PPI: Why pooling, alternatives, fiduciary management and higher charges could boost DC returns

Pooling DC assets, improving scheme governance, greater use of fiduciary management and increasing exposure to alternatives could boost pension pots by up to 62 per cent, a report by the Pension Policy Institute concludes.

The PPI report, commissioned by Schroders, argues firms can improve the likelihood of achieving better returns by pooling assets to give them more cost-efficient access to a more diverse range of assets.

The PPI report says there is ‘a correlation between investment fees and after-fee returns, with high fee funds on average producing higher returns than low-fee funds’, pointing to the Australian experience where funds with greater exposure to alternatives that charge more as a result have seen better returns. To date the focus on pooling in the UK has been on DB schemes, notably the LGPS. But the report indicates the UK’s 3,000 DC schemes – excluding sub 12 member schemes – could benefit from pooling.

The report suggests asset pooling could enable schemes to achieve an increase in investment returns of between 0.35 and 1.5 per cent a year, boosting members’ pension pots by around 16 to 62 per cent.

But the report says the evidence of increased scale leading to improved returns is mixed. However it says improvements in governance and potential for diversification could help schemes to achieve better returns. If funds could achieve higher returns through greater asset pooling, all other things being equal, individuals’ pension pot sizes at retirement would grow, says the PPI.

The report cautions that these gains are not certain and the magnitude of the impact that asset pooling could have on member outcomes is largely dependent on the way in which funds would implement their increased scale in order to access the benefits. The report says scale could be achieved by transferring to larger schemes, using fiduciary management or switching single-employer GPPs and trust-based schemes to more modern arrangements.

The report says that regulatory barriers to switching should be lower if the DWP proposals that the need to obtain an actuarial certificate should be removed for ‘pure’ DC-DC transfers where there are no potentially valuable guarantees or options to be assessed and that the scheme relationship condition be removed are implemented.

In Australia scale is allowing bigger superannuation funds to make increasingly large allocations to alternative asset classes. Alternatives, including hedge funds, commodities, infrastructure, private equity and venture capital, now represent the third largest asset class in Australian institutional balanced investment portfolios. Australia’s largest super, AustraliaSuper, has an allocation of more than 20 per cent to property and alternatives. The report says that this is pushing up charges – the cheapest Australian super fund has an AMC of 0.46 per cent, which is the average cost for a DC fund in the UK. But it says that there is a correlation in Australia between higher charging funds and higher returns, although when returns are adjusted for benchmark indices and asset pricing factors, there is no clear relationship between charges and performance.

PPI policy researcher Lauren Wilkinson says: “It is a possibility that schemes could pay more to achieve better returns. If schemes are already well below the charge cap then increasing charges to get better returns could improve member outcomes, although schemes need to be careful. They can’t predict they will definitely get these better returns, but it is definitely something they will consider.

“In Australia we are seeing a move away from the idea that low charges are an absolute good and towards spending more with the aim of achieving better returns.”

“The UK DC landscape is somewhat fragmented, with a large number of schemes and variation across the market. In general, larger funds provide evidence that pooling is

associated with lower charges, improved governance and access to alternative assets such as infrastructure.

“Although some of the evidence from overseas is conflicting, this may be in part because of regulations and economic circumstances in each specific country. But if all the potential benefits of DC pooling could be realised in the UK, this could lead to better member outcomes through increased pot sizes and, as a result, a better standard of living in retirement.”

Schroders global head of DC and retirement Lesley-Ann Morgan says: “Asset pooling in DC schemes has been limited to date with few benefits to the majority of members in the UK. However, we believe that learning from positive international DC pooling experience is an important milestone in the journey to improving outcomes for UK DC members.

“By pooling assets, improving governance and focusing less on daily pricing, we believe outcomes can be improved for UK members. More creative ways need to be found in the UK to facilitate investment in asset classes such as alternatives and illiquid assets to better invest, improve and protect members’ outcomes for the future.”