Our expert panel considers whether DC is fit for purpose as the UK’s main growing method of pension provision. Funds Europe hosted the debate in association with parent company CAMRADATA.
Niall Alexander (head of DC, River and Mercantile)
Alan Emberson (director, workplace solutions, Punter Southall Aspire)
Lydia Fearn (head of DC, Redington)
Roy Platten (member-nominated trustee and former pension scheme manager)
Jo Sharples (head of DC investment solutions, Aon)
Elena Zhmurova (DC strategist, Invesco)
Can you be damned by mediocrity? This was a fear expressed at the start of a Funds Europe/CAMRADATA annual roundtable on the topic of DC pensions. The panel struggled to find major instances of fraud or embezzlement in UK pensions, in spite of the great sums of money and myriad organisations involved. There is endless new legislation and guidance intended to protect and improve pension scheme management. The latest this year are on fiduciary management, from the
Financial Conduct Authority, and investing according to environmental, social and governance (ESG) criteria, from the Department for Work and Pensions.
For Niall Alexander, head of DC at River and Mercantile, the ethos of pensions regulation for too long has been about ensuring defined contribution plans do not blow up. Erring on the side of caution means DC pensions don’t have a poor public image, but for Alexander, that leaves room for improvement.
“DC provision in the UK is not bad, but it is time we made it better,” he said.
Other panellists were frustrated that the time in which to make DC fundamentally good is running out.
“I fear we are sleepwalking into a crisis,” said Lydia Fearn, head of DC at consultancy Redington. “We can see now that people retiring in ten years’ time will be mostly reliant on their DC pot. It won’t be just a top-up to wealth from other sources such as a defined benefit pension. But those DC pots won’t be enough to live on.”
The inadequacy of many DC pots to support people will appear alongside other socio-economic pressures such as the rising cost of healthcare. Alan Emberson, director workplace solutions, Punter Southall Aspire, warned that people looking to the state to bail them out might be disappointed.
“The state is going to struggle to meet its own liabilities, unless taxation increases. It’s not difficult to foresee a situation where the basic pension becomes means-tested across a widening group. We already know higher-rate tax relief on pension contributions is going to be reduced to a lower or single combined rate. If you then add on top of that, the possibility of the lifetime cap on pensions potentially reducing at some point, you may see the senior people running organisations becoming somewhat disenfranchised from their own pension provision.”
For Emberson, that may have a dangerous effect on lower-paid staff up and down the country: “Remember it has tended to be higher earners that traditionally have taken the greatest interest in pensions,” he said, “and benefit policy within organisations is to a greater extent driven by this group.”
The DC panel acknowledged that many UK employers had switched from defined benefit provision to DC in order to save money. Jo Sharples, head of DC investment solutions at Aon, traced the faultline in DC back to the methodology used when pensions provision switched at around the turn of the century.
“In setting contribution rates for DC in the early noughties, we used yields similar to those for DB at the time. Bond yields were much higher then, which translated into lower contributions. Add in the pressure from employers to keep contributions down and that is where the inadequacy begins,” she said.
“The tragedy is that since then, many DC contribution rates have not been reviewed and are typically set by reference to peers, rather than established with outcomes for members in mind.”
Roy Platten, a former pensions manager and current member-nominated trustee, reckoned that averting a pensions crisis will begin “from below”, with the workers. He saw pressure for change coming not from employers, advisers or politicians, but from the shop and factory floors.
Elena Zhmurova, DC strategist with Invesco’s institutional business, responded that employers of white-collar workers are already responding to this pressure. She said that prospective employers are sensitive to the needs of young talent and want to offer financial security as part of a retention package.
But Zhmurova still felt there was much more to do. “We believe the UK DC market is ripe for innovation,” she said. And even if the groundswell comes from workers, the expert firms on the DC panel have a big role to play facilitating change.
River and Mercantile advises schemes with 100,000 underlying members in total. Aon’s UK DC clients across both advisory and solutions add up to 1.7 million. PS Aspire provides advice to 1,200 pension schemes with 460,000 members, while Invesco, the roundtable sponsor, manages over $100 billion globally on behalf of DC savers.
Zhmurova added that Invesco has several strategies to support DC scheme provision in the UK, among them factor investing strategies, a global targeted return (GTR) strategy and balanced risk allocation (BRA) strategy.
GTR she described as a portfolio of best ideas aiming to deliver returns of cash plus 5% per annum. With volatility of less than half that of global equities over rolling three-year periods, GTR can have multiple applications in DC – as a diversifier to global equities in the growth phase, as a relatively low-risk strategy still offering real returns in the pre-retirement/consolidation phase, or through its sister global targeted income fund, as a source of regular and stable income during drawdown.
BRA has the advantage of working across all market conditions with an attractive Sharpe ratio (targeting 0.8 for the most popular version).
Another innovative approach could be developed around inclusion of real assets in DC portfolios. Invesco is currently looking to provide a liquid version of its global property fund with top Green Star sustainability rankings.
Sharples then gave one example of innovation from a famous UK employer: “We are strong supporters of collective defined contribution (CDC), which offers members a regular income in retirement, without an employer taking on DB obligations.
Aon has been working with Royal Mail on this. It has huge appeal to members over and above traditional DC.”
CDC also has had huge appeal to pensions experts, not least former pensions minister Steve Webb. In spite of this championing, however, Royal Mail’s pioneering project remains something of an isolated case.
Sharples agreed that it could do with a boost from another major employer. Emberson noted the influence of trade unions in getting Royal Mail to develop CDC. Although such union pressure arguably counts as “from below”, in line with Platten’s thinking, the truth is that unions no longer hold great influence in many UK businesses. So while CDC offers more security to members, there are additional costs and risks involved. Record-keeping becomes more expensive because there are actuarial calculations to be made, unlike within individual DC.
Alexander worried that come the next economic downturn, CDC might look too costly for even benevolent employers and they would have to deal with reformatting a relatively complex scheme.
Platten asked whether CDC was valued by members in other countries where it exists. He voiced concern that contributions would have to go up in the event of low investment returns and sharp longevity increases.
Emberson said it was a shame that collective risk-sharing of many hues had fallen out of favour. As one example, he pointed to the older with-profits mechanism as a time-tested means of such provision. “Yes, you pay a bit more but the risk-sharing is great,” he said. “The trick of course is being able to maintain a real-assets growth focus of the fund over time.”
Mastering the situation
If risk-sharing is to return in strength to occupational pension provision in the UK, it is likely to occur within master trusts. Emberson pointed out that the number of traditional bundled DC providers had continued to shrink. That, in part, is due to the current low pricing point, which means they are only achieving “meagre returns on invested capital of 10% or less. This is why you have seen the likes of Prudential and Standard Life pulling back from the corporate market.”
He added that there will be room for a smaller number of major providers (likely to have their own investment arm), even if they sit behind master trusts, itself a rapidly consolidating sector. PS Aspire, which has its own master trust, is excited about prospects for the sector’s growth. “Master trusts are ideal asset capture vehicles,” said Emberson. “They will hold people’s savings for longer as they manage assets not to, but through, retirement.”
This should mean they are more commercially viable. PS Aspire’s model is to use the master trust as a means to offer individuals access to a wider suite of savings options – for example ISAs and assistance with debt refinancing; access to guidance and affordable tailored financial advice; employing modern means such as algorithms to identify client needs and inclinations effectively but at lower cost.
Platten noted that currently, schemes have to get members early to ensure they think about finances in retirement adequately. He recalled that as a pensions manager, he would hold seminars that covered not just pensions but also occupations such as volunteering. “I also encouraged members to bring their spouses to events too. After all, it affects them too.”
Looking to the future, Fearn also expects innovation to come from the remaining master trusts, including more active investment management as they depart from the low-cost, passive model.
Alexander expressed disappointment that currently so little time is spent on the investment strategy when companies are selecting master trusts: “It takes up about two minutes and then discussion turns to the colour of the scheme booklet,” he claimed.
Here the battle is really about who invests pensions money. River and Mercantile, via the PSolve business it acquired four years ago, has a long track record in fiduciary management. Aon also has a fiduciary business. Their sophistication would stand in contrast to the typical master trust investment policy of selecting index-tracking funds. This is not to say that fiduciary managers don’t use passive instruments but that they tend to be just one instrument in the toolkit, and used not merely for long-term exposure but also for more dynamic allocation.
“We have had more and more enquires about fiduciary management from trustees who recognise that investing is not their day job, and want a professional to deal with investment matters,” said Alexander.
Platten approached the issue from a different perspective. “The focus has to be on getting the default right, given that is where something like 92% of members end up. From my experience, there is no point offering scheme members 30 fund choices – they just won’t go for it,” he said.
Fearn agreed that the default was crucial. The panel were then asked whether ESG strategies ought to be part of the default. Redington worked with HSBC’s pension scheme on its new default fund, which has an environmental bias. Redington has a similar approach for its own company scheme. So perhaps it was no surprise that Fearn said yes. She added that great work was being done here by pioneering larger schemes but the DC platforms would need to do more to assist small and medium schemes in accessing ESG strategies. Platten, on the other hand, was more guarded. “I am not convinced that ESG should be part of the default automatically. ESG needs to stand on its own merits,” he said.
One concern he had regarded labelling; that not all ESG strategies were comparable. That would naturally produce different outcomes over time and trustees needed to beware in case members’ financial security suffered as a result.
“Trustees need to dig into the detail of what is done in their name,” he said, “or else it may come back to bite them.”
Alexander agreed that there had to be transparent metrics for ESG strategies so that trustees could demonstrate how they had evaluated any portfolio appropriately. His was an argument not so much anti or pro-ESG as one in favour of accountable risk management. “ESG is one of many risks that make markets go up and down. If it’s not priced in appropriately, there can be money to be made, in members’ best interests.” This fitted with Platten’s warning that trustees had to dig into the mechanism of any strategy.
Sharples gave an example of a large pension scheme that had developed a clear articulation of its ESG commitment, with 10% of the default to be allocated to a focused ESG fund and the other 90% in index-trackers. Sharples said that the ESG fund’s merits were thus not “diluted” and its portion of the default fund in time was likely to rise.
How is responsible investing incorporated into a first-tier global money manager? Invesco has a strong commitment to an authentic approach, which is reflected in strong results in the PRI assessment scores, highlighted Zhmurova. She explained that “rather than impose a single approach to ESG integration in investment processes, the firm provides its investment centres with resources and support that enables them to integrate ESG considerations in a manner appropriate to their asset class and investing style”.
Zhmurova also explained that Invesco is committed to active ownership and engagement based on a well-established set of guiding principles and operates a global proxy voting programme with votes submitted via a proprietary voting platform.
Prime minister for a day
Returning to the topic of fiduciary management, the panel expressed disappointment with this summer’s recommendations from the FCA. “I see it as an opportunity missed,” said Alexander. “Full regulation for investment consultants and those involved in advising on fiduciary appointments or requirements for an independent trustee would have been proportionate, sensible moves.”
Platten described the proposals as underwhelming and noted that it would be left to schemes and trustees to regulate themselves.
And so the panellists were asked which measures they would each introduce to improve pensions if they were prime minister of the UK. One suggestion was that the change from ordinary workers’ petty daily transactions conducted electronically be sent automatically into a pension pot. That way, people would save for their retirement almost without thinking about it.
The idea tallies with much current practice regarding DC pensions which aims to leave members with as little responsibility, or room to slide back or out of contributions, as possible. Auto-escalation is a good example here.
Of course, one reason why contributions are not maintained is because people have so much information that they end up losing sight of priorities. Aon has developed their My Money platform to take advantage of modern digital technology to focus pension scheme members on what is important.
Sharples described My Money as a financial aggregator that not only shows pension values on a daily basis but goes much further to show someone’s overall wealth, including credit card, ISA and bank balances. “Pension is no longer about pension,” she said. “We want people to think of it as part of their money, just like the value of their house.”
More than 40,000 people already have access to My Money, often via workplace flexible benefit schemes, although Sharples recognised that the platform doesn’t go as far as to facilitate bank and credit card transactions. Theoretically these are a possibility, but some extra plumbing would be required. This would necessitate, however, acceptance and alliance between pension providers, such as Aon, with the major banks.
It’s a moot point whether competitiveness and the desire to retain market share will block such alliances. It is not clear who will ultimately profit between banks, pension providers and tech firms as agents and controllers of retail finances. Sharples’ ‘prime ministerial’ suggestion was that each individual ought to have a unique Pensions ID so that throughout any forthcoming change and upheaval, at least savings can be more easily retrieved and recognised.
Emberson ended the roundtable with a firecracker of an idea that employers be given a “get-out-of-jail” card regarding DC provision. He believes that the obligation to contribute to employees’ pension should continue, but legal obligations thereafter should cease. This would make it starkly clear that DC was an individual savings vehicle, albeit with a generous contribution from employers. The fiduciary onus would instead fall on the commercial providers.
Fearn endorsed the idea that individuals should choose their pension provider, not the company. This would increase each person’s sense of entitlement. Such a policy would take the UK towards the Australian model for DC.
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