The future of DC schemes: Go big and go green

As awareness of climate-associated risks rises, DC trustees are coming under increased pressure to provide well-designed, ESG-aware investment strategies that offer good net returns. 

The expectation is growing among members to a much greater level than in defined benefit schemes. 

Research from Cushon, which launched the “world’s first” net-zero pension, reveals 62 per cent of under-35s have said that they would engage more with their pension if they knew it was making a positive impact on climate change. 

Schemes need to bolster their ESG credentials by showing that they are not only managing and disclosing risk, but investing in assets that will form a meaningful part of a greener economy and generate competitive net performance.  

At the same time, we are seeing increased consolidation into master trusts, with memberships of non-hybrid DC master trusts increasing from 270,000 at the beginning of 2012, to just over 18.6m in 2021. 

The Department for Work and Pensions’ recent consultation on the barriers and opportunities to greater scheme consolidation in the UK occupational trust DC market is a clear marker for its ambitions.

Consolidation allows schemes to achieve ESG goals

ESG demands are also a key factor accelerating consolidation. Assets such as infrastructure, illiquids and private markets, as part of a well-diversified portfolio, present some of the best opportunities to achieve good returns for members in the climate change transition. 

Investing in green energy, for example, might arguably be best done via private rather than public markets, through some of the more innovative managers emerging in this sector. 

To access these, a broad investment governance bandwidth and expertise is critical. And this is what a large, consolidated provider can bring. 

To future-proof investment portfolios, all DC schemes – whether single or multi-employer – need to enable members to benefit from scale in more ways than reduced costs alone. 

As larger schemes use their scale to shave basis points off their listed portfolios, continuing to reduce already rock-bottom member fees may not be the best way to deliver value for money.  

Instead, those ‘savings’ could be better deployed in ESG-related private investments to boost net returns. 

Schemes called to set green targets

With new regulation on the way and COP26 fast approaching, pension schemes will face increasing calls to evaluate their investment portfolios and set ambitious net-zero targets. 

DC schemes with more than £5bn or more in assets will face new requirements to report in line with Task Force on Climate-related Financial Disclosures recommendations from October this year. This will be extended to smaller schemes with assets of more than £1bn from October 2022.

The investment strategies and governance required to boost ESG credentials mean we are likely to see smaller schemes under pressure, as they find themselves unable to meet requirements and therefore justify their value. 

Ultimately, we will two see groups of DC schemes in future – master trusts and those that are big enough and resilient enough to remain solo and go green.

Dianne Day is a client director at Independent Trustee Services