LGPS – the benefits of maturity
One of my aims for spending three days with the LGPS crew this week was to see what a fully functioning investment community intent on ESG and levelling up – looked like. I can report that it looked considerably more impressive than I had expected. The investment teams of DC workplace pensions are going to have to raise their game and that can only happen if they are given the chance to do so.
The first advantage that LGPS has is a strong asset base of £370bn on which there are defined cashflow cashflow calls.
The second advantage is that though there are 86 pension , there are only 8 investment pools from which the funds can source investments.
Finally, there is a clear purpose amongst those managing the money as to what they do, they are clear that they provide members with pensions in an “evergreen way”.
Can DC workplace pensions aspire to the fixity of LGPS?
In terms of funding, the core workplace pension schemes (the commercial mastertrusts) have less than a third of the assets of the LGPS and none of the certainty with regards future cash calls. Many are targets of consolidation or takeover. The wider occupational and contract based DC schemes don’t make a lot of sense. DC workplace pensions do not yet have the financial clout to invest in what they might consider an optimal way. In investment terms they are a work in progress.
Secondly, while LGPS schemes work with each other through the investment pools, DC schemes are at each other’s throats. Each is competing for supremacy or survival, though we have seen flashes of co-operation, (Nest.Cushon), for the most part, workplace pensions do not work towards a common good and , outside of the core master trusts , have no obvious reason to be. This is a tadpole industry with a big head and a long tail.
Thirdly, there is no clear idea amongst the leadership of workplace pensions as to what their purpose is. For some, such as Smart and Cushon, pensions are a launchpad for respectively a technology and wider employee benefits business. For Nest, the purpose has been to make auto-enrolment work, People’s Partnership and NOW were first movers but struggle to clearly identify what they are offering their members in terms of “pensions”.
My week in the Cotswold Water Park told me that DC pensions have a lot more to learn from LGPS than the other way round. As they aspire to become part of the UK pension infrastructure, they would do well to speak with some of the industry leaders I met this week.
How far behind are workplace DC pensions?
It is the investment of DC funds and the means they turn pots into pensions which will determine in the long term, who will have offered value for money.
Right now, the investment return is the last thing on the minds of most DC leaders. To get to the point where they clearly focus on “member outcomes”, they must first find a way to make themselves commercially stable, as LGPS is. That means continuing to consolidate the purposeless DC plans that are run by corporately appointed trustees and by insurance companies (as GPPs). We cannot continue to support the wide range of DC options open to employers, the vast majority of DC plans should be combined into a few large master trusts with minimum asset bases of £20bn and an optimal size of five times that. That is the first step.
The second step, and I hope this can be taken at the same time as consolidation, is that those confident pension schemes with scale, must put up the price of investment to members to increase investment returns. Right now the direction of pricing is downwards, this needs to change. If people want low cost passive funds, they should be able to choose them but defaults need to invest more ambitiously and have the confidence to do so. Hymans Robertson 10-10-10 formula is a useful starting point in understanding why.
The final step will require a new vision for workplace DC pensions as the successor to DB workplace pensions. As many DB plans reach their endpoint and become self-sufficient or bought out by insurers, there is a pension budget up for grabs. Right now, corporates regard DC pensions quite differently from their DB plans. They do not invest in DC advice and regard DC investment as a commodity that can be squeezed for value by focussing on lowering the AMC.
Workplace pensions have allowed this to happen by failing to win the argument that they are better than that. They have shown no intent to provide their members with pensions, little intent to really invest in ESG and become part of the productive finance initiative. They have allowed themselves to become platforms for low-cost passive funds that are differentiated by the quality of power-point presentations.
Workplace DB pensions journey to maturity
I think it may take twenty years before we can start thinking of workplace pensions as a mature part of the pension system. LGPS has got there through consistently high funding of a well thought through pension system and through sorting out its governance to maximise efficiency.
It has a strong sense of social and environmental purpose and these are balanced by the fiduciary duty to pay pensions in full.
Sadly, DC pensions do not have secure funding , they have not established a framework to pay pensions and they look highly inefficient.
It was encouraging to see Emma Douglas at the Conference, albeit in her capacity as PLSA chair. She heads the UK DC workplace pension business of Aviva and is well placed to pick up on these messages.
DC pensions need her leadership and capacity to bring others with her.