Forget the charge cap, what about charge floors?
19 Mar 2021
An Australian, an American, and a Canadian walk into a bar. Don’t worry, this is not the start of some joke. It is more likely that these people are getting together to discuss their investments into UK private assets. The pension schemes and asset managers in these countries have significant holdings in UK private markets including infrastructure that everyone will be familiar with. The UK DB sector (including LGPS) is a main player in all of this, but sadly, the average UK DC scheme has not been invited to the same bar.
“There remains a largely untapped pool of capital from institutional investors, particularly DC pension schemes”.
There are well-known reasons for this:
- A charge cap of 0.75% for a DC default strategy (which usually includes the costs of underlying investment funds and DC administration) is often seen as a barrier to investing meaningful allocations in these types of markets, which are significantly more expensive than the traditional asset classes such as passive listed equities and bonds that make up a large proportion of default strategies.
- DC platforms have operational constraints in their ability to handle the daily-dealing nature of the DC market and allowing for the illiquid nature of private markets.
Initiatives are under way to think about the two issues above thanks to the work of the Productive Finance Working Group (which builds upon work done in previous years on this subject) and the recent Budget announcement on plans to consult, once again, on the charge cap.
Direct and targeted incentivisation. Even if sensible steps are being taken to remove the above barriers to investing, nothing has been said about changing or targeting behaviours? Some large DC schemes have invested in private markets already and so barriers can definitely be overcome. And yet the average look-through allocation to private markets and actively managed strategies is very low when we look at some of the largest master trusts in the UK DC market. In our experience, the issue is that of price – price is still a major consideration when prospective employers come knocking for a selection exercise. Master trusts are the future of the UK DC market and if price drives selection, then DC will continue to lag behind their DB and LGPS counterparts in terms of opportunity set. It could actually result in poorer long-term value for members. So how would we suggest providing the incentivisation needed?
- Instead of focusing only on a charge cap consultation, what about extending this to a charge floor consultation? All DC schemes must have a minimum investment fund charge of X%. X must be high enough to allow for meaningful allocations to areas such as private markets and / or more actively managed approaches, including ESG approaches.
- Another approach could be to mandate a minimum meaningful allocation to a sleeve of assets that allocates to areas such as private markets and more actively managed approaches. This would sit outside the charge cap and would be imposed on all DC schemes.
- Allocations to private markets and actively managed approaches require significantly higher levels of trustee governance. The government could consider subsidising part of the increased cost of this governance to allow trustees to take the appropriate professional advice (investment, legal and operational) required.
A timeframe of two to three years to transition to a charge floor regime would be required (with a charge cap as well). After that, DC schemes will finally get invited to the party with default investment strategies receiving more levers to diversify existing approaches. This will ultimately improve member risk-adjusted outcomes and the government will have access to a currently untapped source of capital to continue on its quest to Build Back Better.
Please get in touch if you have any questions or would like to discuss further.