DC Whitepaper - July 2019

A universal solution for the individual?

DC Roundtable

A universal solution for the individual?

DC: A universal solution for the individual?

If savings are a money trail, then it takes no more than a couple of steps to reach the default fund in defined contribution pension schemes. This is where almost all the money people save in modern workplace pension schemes ends up. The sixth annual CAMRADATA DC roundtable began by acknowledging this fact. Steve Hayton, group pensions manager for the Nuclear Decommissioning Authority (NDA) said that around 75% of DC assets were housed in the scheme default fund. Elizabeth Garner, head of pensions and investments at charity, Save The Children, said more than 90% of its members’ total DC savings were in the default.

Given this weight of savings, the panel was asked whether Environmental, Social and Governance (ESG) considerations should be baked into the default option. “It is still early days and whilst ESG is being considered across our client base, making a specific ESG allocation within the default strategy isn’t the norm. Instead it has been more around understanding how existing managers are considering ESG” said Erica Beltrami, a partner at LCP, a pension fund consultancy. “Further consideration around whether a specific allocation should be made is the natural next step as ESG integration becomes the norm.”

Ethics are personal. ‘Should people eat meat? Would the world be better off if we all went vegan?'

Niall Alexander, River & Mercantile Solutions

Integration means including ESG considerations in all aspects of capital management, not merely offering it as an option on the side. “Schemes can and should evaluate asset managers on ESG integration. Ask your manager to demonstrate how ESG is integrated across their research and portfolio construction processes – not at one point in time, but on an ongoing basis,” said Jin Philips, head of strategic relationships, EMEA, at Newton Investment Management. She explained that if a manager is deploying high-calibre research, then ESG should doubtless form an integral part of that research capability. “We see ESG factors as risks and opportunities, which is why Newton has developed our own, transparent ratings methodology,” she said. “ESG is very much about financial outcomes.”

Niall Alexander, head of DC solutions at River & Mercantile Solutions, distinguished between ethics and ESG. “Ethics are personal. ‘Should people eat meat? Would the world be better off if we all went vegan?’” These issues matter a lot but, for Alexander, they do not relate directly to finance. “We describe ESG as telling factors, just like currency and inflation.

So we include them but in the same way - truly holistically rather than a separate debate. And their influence waxes and wanes.”

That means investors should not apply ESG criteria in a static fashion, according to Josh Conran, associate director for UK institutional at asset manager Capital Group. As an example, he pointed out that analysing and engaging with companies thoroughly can mean potential issues are identified long before any scandal; this contrasts with many ESG rating systems which only pick up issues after an event. Such backward-looking assessments were in contrast to the Capital Group approach whereby ESG analysis is incorporated into a whole-of-company assessment by portfolio managers and analysts on a forward-looking basis.

Philips agreed. On the final point she noticed that one value-play in ESG was to focus on those companies progressing their ESG potential: “the improvers”. Philips said that only backing the recognised ESG champions of today could potentially mean missing out on future financial upside from those companies working to improve their ESG footprint over time. The debate over ethical versus ESG persists, however, because many people instinctively want to use their wealth to benefit other people with great need as well as get a return.

“We always have staff asking about ethical options,” said Garner.

“I would have my own retirement sorted if I had a pound for every time I had to explain the difference between ethical and ESG,” commented Martin Willis, a principal at pension fund consultancy, Barnett Waddingham.

He noted that pension scheme members can put ethics into a collective pension fund but it requires a high quorum of approval (Cancer Research has a tobacco-free default fund).

As ever with DC, communication raises its head as a major feature. Philips noted that Newton has been working with a major public-sector pension scheme in California to communicate how ESG factors are taken into consideration in the scheme’s ESG balanced investment option. The intention is to communicate directly to the scheme’s members using tangible and local language to convey how their investments impact the environment, society and their future retirement income.

Who the cap fits

The CAMRADATA panel then segued into fees and costs. These are influential in the UK market ever since the government introduced a 75bps cap on default fund costs. Willis pleaded that people should not see cheap as best or good value.

Alexander’s remedy was for trustees to concentrate on their risk budget first and foremost, rather than extrapolating ‘value’ from past performance and/or fees.There is a further complication in that the insurers and platforms from whom schemes access investment management typically charge a fee, while the houses which actually do the investment management charge the platforms a sub-fee. The scheme will not see those two elements separated.

Conran suggested that splitting them out could be beneficial. There is currently no guidance to trustees on the two parts in isolation so they don’t know what they are paying.

Philips asked why administration costs do not get split out from investment costs. This is a moot question, as the latter is typically perceived as the higher of the two while in reality some platforms take the lion’s share just for administration. Beltrami warned that even if some platform providers rebuff such attempts to make their charging more transparent, there should continue to be a collective push for more transparency in this area.

Is it sensible for DC scheme to move away from daily liquidity, to weekly or even monthly liquidity, in order to diversify their investments?

The panel then came to some fresh thinking on how trustees might get the kind of risk-return pay-off they need for the years ahead. The UK government has been consulting for the best part of a year on how to open up illiquid investments to DC plans. Illiquids here means the likes of real estate and infrastructure, privately traded debt and equity. Alexander did not see an overwhelming need: “What are you trying to achieve?” he asked. “Why worry about this stuff when there are still a lot of schemes with a UK equity bias; and some with 100% in equities in the growth phase at ages when members can retire. There are basics to be improved upon, never mind the refinements.”

Beltrami, on the other hand, said that DC plans were in the habit of using daily-dealing funds even though a member’s time horizon is over decades. She pointed out that daily dealing was not a legal requirement but a norm which merited rethinking. LCP has done just that for a client – taking them into weekly and monthly-dealing funds, which Beltrami claimed was a first not just for the client but also for the platform provider.

Newton gains exposure to less liquid assets via listed securities and trusts and has been able to harness the diversification benefits of these assets within its multi-asset strategies and solutions. “Some illiquid specialists also prefer to incorporate listed securities and trusts, because it is currently the most likely way that pension schemes can access the likes of private equity while staying under the price cap,” said Philips.

DC plans were in the habit of using daily-dealing funds even though a member’s time horizon is over decades

Erica Beltrami, Lane Clark & Peacock

Opening up the DC investment landscape means that pension schemes are becoming more aware of the risk-return profiles of all types of investment strategy. This includes the section before retirement where hitherto sovereign fixed income and cash were used to dampen volatility. Nowadays, more active managers are offering higher-return, lower-volatility approaches to appeal to DC plans.

Conran followed Alexander’s point about doing better from within the universe of public securities by making the case for putting more exposure to Emerging Markets into UK DC plan portfolios. He explained that Emerging Markets [as defined by MSCI] account for 40% of the global economy and 70% of its growth.

Yet in global equity indices, these countries only receive 11% of the weighting, and often even less than that in DC default funds. One route Conran strongly advised against, though, was merely tracking a representative index of leading EM companies. “The EM index is highly concentrated,” he said, “with for example over 53% just in IT and financials. As a result, it can also be very volatile.” Instead, Capital Group advocates taking a broader approach to emerging markets – including EM debt and also companies outside emerging markets but which derive most of their revenues from those countries. This then lowers the heavy exposure of the EM equity index to banks, insurers and IT stocks. To this, Capital adds governance and company engagement. The result is a strategy that produces cumulative returns equivalent to the index but with considerably less volatility.

Hayton said he would be interested in the money-weighted returns as these reflected the lived experience of a DC saver. Philips noted from an emerging markets debt perspective, large UK DC schemes have implemented absolute bond strategies, such as Newton’s global dynamic bond strategy (GDB) as part of the default. “GDB is a way for schemes to gain selective, actively-managed emerging markets debt exposure tactically alongside global HY, sovereign and corporate fixed-income exposure,” she said. “The strategy’s absolute return focus is closely aligned with DC members’ desired outcomes in the growth and in-retirement phases.”

Philips commented that the extraordinary equity returns of the last ten years has undoubtedly impacted default design and asset allocation decisions. She said that focusing on relative performance has been palatable over that period, but “we ultimately should be focusing on absolute returns and outcomes for DC members.”

Late adopters

The golden age of DC is not yet here: one reason being the slowness of financial services in the UK to embrace technology. It is now possible to manage most of your day-to-day money needs using a smartphone. Challenger banks and tech-focused specialists will bring together on one screen various savings pots, including ISAs and SIPPs alongside current and deposit accounts. But progress has largely been thanks to the ambition of the tech companies rather than incumbent banks and insurers. Pension funds and administrators are even further behind the curve. In spite of the trillions of pounds saved specifically for retirement, there is no popular pensions app. The CAMRADATA panel discussed why.

“We have created a pensions dashboard but there has not been a joint initiative with the wider savings industry,” said Garner. “Post Pension Freedom, I think people do think of pension as savings but they can’t access them in the same way.”

Willis said that pension providers were reluctant to engage in a way that would offer scheme members all their financial accounts on one screen, ie pension alongside current account and insurance policies. In theory it is possible but in practice it is not happening.

Alan Emberson, director of workplace solutions at PS Aspire, said that it was possible now to establish such a savings dashboard (if you have the right underlying technology platform in place) however, that does require the member’s consent to such data requests and that schemes also had to make the effort to negotiate with their relevant providers to get these types of data feeds established. He said there are companies who can facilitate this, but in workplace pensions more generally “we are not there yet.” That is because, according to Emberson, no one has yet answered the big question of who should be paying for such unification. At present it could be either of the employer, the Scheme or, the members themselves.

Like most bigger pension consultancies, both Barnett Waddingham and PS Aspire offer their own platforms which tackle the issue. The former’s, called ME2, works as a web app. But it doesn’t have feeds from every source, e.g. student loans, and cannot currently model big expenditures such as weddings.

This matters because if ordinary working people are to gain a better understanding of what their pension savings can do for them – as part of total wealth and personal finance - then pension providers need to reshape their communications into the kind of language around spending ordinary people understand.

Why should employers wish to take on the responsibility for a future benefit that may materialise thirty or forty years further down the line when the employee may only stay in that organisation for a few years?

Alan Emberson, Punter Southall Aspire

Beltrami said that people don’t start planning for retirement in response to a figure on a sheet of paper. They need help to think what sort of lifestyle they expect, e.g do they want to eat out once a month or twice a week? Beltrami said the pensions industry needs to do more straightforward communication on this level of ordinary household budgeting.

Willis agreed. As one example, ME2 uses images such as cocktails to help client schemes’ members decide how much they want to spend on drinking and socialising.

With so much money destined for default funds, should ESG principles be applied to these funds?

Hayton told the CAMRADATA panel that “the solution is not to tell people what to save but to offer better modelling to help them understand.”

The NDA’s flagship scheme has recently switched its plan administrators in order to give members new tools to allow them to do just that – work out what they need to save under various scenarios.

But the NDA is an unusual employer, often one of the biggest in the locale, with a unique purpose, which makes for a very loyal and stable workforce. “We have generations of the same family working for us,” says Hayton. “And there will be work for another hundred years at some sites.”

Nuclear energy is thus the only man-made activity with a longer life than pensions. Elsewhere in the UK, however, employees come and go. Fundraisers at Save The Children might stay for just two or three years, according to Garner.

Which brings us back to Emberson’s question of who should pay the cost of data aggregation and the hauling of pensions into work patterns of the twenty-first century. “Why should employers wish to take on the responsibility for a future benefit that may materialise thirty or forty years further down the line when the employee may only stay in that organisation for a few years?” he asked. “Employers will want to look after their employees - but perhaps only for that shorter time period.”

PS Aspire’s platform extends across all savings and finances and is designed to support the process of financial guidance for larger audiences, which Emberson distinguishes from advice. The platform aims to offer value even for workers with relatively little savings e.g. pots of £30,000 or above, where the existing advisor market fails to offer cost effective solutions. The system is geared towards assisting self-selection. However, Emberson emphasizes that there comes a point where people do need a proper human contact, “a voice” before executing on their important financial decisions.

And here the CAMRADATA panel touched upon the kind of “voices” workers currently rely on. Both Hayton and Beltrami noted that, worryingly, colleagues in the workplace were often easiest to approach because they are trusted individuals. Hayton said there was an excellent response to roadshows when NDA was in the process of announcing the new DC scheme to employees. Save The Children also gets an annual roadshow from its scheme provider. So physically meeting pension professionals responsible for running savings has a positive influence. Beltrami contrasted this with badly designed technological help; members’ frustration with the rigmarole of log-ins to access their pension account online will have an impact on how much they are willing to engage with their pension.

That is just dawning, thanks to the compulsory nature of
auto-enrolment. Moreover, Philips noted that by 2050 as much as half the UK workforce could be self-employed. It’s imperative for the DC pensions industry to be more mobile (physically and digitally) as a greater proportion of the population becomes aware that they have one or more pension pots. They will be searching for them online and ideally from their mobile device.

With thanks to...

Roundtable Sponsors

Capital Group
Josh Conran
Associate Director, UK Institutional

Newton Investment Management
Jin Philips
Head of strategic relationships, EMEA

Roundtable Participants

Barnett Waddingham
Martin Willis
Principal

Lane Clark & Peacock
Erica Beltrami
Partner

NDA
Steve Hayton
Head of Group Pensions

Punter Southall Aspire
Alan Emberson
Director of Workplace Solutions

River and Mercantile Solutions
Niall Alexander
Head of DC Solutions

Save the Children
Elizabeth Garner
Head of Pensions and Investments

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Written by,
Brendan Maton, Freelance Journalist