Defined contribution (DC) investment strategies and the role they could play in UK productive finance continue to be a key focus under the new Labour government, building on the work of the previous government, including the Mansion House Compact.
There are potential benefits for DC members and the economy more broadly by investing in more diversified investment strategies that incorporate alternative asset classes and private markets.
However, there are also potential barriers and trade-offs and it’s vital that member outcomes continue to be at the forefront of decision-making.
Even before the Mansion House Compact and the current pension investment review, we have seen DC schemes tentatively exploring alternative asset classes beyond the traditional equity/bond split.
Allocations to alternatives and private markets have been growing for a number of years now, albeit slowly and from a low starting point, demonstrating an increased focus on diversification in an evolving investment landscape.
More diverse portfolios, better risk management and better returns should deliver improved outcomes for members as DC asset allocation becomes more sophisticated. In addition to seeing their pensions yield better and more secure retirement incomes, DC members could also benefit from the societal improvements that successful investment in UK business should yield.
However, charges may rise with the higher costs associated with some asset classes and the cost of building sufficient expertise to invest in them effectively. This may be offset by the economies of scale and negotiating power of fewer, larger schemes, as we expect to see further consolidation and growth in the DC market.
Consolidation in DC will support and drive greater diversification of asset classes, but with this may come some additional costs for members and increased demands on governance bodies to ensure that new asset classes are understood.
While we expect to see allocation to alternatives and private markets growing in the coming years, it’s unclear how much of this investment will be channelled into the UK economy specifically.
There are potential societal benefits of mobilising the vast and rapidly growing pool of DC pension assets to stimulate the UK economy, but schemes need to ensure that there’s also a strong case for it being in their members’ best interests before making changes to investment strategy, otherwise we will see a growing tension between fiduciary duty and external pressures.
There are also concerns around whether there’s a sufficient supply of quality UK productive finance investment opportunities.
If we see a rapid shift in DC allocations to private markets, there’s potential for a herding effect with providers all putting more money into private equity at the same time, which could have a detrimental effect on asset prices and returns.
We don’t yet know the exact approach the government will take to encourage increased investment in UK productive finance.
So far, very little has been ruled out, from lighter touch measures like disclosure requirements through to potential mandation.
Even at the less prescriptive end of these potential policy levers, with disclosure requirements there’s a risk that we could see less innovation in asset allocation as a result, as schemes tend towards the mean, and there’s the potential it could have the opposite of the intended effect, a reduction in UK investment, if it becomes more evident that schemes that are overweight in allocation to UK assets are underperforming.
On the mandation end of the spectrum, any attempt to force providers to invest more heavily in certain asset classes presents a challenge to trustees’ fiduciary duty and may be met with a considerable backlash. There could also be a tension with the regulators, both of whom place member outcomes at the forefront of their strategies and policy.
Comments