Should the UK adopt Aussie Rules for DC pension schemes?

Six months back in the UK have absolutely flown by. I’ve been asked a lot about the differences between the UK and Australia. After the inevitable comments about Huntsman spiders that always seem to hide in the places that give you the biggest fright, cockroaches that can fly, and magpies that attack cyclists (I’m not joking), I feel compelled to provide a response from a DC pensions perspective. There are lots of important differences, with Australia having a more engaged population, higher contribution rates, and a much more consolidated provider market being some of the standouts.

However, there’s one additional key difference where I think the UK is going to have to become more aligned to Australia in the near future and that is around net performance. The UK DC industry is currently very competitive but mainly on the basis of cost. Schemes in the Australian industry on the other hand primarily compete on performance, especially net returns. In this blog, I’ve first set out some of the benefits formembers if the UK is able to change the current approach, and then some thoughts on how we might go about this transition.

Learnings from Australia

I can’t emphasise enough how much the Australian DC funds compete on the basis of long-term investment performance. The default products of most schemes have a CPI+ primary investment objective. However, I’d say that a peer-relative investment objective (e.g. top quartile performance versus the wider default market) is treated with the same or even higher importance and therefore much of the investment decision-making is made to meet this objective.

There are about 60 DC schemes left in Australia. Unlike the UK, the choice of scheme lies primarily with the member, with the employer paying contributions to the scheme chosen by the member. The process to switch to another scheme has also been made fairly simple. A selection of easy to understand ‘league tables’ published by trusted sources (including the regulator) shine a spotlight on providers with the best (and worst) performance. The league tables receive good press coverage when they are released. Schemes with the best performance will even pay for TV adverts to highlight their success.  Evidence shows a high correlation between strong performance relative to peers and member switching, hence the competition is based on net returns.

In the UK on the other hand, the employer clearly plays a much greater role in designing and selecting the DC offering for their employees and it’s unlikely we’ll see quite the same member-driven switching as there is in Australia anytime soon. But I still expect it would be beneficial to members if comparisons between schemes were made more on performance than cost:

1. Larger pots at retirement.  A lesser focus on cost should enable schemes to invest in more expensive assets, such as private markets and other alternative assets that are expected to generate higher returns than the stalwart of UK DC growth stages, namely equities. Given the long time horizon of DC members, even a 0.4 - 0.5% increase in annual return at the total portfolio level could lead to a10-15% higher pot at retirement.

2. Improved risk adjusted returns.  Everyone is trying to increase member engagement in UK DC schemes. However, there’s a learning from Australia here that I think is important - engagement can be a double-edged sword. There’s a range of evidence in Australia that shows an increase of accumulation members switching to cash during periods of significant market volatility. This behaviour is likely to be at least partly due to the fear of a permanent loss of capital (which unfortunately becomes a self- fulfilling prophecy given the recent tendency of equity markets to quickly recover after a bout of volatility). Allowing a lower focus on cost to build more sophisticated portfolios means that performance should be less volatile which should reduce instances of panic-led derisking as UK savers become more engaged.

3. Decumulation.  A high quality decumulation solution needs a holistic set of products and services. It therefore costs money to develop and maintain, particularly given technology is still being developed in some areas, e.g. behavioural nudges. The requirement to offer decumulation solutions was mentioned in the King’s Speech and hence I think we’ll see some draft policy soon. The focus on value versus cost is arguably even more important in decumulation than accumulation as members likely need help to efficiently budget and manage their savings.

Changing the mindset in the UK

So what can we do to change the focus from cost to net performance in the UK? A couple of thoughts:

• Firstly, it should be acknowledged that there’s already been some progress in the five years I’ve been out of the country, most notably the fact that this is now a clear priority of policymakers. We’ve already seen action, as a result such as the ability to remove performance fees from the charge cap calculation and I think time will show this to be a wise decision.
• I believe that some type of league table constructed using a concise set of metrics based on consistent data collated and published by a trusted source would be an important tool. The FCA’s ongoing Value For Money consultation discusses disclosure of metrics that could be used as part of a quality league table but the consultation notes a lack of appetite from the FCA to use the data to create a league table. I think the FCA should reconsider, even if it appoints a third party to do the job.
• There’s a big role for employee benefit consultants too, specifically DC provider selection projects (and subsequently ongoing provider reviews) need to continue to have a significant weight to performance in the assessment criteria (importantly on forward looking performance potential as well as backward looking performance statistics).

Unlike the Huntsman spider, the pensions industry is not famous for speed and agility.  It will take some time to achieve the cultural shift required to stop focussing on cost when comparing schemes. It’s therefore crucial for us to start now.