Auto-enrolment defaults lack sophistication in their investment design and this is in large part down to a misguided focus on cost. Employers, consultants and advisers need to switch their focus from cost to value said delegates at a Corporate Adviser round table in the House of Lords last month, which covered issues raised by the magazine’s Master Trust Default funds research.
At the event, held with former pensions minister Baroness Ros Altmann, delegates agreed an overwhelming focus on cost and a narrow view of investable assets was selling members short in terms of the efficiency of the asset allocation offered by many defaults, potentially leaving them considerably worse off in the long run.
JP Morgan Asset Management executive director, UK DC Annabel Tonry said: “We have a reticence from trustees, that even though they are way below the charge cap, around increasing cost and having to communicate it to members, even if they believe by adding on an extra 5 basis points they will actually get people to a much better place.”
Aviva investment proposition, workplace benefits Jason Bullmore explained what this focus on cost meant for providers. He said: “From a provider perspective we see an absolute focus on cost and this has got to change. In our master trust we have to have a very low cost basic default. This pressure comes from both the employers and consultants.”
Discussing the alternatives to equities, Willis Towers Watson senior investment consultant Chris Smith said: “Younger investors need equities because they have almost always done better than other assets, excepting private equity and property – but we can’t afford to invest in those assets within the price cap.”
Baroness Altmann said: “So does that mean we have to exclude DC from the gains that we have made in performance in the world of DB?”
JLT head of DC investment consulting Maria Nazarova-Doyle suggested that the price cap could be raised when it is reviewed in 2020.
Tonry argued: “You can design a fund that has a little bit of illiquid, that can come in well within the charge cap.”
Aon Risk Solutions head of DC investment James Monk expressed concern that master trusts had no incentive to seek out the very best asset classes. He said: “What are the barriers to getting socially responsible illiquid assets into DC? What are the barriers to master trusts and GPPs paying more money to access these assets? Master trusts have to make money. But they have no incentive to spend on more costly investments. That incentivisation structure going forward is the thing I am most worried about because defaults have such large amounts of assets being pumped in there – they could afford to put illiquid assets in there.”
Mercer solutions leader, DC & individual wealth Philip Parkinson said: “Does the consultant community not have a responsibility here? All the sponsors come to us for advice about which master trust to choose. So do we have the responsibility to raise as a priority investment, and challenge the focus on cost.”
Bullmore agreed. He said: “It costs about 2bps extra to put an ESG filter on a fund, but decisions on providers will be made on the basis of a single basis point.”
Smith pointed out that cost disclosure rules do not compare apples with apples. He said: “We all think equities are cheap, but equities hide all of the costs of equities inside the business. If you invest in a property business, there are no stamp duty costs being disclosed to the members, there are no costs of insuring the buildings. They are just hidden inside the stock. If you invest in direct property you are buying the same assets, but all of the costs are exposed. It’s the same asset, just held in a different way that looks more expensive.”
Growth alternatives to equities
Altmann argued that other asset classes should be brought into DC. “It seems we are going through the same process that DB managers did 20 years ago where the only choice was how much equities and how much bonds. And they ended up concluding that equities were the right choice, and that
did not serve them well. Now they are diversifying, they are protecting the downside, they are investing in infrastructure, property. They have a much greater recognition of the longer term time horizon that can benefit from different types of risk premia. Yes equities give you a risk premium, but so does illiquidity.
“For me the big thing stopping DC being able to benefit from the learnings of DB which has managed to improve its performance so much over recent years, is daily pricing. If you try to daily price something that is anything other than equities and bonds and has a long term time horizon such as property or infrastructure, it is very hard to get your money back straightaway,” said Altmann.
Monk agreed, citing the performance of ATP in Denmark in comparison to its subsidiary Now: Pensions in the UK. He said: “ATP, Now: Pensions’ parent in Denmark has done very well. It is not restricted by daily pricing and Ucits regulations. It is able to invest in a more unconstrained, DB way.”
Altmann asked: “Should people expect to be able to trade the pension in tomorrow and take it somewhere else? Or should there be a better explanation of the long-term value of patient investing and that might mean if you want to switch to another manager, you can’t switch immediately. It’s a question, I don’t have an answer.”
Debate then expanded into the cost of different parts of a workplace pension proposition.
Nazarova-Doyle said: “For most schemes the admin is a massive chunk of the budget, so for most schemes the investment budget is not 75 bps, but maybe 10 or 15 bps. So you are only left with very cheap passives and it is hard to do any sophistication at that price.
Bullmore argued that admin was not a pricey part of the whole equation. He said: “Administration is not that expensive. We are quoting sub-20 bps for admin.”
Leaving the default?
LCP senior consultant Helen Stokes considered what members would do if their default was underperforming – and argued that for the moment, that would not mean moving to alternatives offered by the provider. She said: “Until we get a higher level of engagement, we are not going to be able to get people choosing alternatives to the master trust. My experience with master trusts is when sponsors choose them, investment is one of the last things to be considered, which is really frustrating. Companies and trustees want sign-off that it is fit for purpose and that it is not awful,
but they are not moving to master trust to access a really good investment solution. This report highlights why investment needs to be at the forefront of decision- making, and highlights the differences in master trusts in terms of asset allocation at different points.”
Barnett Waddingham associate Esther Hawley said: “We have talked a lot about all the challenges and interesting issues we need to grapple with within the industry. But we shouldn’t forget to look back and see how far the industry has come in the last 10 years. It is actually a really positive and encouraging story. Yes we need to be vigilant, yes we need to make sure everything is done properly, but let’s not forget that we are in a very much better place now than we were 10 years ago.”