Industry split on DC investment innovation proposals

Earlier this year, the government unveiled a consultation putting forward a range of proposals aiming to expand defined contribution (DC) investment innovation. The consultation closed at the end of last month.

While the industry welcomes the Department for Work and Pensions' (DWP's) suggestions to encourage investment in illiquid assets, there are split views on its proposals for the charge cap, and transparency in policy reporting.

Illiquid assets

Hymans Robertson head of DC investment Raj Shah supports the government's proposal to encourage DC schemes to make greater investment in illiquid assets, and says these assets have the potential to significantly improve member outcomes at retirement, especially with younger members with longer investment horizons.

He says: "More investment by DC schemes into these asset classes can also make a big difference to society given their potential to contribute to projects such as renewable energy."

Regulatory framework

There were, however, calls from several people in the industry for the government to provide clear framework in place for schemes.

Smart Pension director of policy and communications Darren Philp says: "If and when requirements are put on schemes, we would encourage the government to provide clear guidance as to what is expected to help scheme governance meet policymaker's expectations."

As Pensions and Lifetime Savings Association (PLSA) investment and stewardship policy lead Caroline Escott agrees - noting that a regulatory framework should support schemes in investing in accordance with trust law and with their fiduciary duty to members.

Performance fees

With what's on the table so far, the DWP has proposed an extension to the way compliance with the auto-enrolment (AE) charge cap is measured to make it easier for trustees to consider investments - such as illiquid assets - which levy performance fees, while retaining the same level of protection for members.

The industry is generally supportive of the current level of the charge cap at 0.75%, including the PLSA, which, in response to the consultation, says it has been a "positive step in ensuring greater value for money for members".

However, given the bespoke nature of many illiquid investment classes, fee competition can be quite limited which can lead to difficulties with the charge cap.

The Association of Consulting Actuaries (ACA) agrees. In its formal response to the government, it noted that while performance fees are very common in illiquid asset classes, it does not believe there is always a good reason why they should be required.

The ACA response says: "Market practices are changing with increased transparency and ultimately this may well lead to downward pressure on fees. Given the bespoke nature of many illiquid investment classes, fee competition can be quite limited and this can lead to difficulties with the charge cap."

It also noted, although it is perfectly feasible to access funds with a performance fee within the overall charge cap, it believes that the mechanism does inhibit this.

It association adds: "The legal requirement for a charge below the cap can sometimes lead to an excessive focus on cost rather than value, with cheaper investment options favoured to generate a positive headline figure even if this may not lead to the optimal member outcome.

"The added complexity of a performance fee can further distort a comparison between funds, as well as frictional costs of monitoring and communicating these charges."

Transparency

Some have also welcomed the DWP's proposal for schemes to explain their policy in relation to illiquid investments in their statement of investment principles (SIP).

The ACA said in its response that this will allow schemes to invest flexibly in the most appropriate way, while also encouraging them to consider illiquid investment.

Nonetheless, others were unsure as to whether additional reporting should be required.

In its formal response to the DWP, Smart Pension said if the trustees have included a policy on illiquid investments in the SIP and included any performance from such allocation in the quarterly investment report, "then we would challenge additional annual reporting by the trustees on their illiquid investments".

Consolidation

Meanwhile, amid The Pensions Regulator's (TPR) master trust authorisation regime, which kicked off last October, the DWP is encouraging consolidation among DC schemes, which the industry supports.  

Shah says the drive towards scale may be the catalyst required for schemes to consolidate if they cannot deliver better net risk-adjusted returns than a bigger scheme could deliver.

He says: "Bigger schemes should be able to achieve the economies of scale required to invest and capture more opportunities to improve outcomes to members. However, it's important that the decision to consolidate is not based on assets under management alone, but in a wider value for members' context."

Furthermore, good governance is essential to improve member outcomes, and consolidation will help to achieve this.

Smart Pension's Philp says the proposals outlined on consolidation are a good step forward, "but need clear guidance and clear sanctions for them to have a positive impact".

He adds: "All workplace pension savers deserve to be in schemes that are well-run and offer great value for money.

"We encourage the DWP to grasp the nettle and be even more proactive in forcing consolidation where it is in the members' interests."

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• Topics
• Investment
• defined contribution
• patient capital
• DWP
• department for work and pensions
• Hymans Robertson
• Raj Shah
• Smart Pension
• Darren Philp
• PLSA
• Pensions and Lifetime Savings Association
• Caroline Escott
• ACA
• Association of Consulting Actuaries
• The Pensions Regulator
• TPR