It is heartwarming to see a pension consultant designing a product for the good of savers who otherwise might get left behind.
Much is made of consolidation of DC pension schemes but there is a core of smaller DC schemes with assets between £25m and £500m whose members are generally only considered on a spreadsheet.
XPS have launched a service targeted to allow each occupational scheme with assets greater than £25m to have their own default managed to a specification determined by the scheme’s trustees with an allocation of up to 20% of illiquid growth stocks.
The default will be managed at a premium price , but a price estimated to be 0.4% pa higher than the liquid alternative. My maths suggests that such a default should be within the 0.75% charge cap (assuming 0.15% scheme expenses and a baseline investment cost of 0.1%.
Because each scheme will have a uniquely wrapped fund, there will be no chance that one scheme will suffer from the ills of another (depleting the illiquids). Each set of trustees look like getting their fund rebalanced to their mandate – a case of a consultancy finding a proper role for themselves in what has been a barren part of the investment market here-to-now.
XPS projects that the additional net return would be expected to increase a typical member’s pot by 7%. The extra return is expected from the private market investments stabilised by diversification across different types of investment.
In addition to expecting higher returns, the private market focus also provides scope for additional ESG impact through targeted private market investment in key sectors.
Look – no LTAF!
The arrangement presents a challenge to the Long Term Asset Fund, the Government’s means to allow small DC schemes to access illiquids. My assessment of the Permitted Links rules had suggested to me that the LTAF is an unnecessary and expensive luxury and that as much can be achieved the XPS way without the high costs of the specialist vehicle.
Several master trusts including LifeSight , Cushon , L&G and Aviva’s have gone down the LTAF route , perhaps reflecting the size of their assets (measured in billions rather than millions).
But the LTAF, unlike this unique to scheme solution, runs risks from pooling over a number of schemes to a point that trustees potentially lose some control of asset weights. If small schemes are to justify themselves, it needs to be on relevance to their member demographics. Right now – this looks like a solution that gives them such control.
Whether that level of control is actually exercised is another matter.
VFM for the smaller scheme.
The Pensions Regulator has a requirement for DC schemes with less than £100m that they measure themselves for value for money and wind-up if the trustees don’t consider they can offer it to members.
Adopting a radical new strategy presents a fresh challenge to the Pensions Regulator who will have to determine whether the scheme is phoenixing its way out of trouble. Will trustees argue that VFM should be measured going forward and if so, how will they measure the anticipated return. It will be hard to argue that higher fees are not justified by the projections of higher risk-adjusted return but many will argue that its adoption is a get our of jail card for failing trustees with a history of under-performing funds.
Another test for the gestating VFM framework is the likely increase in fees. Despite protests from legislators and regulators that DC should not be a race to the bottom, there have been virtually no examples of any pension scheme putting default fees up. How members and their representatives will react to more expensive fees, has yet to be tested.
A really brave move
XPS has done a brave thing in launching this product into a very febrile market. The product deserves our support and I hope it will win XPS more than just praise on this blog, it deserves to win them new consultancy agreements from clients.
DC investment consultancy is extremely hard to make pay and for that reason , innovation has been confined to the very large consultancies who are taken on to look after the defaults of the billion pound master trusts and the largest DC occupational schemes. Many of the large consultancies have conflicted themselves by offering their own fiduciary offerings, but XPS, Isio, Barnett Waddingham, LCP and Hymans still serve the remaining DC schemes.
So long as there are small DC schemes, there will be smaller consultancies there to serve them and it is good for First Actuarial, Broadstone, Buck and Capita that there is scope for investment innovation. If XPS is right , then the opportunity to create blended funds using insurance wrappers from Mobius, Phoenix and others , could be exciting.
While the really big DC pension plans will look to invest directly using custodial platforms, the scope for blended plans that give individual schemes their own rebalanced defaults , looks to have considerable merit.
Well done XPS.
