Many years ago I was involved in creating a case study on “Operational Strategy.” One of the big questions was about order qualifiers which are factors that determined whether you were going to be considered for a potential tender. The company I worked for was hugely focused on the quality of its customer service. However this is not usually an order qualifier for new customers. A new customer can only be aware of a supplier’s reputation but axiomatically does not have past experience on which to fall back.
As this was a few years ago, and I was working in life and pensions, two other potential order qualifiers discussed were investment returns and price. Past performance tables were ubiquitous, even if the mantra was always that past performance “is no guide to future returns.” Empirical evidence showed how performance in one period was more likely to lead to later underperformance than to prolonged success.
Price was harder still because few people understood their own company charges. Regardless of how they could/should be compared to those of competitors (remember the products could be held for up to 40 years but also cashed in at any stage over that period). Charge caps and kite marking were introduced by legislation to make the market more price competitive. At the same time, the FCA, following on from its predecessors, became increasingly focused on charge disclosure. It is now clear that price is very much an order qualifier in the UK workplace pensions market. The Pension Investment Review suggested that the average price (bundled charge) is just below 0.5%[1] and can be less than half of that for a large employer with a stable, well-paid workforce.
One big driver of this reduction in price has been simple and streamlined administration. For example, auto-enrolment has worked very well both in terms of low costs and higher levels of employee enrolment. Another driver is a focus on very low cost investment strategies, in particular index tracking (0-0.05% p.a.).
The only workplace pensions market in the world that comes close to the UK, in terms of price competition, is the US 401k market, which is also dominated by index tracking mandates and has been in existence for 30 years longer. That suggested that the focus on cost is a job well done, or perhaps not?
As well as index tracking, the UK pensions market probably has the lowest level of “home bias” of any developed nation, when it comes to equity allocations. The UK is around 3% of the global market cap and, on average, DC pension equity allocations are 11% in the UK (Canada is 2/22%, Australia is 2/42%, New Zealand is <1/45%[2]). I will not go into investment home bias in any great detail but the logic came from investing in companies that were domestically based and so made profits in your own currency. Today that argument is largely untrue, for example US tech, UK pharma and oil or natural resources in Australia, they all make most of their profits in USD.
The home bias caused recent governments to look abroad. Price is yesterday’s game and now we want more domestic investment, particularly in what are called “productive assets” (e.g. Infrastructure or new businesses). Such investment will produce jobs in the UK but also better outcomes for those saving into pensions (via higher returns of perhaps 2% p.a.). Canada and, in particular, Australia are cited as the places to match. Consequently, despite the mantra of the last thirty years, past performance may once again be a guide to future returns.
These productive assets are illiquid, i.e. they cannot easily be sold, and that is a problem for a pension scheme dealing with unsophisticated investors who cannot afford to wait months for assets to be sold to ensure they can access their whole pension pot. The putative solution is to accelerate consolidation among pension providers. It is assumed that bigger firms will be better placed to manage the liquidity risk and we might end up with half a dozen or so “mega” providers. Again, Australia is an exemplar.
Australian Superannuation has existed for decades with compulsory contributions stretching back to 1992. Total assets are almost £2trn (UK DC pensions are around £1trn) with barely 40% of the UK’s population. They have greater absolute scale while average pot sizes are 5-10 times that of the UK (fewer people and proportionately fewer orphaned pots). Of the 40 Australian superannuation providers, 12 have over AUD100bn (or £50bn), which again sounds encouraging.
Further, as well as the home bias in listed equities, big Super funds invest roughly 5% in private equity and perhaps 10% in infrastructure.[3] If UK pensions could receive an extra 2% p.a. return on 15% of their portfolio, savers would be 0.3% p.a. better off. Add in the prospect of a boost to the economy and everyone should be happy.
So why would we not want to copy the Australians?
The big problem with Australia is that despite the greater absolute scale and pot sizes, even the largest providers charge 1-1.5% p.a. range. That is twice those in the UK and when pot size is taken into consideration, more like 5 times as expensive. UK prices could steadily creep up to these levels, removing the theoretical performance premium and a whole lot more to boot.
Further, the proposals suggest funds that do not provide value for money will be forced to consolidate. It has always been true that those who take the biggest bets are more likely to be at the top or bottom of the past performance tables. This is true with other index versus active managers. The likelihood is that those with a low cost investment strategy are much more likely to survive longer, especially where there may be mandatory consolidation of underperformers.
I understand the desire to look to pension assets as a means to facilitate economic growth, even if the conflict with charges appears to be at odds with fiduciary duty. However, most studies show the US is the best place to start up a business and they do not need to direct 401k assets to do so. There is also something slightly odd that proposals designed to foster growth and innovation should be so dependent on consolidation and scale among those who are going to provide the finance.
January 2025
[1] https://www.gov.uk/government/publications/pension-charges-survey-2020-charges-in-defined-contribution-pension-schemes/pension-charges-survey-2020-charges-in-defined-contribution-pension-schemes#member-borne-charges-within-the-cap
[2] https://www.gov.uk/government/publications/pensions-investment-review-interim-report
[3] Infrastructure is listed as a separate category of asset in Australia – something that is very rarely seen on a UK or US portfolio analysis. That makes it hard to draw a clear comparison.