How can DC schemes deliver value for money?

Tasked with defining the similarly slippery concept of value stocks, a factor investor once fell back on the US Supreme Court’s 1964 obscenity test and simply said: “I know it when I see it.”

Value for money is a moving target, it’s going to change so it’s got to be a framework that evolves with this

Jacqui Reid, Sackers

None of which makes the concept any less important for pension providers, employers and end consumers. In today’s ‘lower for longer’ market environment, those defined contribution savers who find value for money could see a considerable uptick in their retirement prospects.

Balancing risk and return

In the search for value for money, product design could focus purely on returns and cost.

Indeed, the Financial Conduct Authority’s recent asset management market study leant upon a definition of value for money for asset management products “typically to be some form of risk-adjusted net return”.

Independent governance committee research into value for money, coordinated by law firm Sackers and NMG Consulting, found that members value good returns above other factors when assessing value for money.

However, high returns usually come with increased risk and volatility. The traditional equity-heavy DC allocation has always assumed young members can tolerate rises and falls in their savings level in pursuit of a larger fund size at retirement.

Recent years have seen some providers deviate from this train of thought. Mastertrust Nest now reduces the volatility of new savers’ holdings for the first few years of membership.

“No one likes to lose money,” says Nest chief investment officer Mark Fawcett, who was involved in a survey of saver attitudes before designing the strategy.

“The reactions to the knowledge that people have lost money were quite visceral and emotional, and people were saying, ‘Well, I’m going to change provider’,” he adds.

No risk appetite consensus

Some still have doubts about the viability of this type of strategy. They suggest that members are not engaged enough to observe the dip in their savings brought about by a financial crash.

“These are auto-enrolled individuals that are coming in with a bit of inertia. Are they going to look?” asks Chris Roberts, a trustee representative at Dalriada Trustees, who estimates schemes embracing volatility “might alienate one or two” members at most.

Alistair Byrne, head of European DC investment strategy at State Street Global Advisors, says low engagement should not excuse unnecessary exposure to volatility, particularly when this could be achieved without sacrificing returns.

“We accept the point that a lot of people don’t look [at their statements] but on balance members don’t like volatility, and I think we should reflect that,” he says.

The idea that members can tolerate volatility becomes more popular in times of market calm, according to Byrne, who holds that dynamic, diversified allocations and alternatives to active management such as smart beta should be included in a good value DC proposition.

Value demands transparency

Once value has been identified in a strategy, cost should, in theory, be the easiest feature to identify.

While the research conducted by Sackers and NMG found that members were more concerned about overall value for money than charges, the negative compounding effect of high fees is well documented.

With overall satisfaction and value scores in the study averaging 6.2 and 6.4 respectively out of a possible 10, controlling cost could be an all-important factor in improving the returns so prized by respondents.

“It’s critical to focus on cost,” says Laura Myers, head of DC investment at consultancy LCP. “Costs are the thing you know is going to happen… they will definitely determine the outcome.”

The FCA’s working group on institutional fees, led by Newcastle University Business School professor Chris Sier, will look to standardise disclosure of asset management fees with a new template.

Trustees can also take steps to ensure they control costs, according to Myers. “Don’t be afraid to go out and benchmark your providers,” she says.

However, strong net-of-fees returns are unlikely to guarantee default members the quality of retirement they might hope for.

“It’s not just about return, it’s about the way you engage with your finances,” says Daniela Silcock, head of policy research at the Pensions Policy Institute.

These soft skills are far harder to measure as different aspects of service matter more or less to different individuals, she says.

That idiosyncratic nature of scheme membership should be kept in mind when designing a process for assessing value for money, says Jacqui Reid, partner at Sackers. 

“I’d probably want to build a process that looks at the needs of the membership,” she says.

That demographic assessment can then be reflected in strategy, for example by changing a scheme’s lifestyling target.

“Trustees and governance groups need to look at their memberships, because there’s lots of things that can skew this,” says Mark Futcher, head of DC and workplace wealth at consultancy Barnett Waddingham.

Demographics, market conditions and benchmark costs are all liable to change regularly. A scheme with a good grasp of value for money will therefore have to revisit this over time, says Reid. “It’s about establishing and maintaining a set of principles. [Value for money] is a moving target, it’s going to change, so it’s got to be a framework that evolves with this,” she says.