Since 1 October all DC schemes have been required to report on the net performance of their investments. This is the first step towards the value for member (VFM) assessments that are required for smaller schemes (with assets of less than £100m) from 1 January 2022.
In principle, the new assessments are intended to identify the poorly performing schemes and push them towards either improving or moving to a larger, better quality scheme such as a master trust.
Further legislation is on its way, in the form of the Own Risk Assessment (ORA) and Task Force on Climate-related Financial Disclosures (TCFD) which will both put greater pressure on trustees. The direction of travel is clear, and the number of smaller schemes will undoubtedly decline.
Unfortunately, trustee understanding on the new VFM requirements is not as strong as it should be, particularly for those schemes without a professional trustee. Trustees may think the small difference in name, moving from value for money to value for members, implies only a slight strengthening of the requirements, but the reality is that the new VFM assessments are significantly different and need considerably more work.
We have been conducting free indicative VFM assessments to help trustees understand the likelihood of passing the costs, charges and net performance assessments. Our indicative assessment compares existing scheme default funds to three master trust default funds over 1, 3 and 5 years. Results have been concerning, with few passing the assessment over all three periods.
Aside from the difficulty of passing the assessments, schemes may also find them hard to complete. While historic investment performance data is available, the format of the new requirements is strictly prescribed so it
may not match the data on record. Actively governed schemes that have made changes to their funds will have additional challenges in unravelling this historic data to make the required comparisons and this is likely to be time consuming and expensive.
Many schemes have been around for decades and conducting a VFM assessment for them will include challenges. We have seen that when a scheme involves fixed administration charges paid by members, with-profits investments or GMP underpins it makes the VFM assessments required more complicated and potentially more expensive.
Faced with these challenges and the additional legislation coming along over the next few years, it is likely that the objective to reduce the number of poorly performing small schemes will be achieved, but there will be a cost.
Strong, well-managed schemes are in danger of disappearing under the weight of legislation and we could find that we are throwing out the baby with the bathwater.
The increased activity in larger schemes considering a move to master trusts – possibly in response to the consultation paper issued in June exploring the extension of VFM assessment to schemes with assets of between £100m to £5bn, also gives cause for concern. If we see larger schemes moving towards master trusts overlapping with smaller schemes there is a danger of capacity being stretched to the point where smaller schemes, which will benefit most from the move, could be unable to secure attractive terms from the master trust community.
There is also limited capital available to support a lot of scheme transfers. This means securing the funding to reduce out of market risk for members on transition is likely to get very stretched, especially if the larger schemes also join in the consolidation process.
On a positive note, there may be opportunities for DC schemes to invest in a wider range of investments and this could open some exciting options. There is speculation around the increased use of illiquid assets and infrastructure projects, particularly considering the announcement by Rishi Sunak in the Budget that pension scheme charge caps are to be reviewed. However, these higher-return investments will be considerably more accessible with the scale available through master trusts and would be difficult for smaller trusts to offer, due to the need for liquidity and daily pricing.
On balance, the new VFM assessments are likely to go a long way towards improving pension outcomes for members of failing DC schemes, but the timing may create some stress in the market and there is a danger of losing some well-managed schemes in the process.