Former pensions minister warns of risks of government’s retirement fund investment drive

The government is hoping that the creation of pension mega funds could boost the UK economy and reduce fees for investors, but experts warn that risks remain.

New pension reform legislation currently going through parliament aims to shake up the way defined contribution (DC) schemes invest.

The Pension Schemes Bill wants to create mega funds that merge smaller multi-employer schemes, known as master trusts. The Bill is currently going through Parliament.

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The idea is that these will invest in assets such as infrastructure to boost the UK economy.

The legislation also requires these master trusts to be a minimum scale of £25 billion by 2030 and threatens to ‘mandate’ them to invest in British private investment markets if they don’t meet a minimum threshold.

The Bill also creates a ‘value for money’ framework designed to help trustees assess how a scheme is performing and to force the consolidation of smaller schemes.

The Treasury claims that the move to pension mega funds - inspired by the success of similar schemes in Australia - will give savers a 0.06% reduction in fees.

But a new report from former pension minister Steve Webb, now a partner at consultancy LCP, compiled with Frontier Economics warns that these interventions could actually impact the performance of pension schemes, ultimately reducing returns for savers.

Here are the main concerns raised about the government’s pension reforms.

Master trust changes

There are around 30 master trusts in the UK.

These make it easier for employers to set up a scheme by just joining one that works for several companies at once.

The government is looking to force consolidation by stating that the main default fund in a master trust should be at least £25 billion by 2030.

The aim is to create a smaller group of larger master trusts that can then help fund UK economic projects.

This is inspired by the success of superannuation schemes in Australia, where the largest providers have assets worth hundreds of billions.

In contrast, big multi-employer schemes in the UK such as NEST have assets of £50 billion.

But the report warns that the overall impact may be marginal given that the DC master trust market is already relatively concentrated.

It adds that it takes time to build scale and the mandatory Australian system has been around since the 1990s, while auto-enrolment and the rise of DC schemes only started in the UK in 2012.

Webb said: “We need to move away from spurious comparisons with the pension systems of other countries when deciding what is right for the UK.

“The Australian DC system in particular is currently far larger and far more mature than the UK system and this will inevitably lead to a different investment mix compared with the UK’s smaller master trust sector.”

Investing in private markets

The legislation includes a reserve power for the government to mandate how master trusts invest, with an aim to boost private UK investment markets - known as productive finance.

But the report warns that smaller pensions face barriers to being able to do this due to a lack of public information .

The paper argues that there is no clear case either for the government to override the judgments of trustees acting in the interest of members or for setting arbitrary top-down targets.

Webb added: “The UK investment mix will in any case shift rapidly in the coming years, as UK DC schemes grow rapidly, and the government should not be in the business of over-riding trustee decisions to impose what it thinks is the right answer.”

Value for money framework

The Financial Conduct Authority (FCA), the Department for Work and Pensions (DWP) and The Pensions Regulator (TPR) have published proposals aimed at encouraging workplace pension schemes to improve their performance.

Under the proposed changes, pension schemes will need to publish clear data on their performance, costs and quality of service based on a ratings system giving each a Value for Money score.

If a pension is deemed to offer poor value, firms and trustees must then fix it by moving staff to better schemes or by making improvements.

But the report warns that ‘league tables’ could be counterproductive, leading to ‘herding’ of investment strategies with schemes reluctant to step away from the pack’ and innovate.”

Paul Johnson, senior adviser at Frontier Economics, said: “We need a rigorous framework to assess value for money, making sure that interventions are laser-targeted on areas where market forces alone will not deliver the right outcomes.

“The appropriate interventions will depend on the specific market failures we need to tackle and not on some arbitrary top-down target.

"Governments should act with great humility for fear of reducing the value of people’s pensions.”

Steve Webb: Using pensions for property | MoneyWeek Talks - YouTube

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Steve Webb was a guest on the MoneyWeek Talks podcast, where he discussed the state pension triple lock, using pensions for property, and more.