The Government’s first meaningful discussion with the industry is part 1 of their much trailed Pensions Investment Review.
The Review has key goals to increase investment in UK assets and also to accelerate consolidation in defined contribution (DC) schemes.
However, we have a few areas of scepticism that we think the Government will need to understand when determining next steps and whether their policy goal is achievable.
Consolidation
Consolidation of DC schemes has been a theme of recent times. It is clear that the Government, and perhaps regulators too, would like to have a universe of fewer schemes to regulate. This would be accompanied by the benefit of more consistent outcomes for members as well as economies of scale.
For instance, concurrent with this call for evidence is ongoing work included in the Pension Schemes Bill and a recent Financial Conduct Authority (FCA) consultation to clarify what Value for Money (VfM) is and how this can be measured across all DC pension schemes, trust or contract based.
UK Assets Mandatory
The bonus of fewer and larger pension schemes will be greater allocations to private markets via initiatives like the Mansion House compact. Larger funds are likely to be more inclined to make those allocations in their default fund portfolios.
The challenge for government is how to enable this allocation and accompanying higher charges which will impact members’ fund performance. UK private equity is likely to be illiquid and potentially volatile. Making this work in a meaningful way is fraught with risk for members and for providers looking to help the Government achieve their aim.
Challenges to the Policy
The VfM framework has a contradiction at its heart.
If value is a combination of performance, service and charges but the Government wants to overlay UK asset allocation as a metric to value, in addition, then this is going to create an issue.
If schemes are to be charged by performance they are going to use low cost diversified tracker funds. These have been popular with members for many years and it is against these that performance will be measured. However, if schemes will be downgraded due to low allocation to UK productive asset classes but these asset classes are underperforming then this is going to create an issue for trustees and providers looking to set their asset strategy.
Ultimately what has to win is the right outcome for members.
In addition, consolidation is happening too slowly. Schemes that are working through VfM assessments already will be considering the outcome of these assessments and deciding whether or not they should invest to improve or wind-up.
These decisions take time and even the act of choosing a new scheme and discussing this with members is also a time-consuming exercise. This time lag is a major barrier to the Government’s success. It needs money to be invested as soon as possible but the pensions oil tanker is just moving too slowly and there isn’t an obvious turbo button.
What Might the Government Do?
Incentivisation – there could be tax breaks or other similar benefits to investing in UK based productive assets. We may hear more on this in the Budget if this is being seriously considered.
Build it they will come – the Government could focus on building a product that makes it more compelling for pension schemes to invest. First loss protection could be introduced so that the Government is a co-investor but also takes the first hit. This would reduce the risk rating of the fund. They could also provide liquidity for members approaching retirement and looking to take their benefits.
Social contract – similar to the discussion over the past few years where we’ve seen schemes encouraged to invest in funds that have a consideration to ESG, we could see a softer encouragement that investing for the good of the national economy is good for all our well beings as citizens of the UK.
Mandating investment – It seems highly unlikely that this is a step the Government would take, at least not in the DC space. LGPS or other pseudo-State backed pension schemes may have different pressures placed upon them but where returns have a direct correlation with saver outcomes, mandating an allocation will be a reluctant step.
What Next?
We have part 2 of the Government’s review which is to be focused on adequacy and likely to be announced imminently, but also we should expect to hear from government on their next steps for consolidation and UK investment later this year or early next.
For now, all eyes are on the Budget to see if there are any snippets about new products being launched or incentives to invest.
