “unfair.”
The consultation has been launched at a challenging time for DC pensions. After more than a decade of rising stock markets, inflation and quantitative tightening have now eaten into DC investment returns and the impact varies significantly depending on the scheme.
Over a three-year period, some of the best performing master trusts, including SEI, National Pension Trust and Aon, have returns between 5% and 6%, albeit at a volatility around 10%. Meanwhile, the Fidelity Master Trust performed -2%, according to Hymans Robertson in October.
While the previous focus of DC rules was on providing a cost-efficient investment option, the emphasis of the consultation is now on greater transparency of performance net of all charges, including transaction costs and performance-based fees. This acknowledges a growing possibility of DC schemes investing in alternative assets, which may come at higher performance fees. In addition, the consultation also proposes the inclusion of a forward-looking metric on future investment performance.
While the government wants to keep a closer eye on underperformers, it is unclear what the benchmark for performance will be. The consultation suggests the option of either a central benchmark for performance set by the regulator versus a market comparison, whereby the performance of once scheme would be weighed against at least three other schemes.
Nigel Peaple, director of policy and advocacy at the PLSA, broadly welcomed the government’s new focus on value for money but also stressed the need to set a clear timetable on increasing automatic enrolment contributions.
The People’s Partnership, which provides master trust The People’s Pension, also endorsed the proposals. “This framework has the potential to reshape the workplace pensions market, and in time, non-workplace pensions as well. Given the scope of the government’s ambitions, it’s important that they get the value for money metrics right by measuring the value added by pension schemes and recognising the different challenges by schemes serving the whole of market,” a spokesperson said.
Charge cap
Alongside the announcement focussing on value for money, the government also confirmed that it is significantly loosening the charge cap on DC investments, which limits a scheme’s investment options. From April 2023, schemes can apply for an exemption to allow them to exclude certain performance-based fees from the charge cap.
This announcement follows the government’s consultation on “broadening investment opportunities of DC schemes” which took place at the end of last year.
In scrapping the charge cap, the government hopes to bolster investment in illiquid assets and, in turn, plug the funding gap in infrastructure investment. “Trustees and scheme managers are now more aware and alert to the benefits illiquid assets can bring. DC pension schemes can afford to take a longer-term view with investments so they are ideal vehicles for investing in illiquid assets which could deliver members higher net returns as part of a diversified portfolio that balances risk and opportunity,” the consultation stated.
The relaxation of the charge cap could have far reaching implications for DC allocations in illiquid assets. Among the first to embrace the new asset class was Nest, which last year announced two private equity mandates.
But the move towards illiquid assets could also create new challenges. For one, the government’s aim of enhancing transparency and disclosure of asset allocation strategies may be at odds with investing in an asset class where reporting standards are far less stringent than in listed markets.
The proposal to include a forward-looking metric on returns may be controversial in listed markets already. But to produce forward-looking return data based on private market allocations could become a daunting enterprise.
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