The debate about consolidation has been raging for years.
The defined contribution consolidation picture is blooming complicated and it is not yet possible to tell who is going to come out on top.
But how did we end up here?
There are, principally, two reasons to consolidate: economy of scale, which leads to lower costs, and more sophistication and ‘better’ governance.
The debate about consolidation may have raged for years, but now is the time of reckoning. Win or lose. It is binary
The latter happens for two reasons: the evidence is that bigger schemes tend to be better governed than smaller schemes and, for master trusts, because the governance is policed by the Pensions Regulator.
There has been consolidation in this sector, most notably in the micro market — schemes with fewer than 12 members.
But even in the larger schemes there has been a shift, according to TPR’s latest data in this area. The figures show that since the beginning of 2010 the total number of schemes with 12 or more DC members has declined by 62 per cent to 1,740.
That said, and probably not surprisingly, the higher you go up the scale of size, the less consolidation there has been.
Where are these schemes consolidating to? This is one of the easier questions, as they have been choosing master trusts.
Out of almost nowhere a new generation of these schemes has sprung up and sucked in money at a phenomenal rate.
Is consolidation sustainable?
Now that is a more interesting question.
A recent EY Pension Consulting survey revealed a clear majority of the master trusts are in a race to take on the single employer schemes in the £10m-£250m part of the market. That is about 800 schemes. And they need to.
The economics of running a master trust are very challenging — amongst other things there are administration, investment, governance and legals to pay for.
Then there is the small matter, for all, of making a surplus to reinvest and, or for, perhaps, paying out dividends to shareholders.
All of this must be done from an average total expense ratio of 0.4 to 0.5 per cent, according to the Pensions Policy Institute DC Future Book 2020.
The last stats published by TPR showed 38 master trusts with combined assets of £38.1bn, although this contrasts with some numbers published by the DC Investment Forum, which surveyed 18 master trusts claiming combined assets of around £60bn.
Some of this difference may be down to timing, but either way the average master trust is still small at around £1bn-£3bn assets under management. Take the currently £16bn of Nest assets out of that and the average is significantly lower; in other words, the average master trust has revenue — ie. before costs — of less than £10m.
This is not sustainable. To address this there are three strategies schemes can follow: get more contribution income (although for all except those in the auto-enrolment market this is tricky), the race for growth spotted by EY, or consolidation of the consolidators.
And it is telling that the market, with 38 approved master trusts in 2019, has already diminished to 36.
DC master trusts are now a permanent fixture of the marketplace, but that is not to say all the current master trusts are here to stay. The next two years or so will be critical. They must win business or accept being consolidated themselves.
Who will be the winners?
Who knows? Nest will be there, but otherwise? Whatever the magic formula is, they need to find it now.
If you do not stand out, you will not win. And if you do not win you are on the slippery slope. There is too little time left to be a laggard.
Admin is a hygiene factor: get it right and no one notices, get it wrong and you are in trouble. Same, in a sense, with investment (leaving aside style preferences) and governance.
For my money, there are two things that will make the difference.
First, and rather prosaically but none the less importantly, distribution. A master trust that cannot access new customers will not grow.
Second, and more interestingly, how the master trusts engage with their members — how they will help them to help themselves get a better income in retirement.
The debate about consolidation may have raged for years, but now is the time of reckoning. Win or lose. It is binary. It is going to be an interesting couple of years.
Richard Butcher is managing director at PTL
