The curfew tolls the knell of small DC

I was a bit churlish in yesterday’s blog to the DWP who – on re-reading – have produced an excellent paper outlining the advantages of incorporating social purpose into the DC funds we default to.

I urge you to read the paper, which at 15,000 words is meaty, but if you are in the business, then it provides a wealth of background and asks some important questions of DC schemes. As I said yesterday, it will make for a better conversation between trustees and members and should get some of those chair statements read!

What is so good about this paper is that it looks at the problem holistically. DWP have worked out the key market dynamic – that small occupational DC schemes simply aren’t viable to a single employer. However, where scale has been achieved, much can be done.

There really isn’t much in it for the trustees of small occupational DC schemes. If you want to maintain control of your default – then you have to contend with the strictures of the charge cap and justify your decision to your members every year. This is fine if you are offering a fund that is providing value, but if you have deviated from a beta position and the bet goes wrong, you risk being accused of gambling with someone else’s money.

The thrust of the DWP’s paper is that trustees of small occupational DC schemes and that’s the vast majority of them, are simply not able to participate in the discussion about patient capital as they will never have the scale to build the kind of diversified defaults, the DWP has in mind.

The paper does this using four charts that tell their own story

DC is growing – it has replaced DB and is surging because of auto-enrolment

Small DC plans are packing it in – giving up the unequal struggle with tougher regulation

Schemes are getting fatter (through increased numbers of pots as well as investment growth) – Tear for Year typo not mine!

There are still less than 50 occupational DC schemes with more than £250m in assets and only 16-17 with assets of more than £1bn (mostly banks and pharma)

Turning the screw on small DC plans

Clearly the DWP are turning the screw and this looks like the kind of market intervention that is needed. Too often , under-performing pension schemes are allowed to continue because they mean well. In the DB context, this may be acceptable because an employer stands behind the pension promise (unless the covenant is so weak that it cedes to the PPF). But in DC – a failure puts at risk the member’s pot and retirement income.

No matter how well meaning, trustees cannot be allowed to deliver sub-optimal decisions because they cannot afford the investment tools to do the job.

The conclusion is that DC trustees will have to fight – for their right – to party.

So what of big schemes – will they buy the green ticket?

So far – the adoption of the ESG principles that drive a move to patient capital have not been generally adopted. HSBC’s “FutureWorld” default is an exception rather than the rule and until L&G adopt the fund or a variant for its master trust and GPP, there will be a lack of conviction about the fund. I know of one or two small schemes that have switched default to Future World but this genuinely green accumulation fund, has yet to get popular acclaim.

The most interesting use of the fund is within the Pension Bee SIPP. Here the fund has to be actively chosen against other “cheaper” alternatives. It will be interesting to hear how take up is progressing fro the Bee-keepers.

The indications are that the the majority of savers under the age of 40 consider how their money is invested important and that investing responsibly is what trustees are about. If trustees cannot demonstrate – both in their SIPPs and in their annual chair statements that they are proactively choosing to invest green – they will be failing not just to comply with DWP rules but in their fiduciary duty – especially to their younger membership

Sure there is a cost to a green fund – FutureWorld is more expensive than the vanilla global equity alternative – almost twice so. But there is a price to pay for cleaning up the planet, the boardroom and the ethics of investment. Exercising good governance does not come cheap – you need good people to do it.

This is a scale play

This brings us back to the central “holistic” view of the DWP. Small schemes simply can’t afford to do responsible investment properly. Large schemes can. They can afford to monitor what their managers are doing and when they get to a certain size, they can start exercising rights over assets by purchasing directly.

NEST, People’s, NOW and even Smart will be of a size within the next few years to create segregated portfolios for their assets. They will be able to invest not just in patient capital funds but directly into the assets into which funds currently invest.

But this can only happen because they all manage millions of small pots.

So if you are reading this and you are a member of a small occupational DC scheme or a trustee of such a scheme or a sponsor of such a scheme, my advice is to start making some noise as to why you are in a small scheme and not talking to NEST or NOW or People’s or Smart.

And if you are a consultant to these small schemes, you should be having that conversation in the member’s stead. It is not enough for you to argue for the status quo, even if the status quo keeps you in annuity income.

Many consultants have decided to set up their own master trusts and encourage small schemes to aggregate to their platforms. Fund platforms like Mobius are available if you want to buy into scale. I do not think that the master trust market is saturated yet.

But unless you are able to access scale and use bulk-buying power, the chances are you will eventually be subsumed by the bigger players.

And the DWP will be applauding your demise.

Of course CDC does this best of all.