In 2024’s Mansion House Speech, the Chancellor unveiled the Government’s vision to propel the UK's financial services sector into a new era of growth and competitiveness. This address, along with the simultaneous publication of the interim Pensions Investment Review consultation, signaled the Government's intentions of achieving economic growth and substantial investment for the UK through defined contribution (DC) pensions. But how fast could the market move to such ambitious targets, is it in DC member best interests to do so and is 2030 a credible timeframe?
Central to the latest Mansion House address was the introduction of the first ever Financial Services Growth and Competitiveness Strategy, conceptulising the creation of ‘mega funds’ to boost investment in the UK. This plan seeks to bolster private sector participation in the UK economy through access to long term pension assets. A call for evidence to shape development has been initiated through the interim Pensions Investment Review which, at its heart, is seeking to improve investment scale in both Local Government Pension Schemes (LGPS) and the DC pensions market through consolidation, in turn unlocking capital for private UK opportunities.
The review's proposals for consolidating the UK's DC pension system are particularly noteworthy. By aggregating assets across contract-based pension products and setting the required scale for default pension investments at £25 billion, the Government hopes to unlock billions of pounds in new investment for the British economy. This proposed consolidation aims to enhance the efficiency of DC pension funds to ensure they can cost effectively invest in UK’s high-growth sectors and infrastructure projects.
This vision for the future depends on achieving significant scale in pension assets by the proposed target date of 2030. Large life companies with substantial existing DC assets and some of the bigger master trusts seem better positioned to meet this target if they can overcome some of the operational aspects, but newer entrants to the DC market may face more substantial challenges. Some of the largest automatic enrolment master trusts are approaching £30 - £40 billion in their defaults, while others are much further behind with some yet to reach £5 billion mark. Whilst it may be unpalatable, achieving the proposed £25 billion in scale required for a mega fund by 2030 may necessitate a concerted effort to consolidate, pool resources or perhaps even rely on access to other provider defaults to achieve the desired scale (something for which there is no current precedent).
The process of consolidating assets and transitioning to fewer defaults will require coordination and investment as well as tremendous resource. Moreover, providers must also navigate the complexity of these projects whilst maintaining member best interests and service continuity during any large-scale changes.
WTW researches the DC market in depth which in turn supports an extensive market review process when selecting a pension provider or considering the suitability of their default funds. Through this process, employers have already begun placing a greater emphasis on sustainability and scalability in their decision making when selecting a new provider. This shift could disadvantage smaller providers, that may now struggle to compete with the established players on innovation and quality alone.
The push towards consolidation into fewer, larger, default funds, is also being driven in part by the Government’s desire to reduce exposure to poor performing or poorly governed workplace pension default funds. This transition may come at the potential expense of reducing competition and choice for scheme sponsors. Any material reduction in choice by mandating for fewer default funds is likely to stifle innovation in the market, which should be a concern. There is a risk that by limiting the number of funds or introducing relative performance targets for example, it could encourage herding and consensus forming, resulting in the illusion of choice for investors while severely limiting access to higher quality options.
For members, the move towards larger, more efficient pension funds could result in better investment prospects and lower costs. Especially for those members invested in legacy defaults that may have been left withering on the vine by their providers. However, in a market move to fewer consolidated defaults, members are likely to foot the bill for the associated costs which will be reflected in their net investment returns.
The inclusion of private market investments in default funds is a promising development. The scale achievable through further consolidation could potentially allow for more substantial investments in private equity, infrastructure and real estate and credit solutions, offering members cost-effective access to higher-quality, higher-return producing assets. The current trend suggests private market assets held within DC default funds will follow a global asset allocation strategy to benefit from having a broader market exposure and better diversification of risk. There are no guarantees that the UK will be the main beneficiary of any new investment capital made possible by further consolidation or the creation of mega funds. Additional financial incentives may need to be considered to make the UK more attractive to pension fund managers.
We are already observing a growing number of providers introducing a meaningful allocation towards private market assets in their strategic workplace defaults today. Although we note that, for a section of the market, this is only likely to be made available by employers actively moving their members to a new default solution. Our expectation in the short term is for nothing more than a tokenistic allocation to this asset class within some of the markets’ largest workplace defaults due to cost restrictions and a provider reluctance to increase charges. Whilst the trend towards including private market assets in DC pension defaults may have been likely to continue on its own without government intervention, it will presumably be accelerated once the full recommendations following the Government’s consultations are published in early 2025.
The Mansion House speech and the intentions underpinning the interim Pensions Investment Review reflect a bold vision for the UK DC pensions market. Achieving the ambitious targets set for 2030 will require a blend of collaboration, innovation and resilience from participating stakeholders, but may come at a price to freedom of choice. While challenges abound, the perceived upside in terms of the rewards for the economy and pension savers suggest that the UK Government is unlikely to waiver in its commitment to this objective. But it should proceed with caution to avoid the undesirable and potentially damaging consequences of suppressing innovation by constraining free market potential.
