Does master pass muster?

Master trusts promise trustee oversight of the default investment process. Emma Wall puts them under the microscope

Do decisions made by master trust boards hold sway?

Thanks to auto-enrolment, master trusts are making a comeback. Promising low costs delivered through economies of scale and majoring on independent governance, master trusts are challenging contract-based group personal pensions on the battlefield of investment.
While Nest looks set to become the biggest of all, we also have offerings from L&G, Standard Life, The People’s Pension, Now: Pensions, SmarterPensions and Zurich – to name just a few, promising to deliver a high level of trustee oversight at a fraction of the cost of traditional trust-based schemes.
The investment propositions differ widely in terms of the level of choice on offer. The big insurers offer the option to bespoke the default fund, from a large range of options, while Now: Pensions essentially has only one investment option. Nest and The People’s Pension offering limited ranges centring round a default fund.
Henry Tapper, of First Actuarial sees a broad consensus among the trusts during the growth phase before members close in on retirement as people want the kind of returns traditionally produced by equities.
The schism between approaches become more evident when it comes to the latter part of a member’s saving horizon, and how much volatility is acceptable.
“Smoothing volatility generally involves investing in more expensive assets to get diversification and this is where the debate heats up,” he says. “Do you agree to pay more to get a “smoothed ride”? Behaviourists argue that high volatility makes for sleepless nights and that many people would sacrifice return for security. Others argue that as you can’t cash in a defined contribution pot early, why not take the rocky road.”
Mark Jaffray, partner at Hymans Robertson points out that the trusts do not only differ in investment approach, but in construction as well.
“The common feature across all providers is the use of passive management to gain access to the main investment markets. Is this a fundamental belief of all managers – that passive management is better – or a way of reducing the cost to the member? It is probably both and also due to the lack of scale in funds under management that any of them have currently.”
He expects that as scale of funds under management starts to build we would expect to see the sophistication of the investment strategies increase with the inclusion of alternative asset classes and specialist active investment managers which should be able to be accommodated within the current fee.
Ryan Taylor, principal consultant at Aon Hewitt says the degree of variation between the different investment strategies offered by the master trust solutions highlights the fact that reviewing the investment strategy is as important for this contract type as it is in any other pension type, such as a contracted-in money purchase scheme or group pension plans.
“The decision by some to offer just one investment option, whilst supporting simplicity of choice for members, does increase the risk should returns not be in line with expectations,” he warned. “Others have taken the view that the master trust structure shouldn’t necessarily restrict the range of investment options available, which can place increased costs back on the sponsors of the individual schemes within the master trust.”
The subject of fees divides pensions consultants.
Jaffray thinks that the competitive fee structure is a positive thing for the market.
“Most providers have taken on the challenge on fees and produced offerings that have competitive total charges to members,” he says. “Some of the ‘strategic passive’ offerings within the insurers, MyFolio range at Standard Life, for example, provide a good compromise between an efficient well diversified active portfolio and cost. The large insurers can provide bespoke master trust offerings and allow the range to be tailored to different employers and groups of employees.”
But Taylor complains that while it is admirable to aim to not exceed the target annual management charge on a trust, this figure-hugging can restrict the holdings.
“A number of master trust providers have clearly stated their intention to operate their investment proposition within a stated level of charge,” he says. “Whilst this helps to give clarity and reduce the impact of high fund management charges it can restrict the range of investment options available to schemes and members. The member profile of the scheme will determine if this is regarded as an advantage or a disadvantage, as often it is identified that most members don’t want too much choice.”
Restrictions are a bugbear of Jaffray too. He said that some providers, Now: Pensions, for example, had very limited investment options and employed a one size fits all approach.
“There is no choice for members who want to invest in higher return seeking assets or a lower risk strategy,” he complains. “Some providers passive offerings lack diversification and rely on too few asset classes equities and UK bonds.”
Graham English, a consultant at Capita Hartshead Actuarial and Consultancy Services says that some of the pension schemes have trustees appointed by the provider of the master trust. This means that the employer joining the master trust is unlikely to have any trustee representation and can become disengaged from the pension arrangement. But English says that master trusts do have advantages, despite this.
“Master trusts have the ability to drive down operating costs through bulk purchasing,” he says. “Members also benefit from the ongoing management and oversight of investments with a consolidated accounting and governance requirement.”
Hymans Robertson prefers the offerings from the large insurers given their inherent scale and experience of pensions administration and their ability to price competitively as well as the ability to offer bespoke solutions. The pensions consultancy stresses that truly independent trustee board is a must have to provide the opportunity for the governance structure to flourish and offer appropriate challenge to the provider.
First Actuarial rates Alliance Bernstein for their target dated funds, closely followed by Nest and Now: Pensions.
“Whichever school of thought you subscribe to, no one can deny the virtue of good execution in terms of the management of the fund. The divergence of costs between the very best executed and worst executed funds is much greater than the dispersion of returns between one investment style and another. Academics such as David Blake would argue that ‘it’s not only what you do but the way that you do it’. That said, it would appear that the cards are stacked against the active managers in this respect, they start in racing terms with a big handicap,” he says.
“The best accumulation options such as the Legal and General Multiple Asset Fund, offer diversification across non-correlated asset classes at a price not much higher than a global equity alternative but with the prospect of equity like returns without the volatility. We do not think that such funds on a stand-alone basis should cost more than 0.20 per cent – L&G’s is available at 0.13 per cent and represents good value.”
Nest has come under fire from some quarters for being too cautious in the early years of savers’ journeys. Nest 
was introduced as a low-cost, not-for-profit option to fill gaps in the existing market. The default pension scheme provided by the Government invests younger savers into “safer” assets so that they do not get scared off by volatility and opt-out of the scheme. But this means they are missing out on irretrievable gains, as even upping exposure to risky assets later will not make up for the potential compound interest that has been lost.
Considering the scheme has its own investment think tank paid for by the taxpayer, Henry Tapper thinks their solutions are well thought through and well argued, but they could improve by being less conservative in the early days of investment. Nest argues that the amounts invested in the early years are relatively insignificant, and that getting members engaged is a bigger priority.
Jaffray says all of the investment options all have some compromises to fit the total charge into an acceptable level.
“The use of alternative asset classes and the use of specialist active managers is limited in the main due to the expense of accessing these arrangements,” he says.
“The glide paths in the main lack sophistication. We would like to see much more thought given to evolving investment strategies. A relatively high risk for high return strategy when people are young is sensible, as they won’t be selling any time soon, but should be gradually replaced by one that focuses on risk reduction and in particular capital protection as members pots increase in size and the impact of any market fall on retirement outcomes becomes much more significant.”
It is glide paths that Jaffray has a particular issue with, foreseeing greater problems in the future as they work under the assumption that all pension savers will buy an annuity to provide retirement income.
Lifestyling automatically switches pension savers out of equities and into low-yielding bonds and gilts as they approach retirement. This investment approach is automatic – regardless of the cost of that asset. The idea is to preserve capital in order for the saver to secure a competitive annuity and the largest possible retirement income. But in the last couple of years retirees have been hit by expensive low yielding gilts – effectively seeing their pot eroded by inflation.
“Although not an issue yet for the market, we believe glide paths need to adapt to reflect alternative retirement strategies,” he warns. “Not everyone will purchase a level annuity when they retire. Income drawdown will be a feature for many average workers in years to come, as people seek more flexibility in taking their retirement benefits and turn away from the very high cost of annuities.”
Paul Farrell, Dimensional’s head of UK institutional clients agrees that life-styling should not be the default option for master trust pension schemes.
“Most of the master trust schemes offer versions of the life-cycle strategy,” he notes. “In general, these approaches overcome some of the shortcomings of more traditional default funds, but their one-size-fits-many approach means they do not have a goal that is meaningful to individual members. In addition, because they are mechanical, their asset allocation is adjusted irrespective of the member’s progress towards their retirement income goal or the prevailing economic environment.”
He says that some target-date approaches shift towards a duration-matched fixed income portfolio to reduce interest rate risk as the target date approaches. But if the member’s goal is to manage their personal risk of not achieving their desired retirement income, interest rate risk is as material as traditional investment risk.
Instead, he suggests, it should therefore be managed from the outset – not just in the final years before retirement.
“A typical life-cycle strategy is not aligned to the member’s goal of achieving a retirement income. It is merely a growth strategy with a degree of volatility or interest rate protection built in to the end of the cycle,” he concludes.
“Technology exists today to build truly bespoke income-focused strategies for every member of a DC scheme and thus overcome the mechanical one-size-fits-many approach of the typical life-cycle strategy.”
Only time will tell which trust is the best offering for retirement savers. Normally advisers like to see some track record before they nominate a fund. But the pressing needs of automatic enrolment mean this luxury will not be afforded those deciding on some of the newly-available propositions.