Master trust providers could soon partner with rival firms for the first time to offer new investment opportunities for members — and that could include investments into infrastructure, private equity and other illiquid assets.
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Speaking at Corporate Adviser’s roundtable event at the House of Lords, on driving better outcomes for master trust and GPP investors, Cushon head of workplace savings Danny Meehan confirmed the company was currently in discussions with other master trust providers. He said that while these conversations currently remained confidential, he was hoping to share more details soon.
Collaboration between commercial master trust providers has not been seen in the UK market to date, although there are parallels overseas, with a number of not-for-profit Australian ‘supers’ joining forces to launch an industry-wide infrastructure fund.
With most large master trust and GPP providers being commercial enterprises it is thought this more collaborative approach might prove difficult. But there was support for this initiative from the delegates at the event, with L&G co-head of DC Rita Butler-Jones saying the insurer would not rule out such an approach.
Baroness Ros Altmann, a former pensions minister, said that a pooled approach could help address some of the barriers that have to date restricted widespread investment into infrastructure, private equity and other less liquid asset classes within the DC sector. These barriers include the potential hurdles around daily pricing, and cost, particularly in relation to getting investment management fees with the 0.75 per cent charge cap on AE default funds.
Altmann asked whether it would make sense to have either a government, or quasi-governmental organisation setting up a pooled fund to invest in UK infrastructure and other illiquid assets.
She pointed out that DB schemes were typically invested in a far broader range of assets, when compared to the DC sector, and this had benefited members.
There was agreement among all the panellists that these new asset classes could offer significant benefits to DC savers too, in terms of enhanced investment performance during the growth phase, as well as steadier inflation-linked returns for those approaching or at-retirement. Many attending the event thought that these new asset classes could be an important part of a DC allocation strategy as the economy moves into a period of higher inflation and potentially more volatile investment returns.
When it comes to addressing some of these barriers, regulation to allow Long Term Asset Funds may address the potential hurdles around daily pricing. Mercer partner and director of consulting Brian Henderson said that effectively these new fund structures were “liquid funds of illiquids.”
He added: “If you’re investing in LTAFs within a default you’ve got liquidity in play around that, so you can try to avoid problems like the property debacle where assets were gated and tied up for a year and a half.”
For many on the panel the bigger challenge was the cost of investing in
these illiquid assets, particularly as the trend in recent years has been to drive costs downwards in the workplace pensions market.
Henderson said consultants have a significant role to play in challenging the norm that low cost automatically equals better value. But he said this might be a difficult task, particular as providers tend to compete on costs.
“If you are doing a selection exercise there is pressure on consultants to look at costs and keep them down. Master trusts are commercial beats and compete against each other predominantly on cost at the moment. And so it is going to be a real challenge for the industry to shift towards buying asset classes that are not just moderately expensive but can be very expensive.”
Added to this is the complex way that these charges are often structured, with the vast majority of infrastructure or private equity managers levying performance fees.
The government has proposed that these fees could be excluded from the charge cap, but there were still concerns from those on the panel about how this might work in practice.
Henderson said: “To me, one of the main issues is ensuring how a performance fee is fair across all members. I wouldn’t want some members to be disadvantaged at some point in the cycle compared to others. There is the potential for this to happen with performance fees.”
Altmann said it was important to structure these fees correctly to ensure this did not happen, and said lessons could be drawn from the DB sector. “I’ve been involved with DB schemes for years, and we have negotiated fee structures where you get a certain amount each year over 10 years.”
Aon head of DC investment James Monk said that while this remained possible, the problem remained that there was no common industry practice around how you apply performance fees in DC, while also complying with ‘treating customers fairly’.
Large master trust players like Nest have included infrastructure and illiquids within their default, and may have the buying power to negotiate good deals on fees. A larger cross-industry fund could also potentially wield the same collective clout.
Monk points out that if infrastructure or private market funds within DC have lower or no performance fee this could potentially create some unintended market distortions, which may not benefit members.
“If you have one fund which doesn’t have a performance fee, and another that does, the manager is incentivised to put the best private market deals in the one with the performance fee, and conversely the worst deals into the structure without this fee. It’s really important that if the entirety of the private markets sector operates with performance fees we find a way to work with them to ensure that DC members also get access to the best deals.”
Franklin Templeton head of UK retirement Lee Hollingworth argued for more of a focus on the potential benefits of these new asset classes, and said consultants had a role to play in changing the conversation with employers from one focused on costs to discussions about value.
“A lot of the debate seems to have focused around the barriers to investment, be it cost, or daily pricing. I suggest it should be more focused on the potential value these asset classes can offer, and how their might apply across the member journey in the DC space.”
He pointed to private equity assets offering good growth potential particularly during the early stages of investment. He added that infrastructure has a place pre-retirement and even into retirement.
Such investments can also help schemes deliver on ESG and social purpose targets particularly in relation to investments in social housing, education and healthcare.
Both of the providers attending the debate — Cushon and L&G — said this was an important aspect of private market investments. Butler-Jones pointed out that research by the insurer found that members were prepared to pay more for investments that delivered on social or environmental benefits. This may address some of the barriers around cost. Meanwhile Meehan pointed out that such private market investments had already proved to be effective ways to get more members engaged with their pensions.
Hollingworth said that while there was widespread agreement about the benefits of including these new asset classes within DC defaults, the big question was how does the industry make it happen.
“There has to be a leap of faith in terms of both the increase in costs in what at the moment is a very competitive market.”
He added: “It is a challenge. Everybody in this room is probably quite well initiated in the value of private markets, but much of the industry is not.”
Kerr Henderson head of corporate pensions Jason Marley says that the conversation consultants have been having with employer clients in recent years has been driven by cost. He pointed out that as the underlying assets within default funds have shifted from active to passive funds, the costs have fallen. “Over the past five to seven years the conversations have been around how 75bsp is too expensive, we need to get down to 50 bps.”
But Marley pointed out that new Value for Money (VFM) assessments may cause further problems for DC funds introducing substantial exposure to private markets.
“The question is how do we assess these investments against an annualised value for money assessment?” As he points out returns from private markets investments tend to have a “slow burn” delivering relatively low returns in the early years. “So for funds that adopt private market investments we may start getting quite poor value for money assessments in the short term.
“I think this is one of the barriers that is going to concern employers, is going to concern trustees and is going to concern members.” Private markets may have the potential to deliver better longer-term returns, but many on the panel said there was a lack of publicly available data and information on this issue.
Asking trustees to potential pay more for assets that may appear to underperform in the short term is a pretty tough conversation. Joanne Neary, head of consulting at PIB Employee Benefits said: “Trustees are naturally cautious and won’t necessarily want their scheme to be the first to step out of line. So we need to educate trustees, and members, about why these decisions are being made.”
Monk added that this was not just a difficult issue for trustees. It was also a potential problem for providers. “If we acknowledge with greater illiquid investment that there’s going to be a short term detriment to returns, in exchange for better long term gains, it’s not hard to see why a lot of master trust providers might be very shy of going down this route at present when there is a huge amount of consolidation going on in the market.
“For providers looking to win new business now may not be the right time to be falling slightly behind on performance.”
Barnett Waddingham partner and head of DC and workplace wealth management Mark Futcher said that it was perhaps useful to make a distinction between relative and absolute value.
“I think small schemes and master trusts are driven by relative value because they’ve always got an eye on what other schemes and doing and what they could be doing commercially.
“But larger trusts that do not necessarily have the same commercial considerations can look at absolute value and ask what is genuinely best for members. Larger single trusts schemes are doing that.” He gave the example of a scheme that the firm had worked with that had charges of 71 basis points on its default fund. “This schemes offered fantastic value to its members. It had all these different asset classes, it had engagement tools, it had proper interaction with members including face-to-face sessions. And the performance was there as well, although this is only one element of a DC scheme’s overall value.”