A new threat to Government plans to upgrade DC pension plans through investment in productive finance has emerged.
Hymans Robertson has proposed a “10-10 and 10” strategy to get our pensions working as hard as we do.
“If you are able to spend an extra 10 basis points, you can support a 10% allocation to diversify illiquid solutions, which can improve retirement outcomes by at least 10%.”
10 basis points is a flash way of saying 0.1% on the annual management charge (AMC) that members pay on their retirement savings. So if your scheme has set its default AMC at 65 bps , including more powerful illiquids would increase the AMC to 0.75%.
This is important as the Government is encouraging employers and trustees to purchase on the expectation of better “outcomes” than on a price comparison. On a face of it, outcomes are improved much more by including illiquids than hampered by the extra cost of the investment strategy. It should be a “slam-dunk” for 10-10-10.
At a meeting of business heads convened yesterday and attended by the Government’s FVM team, one workplace provider after another complained that in competing for new business , they were being asked to provide AMCs at ridiculously low figures.
A typical AMC for a scheme with reasonable cashflows and £100m is now being auctioned off at between 8-12 bps, leaving no scope for illiquids , other than through a price increase.
To meet what one provider called the “charges limbo”, default funds are being stripped of all unnecessary expense , meaning that fund management costs are trending to zero bps, so that providers can maintain a semblance of sustainability in their pricing.
This can best be described as “scorched earth pricing” and unless contracts allow for a reflation in pricing, it means that large swathes of members in master trusts will never see the positive impact of 10-10 and 10 but will be stuck with sterile investments in unproductive investments.
The law of unintended consequences
The collapse in prices for master trust services is being driven by fierce competition for assets – an “asset grab” as one of yesterday’s participants called it.
Normally – such competition would be considered a boon for consumers who may find themselves paying half as much for “the same thing”. But the suspicion is that such pricing is not a dividend of better systems and more efficient investment, but of underpricing by a part of the market. The fear is that mastertrusts are being incentivized to increase assets under management by business models agreed by backers with little mind for outcomes. Such models see workplace pensions as a means to create platforms for the sale of higher margin products and services in time.
The unintended consequence of a push to consolidation of smaller schemes, may be that we end up with large schemes that are not producing better outcomes and are unable to convert to richer investment strategies as they are now promoted not on value but price.
It is easy to ski downhill on price. Well organized corporate procurement teams, tasked with getting best price on what are seen as commoditized services are reported to be choosing one proposition over another for as little as 0.5bps price advantage (0.05%).
The trophy price achieved can be trumpeted in the boardroom though it may have little impact on members for whom such a difference in pricing has no perceived advantage either to their current or future finances. Research from Ignition House , SUEZ and other employers reporting to the DB DC Summit earlier this week suggests that consumers are more interested in what they are buying than what they are paying.
The worry is that once such pricing structures are implemented, it will be hard to increase prices, it is much harder to ski uphill.
The root of the problem
A number of providers saw the root of the problem as uneducated buyers and the key to solving the problem, educating these buyers. We have known that employers buy DC pension services poorly ever since the OFT wrote this in 2013
In the nine years that have passed since the publication of that statement, we have seen no great improvement in the buyside behavior of those purchasing pension services on behalf of their staff. The focus may have moved from AE compliance to AMC minimization but employers seem nowhere near recognising 10-10-10.
Meanwhile, those who they purchase on behalf of are left asking “what are we getting for our money”. “Their money” in this context , is not the amount taken in charges but the amount they pay as contributions and “what they get” is measured in likely income in retirement , likely cash in retirement and in the support they are getting from their workplace pension to manage their later life finances.
So long as employer procurement teams are buying on price and the gatekeepers are acting as auctioneers , the consolidation of schemes is creating scorched earth and infertile ground for the seeding of productive and patient capital. This is not what their staff want or expect.
Over the course of 150 minutes of discussion, three things became clear
- Without a change in purchasing behavior, members are being denied value
- Education has so far failed, we need a fundamentally different means of comparison for “the buyside”.
- If VFM fails , then mandating allocations to illiquids is the long-stop.
I fear that the VFM project will fail unless it can reverse the trend to commoditize workplace pensions by price. Someone needs to take the lead, yesterday it was Hymans Robertson – good for them. There needs to be new ideas, I believe that overhauling the value metrics is the new idea. Mandating investment strategies is an idea that even Nicholas Lyons, who is mooting it, only wants to see happen as a last resort.
It is time to stop sitting on our hands and hoping that something is going to turn up, it’s time to try something different.
If the advisers organising the auction of such schemes on the basis of lowest price gets the business are FCA regulated, then soon they will be paying redress under Consumer Duty if more expensive schemes with a holding of illiquids produce better outcomes. I think that setting the price so low that illiquids are ruled out will fall within the definition of foreseeable harm.