The questions discussed on the VFM blog have so far been rather less than challenging. I posted my review of the latest podcast yesterday and got this question on my blog. John is an IFA who started in the mid 1970s and still thinks hard about delivering value to those who were his clients and now are pensioners as he is. Here is his question.
Well the answer to that question has been simple over the past fifteen to twenty years. If you run a DB scheme your strategy whether as trustee, executive or sponsor is to “de-risk”. The appetite for higher growth assets like UK tech or infrastructure has been reduced by threats by TPR to take action against trustees who take risk and jeopardise the sponsor (employer).
For DC schemes, there is the commercial consideration that investing in alternative assets, often in the private markets and hard to value , makes such assets unfeasible for the provider and of little interest to the trustee (who is the goalkeeper not the striker) to use a good analogy from Nico in the latest blog).
In short there has not been much motivation to invest in high risk investments because the short-term impact of failure outweighs the potential for growth in the long term. Although pensions have the longest of liabilities (our lifetimes and those of future generations), the thought of DB schemes lasting much longer than the current “end game” has made the question exclusive to LGPS and to an extent USS, Railpen and a few defiant schemes run by UKAS , the unions and a few outliers from the public sector (the MP’s DB scheme is an outlier).
The DC schemes are now beginning to adopt risk. Mark and Elizabeth and Paul at Nest have shown they are interested in investing in infrastructure and People’s and a few other larger insured and consultancy schemes are taking a few decisions to invest for the long term in what are high-risk short term assets. But let’s not be too optimistic, we have no Maple 7 equivalent yet in Britain. If VFM pits DC schemes against the best, there must be “best” DC schemes which invest for the long term for growth and this is very hard for DC to do. There is always the consideration that it is the member/policyholder’s pot. There is freedom to take money away and that means liquidity is more important than perhaps it should be.
When I say “should be”, I mean the situation that DB and CDC schemes have when in their sweet spot with no consideration of liquidating individual pots and where the DB and CDC schemes have an infinite investment horizon. You know the diagram that Derek Benstead drew me to explain the innate advantage of a pension scheme over a savings scheme.
Here we have the answer to John Mather’s question. So long as CDC stays open , the market value of the fund is irrelevant. It is not marked to market as a DC or closed DB scheme is because it is not in an end-game, liable to pay-out its proceeds free from pensions or to a bulk annuitant.
With the clarity that an open pension scheme has (whether DB or DC) , a DC scheme has no chance to compete over the long term and so is relatively lousy value for our money. It is simply constrained as a closed DB scheme is constrained.
I hope that the longer term impact of CDC is to return pensions to the kind of strategy that John Mather wants to see as the benchmark for VFM. That strategy may be achieved to a degree by the larger DC schemes which can as the big master trusts are beginning to do, invest in long term assets but I think they will never reach their full potential till they become collective with a single pot and a simple aim of paying everyone as much pension as can be afforded.
I could have asked John’s question and should have done to the podcast. I hope that people will send in their views to this blog either privately or by comment. It is important that the big questions facing us as we consolidate and move towards collective pensions, are discussed and that we do so openly and passionately!
Henry
I had hoped by now that you would know when I am pulling your leg since the pension or pot is not described with an objective any where will do. Let’s try again.
The “Value for Money” (VfM) debate in the UK has historically been stuck in a tug-of-war between low fees and investment performance. For years, the industry leaned heavily on “cheapest is best,” but the Department for Work and Pensions (DWP) and the FCA are now pushing for a more holistic view.
To resolve this, we can move away from complex spreadsheets and use a “Three-Pillar Scorecard.” If a scheme cannot demonstrate strength in all three areas, it is likely failing the VfM test.
The “Holistic Value” Test
Instead of looking at a single number, a scheme should be judged on its ability to maximize the Net Outcome for the member. The test is simple: Value = (Returns – Costs) + Quality.
1. The Performance Test (Net Returns)
Don’t just look at the growth; look at what the member actually keeps.
• The Metric: 5-year and 10-year annualized net investment returns.
• The Benchmark: Compare the scheme against a composite of its peers, not just an arbitrary inflation target. If a “cheap” fund consistently underperforms the market average by 1% while only saving 0.1% in fees, it is poor value.
2. The Efficiency Test (The “Cost per Unit of Growth”)
Costs are only “high” if they don’t produce results.
• The Metric: Total Expense Ratio (TER) vs. Risk-Adjusted Return.
• The Question: Are the higher fees paying for “active management” that actually protects the downside or boosts the upside? If the scheme is a “closet tracker” (charging active fees for passive results), it fails.
3. The Service & Engagement Test (The “Soft” Value)
A pension is worthless if the member doesn’t contribute enough or loses track of it.
• The Metric: Member Engagement Levels & Administration Accuracy.
• The Indicators: High-quality digital interfaces, clear retirement projections, and low error rates in data.
Value is found in a scheme that nudges a user to increase contributions from 5% to 8%, as that has a far greater impact on retirement than a 0.05% fee reduction.
Henry
I had hoped by now that you would know when I am pulling your leg since the pension or pot is not described with an objective any where will do. Let’s try again.
The “Value for Money” (VfM) debate in the UK has historically been stuck in a tug-of-war between low fees and investment performance. For years, the industry leaned heavily on “cheapest is best,” but the Department for Work and Pensions (DWP) and the FCA are now pushing for a more holistic view.
To resolve this, we can move away from complex spreadsheets and use a “Three-Pillar Scorecard.” If a scheme cannot demonstrate strength in all three areas, it is likely failing the VfM test.
The “Holistic Value” Test
Instead of looking at a single number, a scheme should be judged on its ability to maximize the Net Outcome for the member. The test is simple: Value = (Returns – Costs) + Quality.
1. The Performance Test (Net Returns)
Don’t just look at the growth; look at what the member actually keeps.
• The Metric: 5-year and 10-year annualized net investment returns.
• The Benchmark: Compare the scheme against a composite of its peers, not just an arbitrary inflation target. If a “cheap” fund consistently underperforms the market average by 1% while only saving 0.1% in fees, it is poor value.
2. The Efficiency Test (The “Cost per Unit of Growth”)
Costs are only “high” if they don’t produce results.
• The Metric: Total Expense Ratio (TER) vs. Risk-Adjusted Return.
• The Question: Are the higher fees paying for “active management” that actually protects the downside or boosts the upside? If the scheme is a “closet tracker” (charging active fees for passive results), it fails.
3. The Service & Engagement Test (The “Soft” Value)
A pension is worthless if the member doesn’t contribute enough or loses track of it.
• The Metric: Member Engagement Levels & Administration Accuracy.
• The Indicators: High-quality digital interfaces, clear retirement projections, and low error rates in data.
Value is found in a scheme that nudges a user to increase contributions from 5% to 8%, as that has a far greater impact on retirement than a 0.05% fee reduction.
Sorry for the duplication Not sure why this happened