Workplace pension providers who fail to deliver sufficient investment returns for their members could be asked by The Pensions Regulator (TPR) to either consolidate or exit the market, pensions minister Laura Trott has told portfolio institutional.
The government plans to bolster the regulator’s powers to intervene on poor defined contribution (DC) investment performance, as part of a wider overhaul of regulation under the Value for Money framework. A consultation on the proposals closed at the end of March.
Speaking to portfolio institutional, pensions minister Laura Trott revealed that she considers bolstering investment returns for DC savers as the key challenge for the industry. “For most people now, the pension that they’re paying into will be a defined contribution pension. So we’ve got to get defined contribution right,” she added.
The government’s approach differs from previous DC regulation in its focus on investment returns, said Daniela Silcock, head of policy research at the Pensions Policy Institute.
“For many years, the government has been focussing on costs and now they’re trying to encourage schemes into illiquids and alternatives and encourage poorer performing schemes to consolidate. Part of the point of this is to look beyond costs and at other factors that make value for money,” she said.
Silcock broadly welcomed the proposals and said that further consolidation could help to generate better oversight and transparency. But she also added that the timeline of the reforms was crucial and warned against a rushed implementation.
Master trusts in the UK already have to comply with an authorisation regime, which was introduced in 2018 and has resulted in the approval of 37 master trusts, at the time of writing. But rules and standards for the multitude of single-employer trust-based DC schemes, of which there were more than 1,300 in 2022, remain opaque.
The government has made it clear that it would like to see further consolidation in the DC market and that investment returns could become a key factor, Trott said. “What I want to do is make sure we judge schemes on how they are performing, that they are getting the returns savers need. If they are not, they need to either consolidate or exit the market,” she said.
Silcock believes that the announcement that DC providers would be taken out of the market is initially aimed at smaller single employer schemes.
“Any master trust that’s doing well is going to have volume enough to be more creative with their investment strategy. If a master trust is really too small, it might be included, but the single employer schemes will be the ones they are talking about,” she said.
When asked by portfolio institutional if she expects the number of master trusts to decline, Trott replied: “Absolutely.”
Benchmark challenge
By focussing on investment performance, the government now faces the challenge how to define what constitutes good or poor performance. The draft Value for Money consultation has outlined two potential approaches, one includes the option of standard criteria defined by the regulator another that of benchmarks versus per group performance.
But for Nico Aspinall, a DC pensions and sustainability consultant, this approach lacks clarity. “The consultation has set out two proposals for benchmarks but they didn’t say whether they preferred one or the other.
One is an absolute benchmark set by the regulator, while the other is for the industry to set their own benchmarks.
“What they haven’t put out is a quantitative measure of Value for Money, something like risk-adjusted returns per basis points. Without that, closing schemes down for offering poor value for money sounds nice but is also pretty meaningless.”
He also argued that the government already has the means to drive consolidation. “If they wanted to close what they consider to be underperforming schemes now they could do that, that could be the focus, but they need to tell us what underperforming looks like.
“They could just tell them to either close or accept that to stay open they have to be properly licenced like an authorised master trust is,” he added.
Lack of comparable data could be a key stumbling block in the implementation of an investment-focused Value for Money approach.
“The fundamental issue is whether they have enough data to identify who is actually underperforming and what that means,” he added. “This is a value for money assessment, it’s not a returns assessment so the results are relative to the money you spent. But I am not sure they are going to get the data to prove or disprove that.”
Illiquids nudge
The Department for Work and Pensions’ (DWP) new focus on investment returns is closely aligned to the government’s agenda to promote institutional investment in illiquid assets, a topic that as among others been raised by a DWP consultation on “enabling investment in productive finance”.
Speaking to portfolio institutional, Trott emphasised that she hoped to see more institutional investment in illiquids. “The central point is that as a country, we are underinvested in illiquids compared to elsewhere and we know that illiquids tend to have higher returns,” she said.
Indeed, compared to some markets like Australia and the Nordics, UK pension funds tend to have a lower percentage of their portfolio invested in illiquids.
But with the term illiquids encompassing sectors from infrastructure to private equity over venture capital to private credit, the argument of higher returns remains hard to validate.
Aspinall said that the relaxation of performance fees for DC investors means that the government is primarily focused on venture capital and private equity, rather than investments in the green energy transition.
He sees potential conflicts of interest. “We know there are a number of Tory donors who are venture capitalists and private equity managers, so it seems semi-explicit that this is about getting more into their products.
“They ran the Patient Capital review with the bias of ‘isn’t venture capital a wonderful thing to do and aren’t DC people stupid not to invest in it?’
“The Productive Finance Working Group was framed along similar lines but with a more open brief. Enabling performance fees are not about enabling windfarms and infrastructure, you only pay performance fees on venture capital and private equity. If they are pitching this as investments in green energy then you don’t need performance fees for that,” he said.
But Aspinall warns that simply easing investment restrictions offers no guarantee that money will be invested in illiquids. “They can put whatever powers they want to in law they want to try and force assets into pension schemes but if trustees don’t consider those to be value for money they won’t go in,” he said.
Trott stressed that DWP had no intention of telling schemes how to invest: “What I want to do is make sure we judge schemes on how they are performing, that they are getting the returns savers need. If they are not, they need to either consolidate or exit the market. We have to remove barriers to allow them to seek those higher returns. That is how we are trying to do it” she explained.
The full interview with pensions minister Laura Trott will appear in the May issue of portfolio institutional. Image credit Richie Hopson
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