DC Progress has been disappointing - but there's still hope

By Hugo Gravell FIA | Barnett Waddingham

DC members have been standing at the crossroads for too long. The pension freedoms announced in 2015 promised a utopia of flexibility, personalisation with bigger pensions.

Yet nearly a decade later, the industry has collectively failed to develop the products and infrastructure that members need to truly engage with their retirement and prosper. And the problem is only growing: the cost-of-living crisis is leading more members to explore accessing their pension in-work and DC is becoming a larger share of pension savings for members reaching retirement.

People are being left floundering as they try to navigate a list of acronyms and jargon (e.g. UFPLS!) that could give sustainable investment a run for its money, let alone make informed financial decisions on how to make their savings last deep into their retirement.

The real challenge for trustees – both own trust and master trust – is deciding where to focus to have the biggest possible impact on the quality of their members’ retirement. And that’s no easy feat with announcements from DWP, HMT, TPR and the FCA, alongside a cascade of consultations covering VFM, CDC, trustee decision-making, consolidation, and plenty more besides (did I complain about acronyms?).

But, while progress has been disappointing, I’m excited about the opportunity we all have to make a real difference. Here’s three big areas we’re discussing with our clients.

Private markets

After decades of ‘easy money’ the outlook for public and private markets is by no means clear cut. The global economy faces huge uncertainty – compounded by global warming affecting people and economies today – and diversification has never been more important. Diversifying across asset classes, geographies and across public and private markets is essential.

The advent of Long-Term Asset Funds (LTAFs) offers potential for a step change in the take-up of private markets, although I’m still worried that commercial cost pressures will continue to hold DC providers back, despite many signing up to the Mansion House Compact. What’s more, despite the ambition of the Compact, the Government’s own calculation that private markets would benefit DC savers relies on significant fee discounts. Pension schemes face competition from a host of other investors in private markets, meaning those discounts may not be forthcoming – and the benefit to members left unclear.

We’re excited to see innovation in this space, with plenty of LTAFs coming to market. The next phase of innovation will be a move away from multi-asset funds to more specialist mandates to reflect how the desired balance of risk and return evolves as members get older. For larger schemes, private credit and secured income offers real opportunities in the lead up to and through retirement, not just in the growth phase. By extending the amount of time members are invested in private markets and investing when pot sizes are larger, this innovation holds the key to ensuring the benefits of private markets are really tangible for members.

Managing risk in the consolidation phase

In absolute terms, performance in 2022 was not good. With a selection of DC Master Trust strategies delivering negative returns ranging from -6.1% to -17.2%

While improving annuity rates suggest members can still enjoy a similar quality of life in retirement, that won’t be the case for individuals who access a large part of their savings early on in their retirement.

The lead up to retirement – that is, the consolidation phase – is a key area for innovation. Active management of credit holdings – ideally with flexibility to invest tactically across sectors and to reduce duration – is set to become a mainstay of DC strategies. Other options – like protected equity, which is discussed in this series – may offer potential where trustees are comfortable with more sophisticated approaches for their membership. In fact, many traditional investments underperform during sharp bouts of inflation, meaning sophisticated approaches may become a necessity if global inflation remains volatile during the transition to a greener economy and ongoing geopolitical tensions. There’s a key opportunity for own-trust schemes to stand out here, given the cost pressures facing DC providers. Interestingly, we are seeing more noise from providers around the potential to use tactical asset allocation –including actively managing the length of the glidepath. However, it remains to be seen how impactful this will be on financial outcomes given tight guidelines and being limited to existing building blocks, which makes it harder to manage financial risks like duration, which was the key contributor to poor at-retirement performance in 2022.

It's all about member outcomes…

Helping members make the most of their retirement is the topic trustees find more engaging than any other. We’ve seen more schemes innovate to help members stay in the institutional space when they retire – for instance, using retirement master trust bolt-ons to avoid sky-high retail charges and in some cases out-of-market risks and transaction costs. But there’s a lot more we can do.

The technology and investment products members need to plan effectively for retirement and stay on track throughout do not exist. The new solutions coming to market don’t go far enough. Relying on a stable asset mix in the early years of retirement before taking an annuity is too simplistic. Most people are not financial experts and cannot understand the risks and trade-offs involved when deciding how much to drawdown each year.

We believe there is a better way. The DC market is missing out on simple yet effective investments, like maturing bonds, that can offer more certainty to members and would be a natural fit for a retirement ecosystem that draws on the best thinking from investment, communications, financial planning, and user experience technologies. We believe this is the most exciting area of innovation for the DC market and are excited to be sharing more on this with the industry soon.

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For professional use only and should not be constituted as advice