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Exceptional investment returns, net of charges, are the holy grail for defined contribution (DC) schemes. And delivering better retirement outcomes for members is now also central to the government’s ambitions for DC. Value is the name of the game. With price becoming less of a decisive factor, and with service levels improving overall, investment excellence is now the main constituent of delivering value.
However, regulation is also being aimed at improving ‘values’ as well as value. The Pensions Regulator (TPR) recently said that ‘too many pension schemes [are] focused on minimum compliance with ESG duties’,
and they would like to see schemes do more. And the government’s desire to see DC money fuelling UK Growth is clear to all. The questions is – can you have both? Value and ‘values’. In other words – can you have your cake and eat it?
Rethinking Value Factors
In theory, increasing pension contributions is the simplest way of improving retirement outcomes. However, within the economically constrained environment that individuals and employers both exist, it is often the hardest one to achieve.
Similarly, reducing DC charges has long been a strategy for improving outcomes. But unfortunately, lower fees do not really help much. Aon modelling shows that, over a typical saving lifetime through a master trust, lower charges would add only 10 – 15% to final pension.
However, provider investment performance makes a dramatic difference. Having average upper quartile performance, rather than bottom quartile, can double your retirement adequacy. It is encouraging to see the government acknowledging this in its value for money framework.
Putting the ‘Values’ into Value
There has long been a debate about the impact of ESG investing on returns. However, Aon’s experience demonstrates that it is possible to invest responsibly and generate strong returns.
I would urge readers to look at five-year performance of the main providers’ defaults against their fund’s carbon footprint, as measured in the latest Corporate Adviser DC Pensions Responsible Investment Report.
It shows Aon’s default strategy achieved among the highest level of returns in the peer group and has almost the lowest carbon footprint, the highest proportion of investee companies aligned to the SBTi framework and the highest allocation to impact funds in the sector. It is possible to invest to meet both sustainability and performance objectives.
The Impact of Investment Scale on Performance
The Chancellor and the pensions minister believe that ‘mega funds’ can capitalise on their size to deliver improved value. However, we have yet to find compelling evidence of a correlation between simple scale and investment returns for the UK DC market.
Looking at cumulative returns during the crucial growth phase achieved by the large DC providers, there is no direct relationship between size and performance. If anything, it is the opposite. More information, and an illustration, is available at aon.com/betterbydefault.
Expanding the Investment Universe
The government’s ongoing review also considers options to boost returns through allocations to private assets and, more specifically, UK productive finance. Increased private market allocations can potentially be part of the solution. But investments must be selected and implemented in the right way. For example, you need to use the right asset class at the right point in the glidepath. Additionally, costs must be considered overall, and the selection of specialist managers, rather than generalists is essential.
Into the Future
Investment returns play a crucial role in delivering value for DC members, and we welcome the government’s emphasis on expanding value assessments to focus on net investment performance. Both private assets and sustainable investments offer potential benefits here.
We expect to see the continuation of existing trends towards consolidation, given the transition from single employer own trust schemes to master trust, in particular. However, we do have concerns about any forced consolidation which may impact competition, innovation and therefore member outcomes.
Investing in a way that improves the world people will retire into is important for DC members, many of whom will be taking their pension well into the second half of this century. With the right default fund, it is possible to invest sustainably and achieve positive investment performance.
Nigel Aston is a specialist for Aon DC Solutions, which provides The Aon MasterTrust, Aon’s Group Personal Pension, and investment services for own-trust arrangements. Contact Nigel at talktous@aon.com
