As the latest consultation on the proposed Value for Money regime comes to a close, Owen McCrossan of the Society of Pension Professionals warns of negative consequences if there is not enough room for nuance in the system.
Proposals for a Value for Money (VfM) framework have been developing since the publication of a discussion paper almost five years ago.
However, plans to require pension providers and trustees to publicly disclose standardised performance information about their schemes, accompanied by league tables and the proposed RAGG (Red/Amber/Light Green/Dark Green) ratings, represent a major change.
What we don’t yet know is whether it will drive better member outcomes, accelerate market consolidation, distort investment behaviour – or all three. Given the potential for significant unintended consequences, a phased “safe” period before going fully live would be advisable.
“The easiest way to manage performance volatility relative to peers is to herd around similar investment strategies. We are already seeing this behaviour, and the proposed VfM framework may entrench it.”
Owen McCrossan, SPP
What the government wants
VfM originally emerged following auto‑enrolment, based on the reasonable premise that if people were being quasi-mandated to save into a pension, the schemes receiving those contributions needed to represent good value.
At that stage, the regulatory emphasis on costs created an inevitable race to the bottom, with providers pulling on the easiest lever – the investment fees budget (recognising these are often bundled in an overall charge), leading to low‑cost, highly passive investment strategies.
Today, the objectives have evolved. The government’s primary aims appear to be better member outcomes (unquestionably sensible) and more investment in the UK economy and private markets. The latter is strategically understandable, though not without debate on the practical limits achievable.
Underpinning these aims are several key beliefs:
- Net-of-costs performance is a better measure of member value. This is hard to argue with in principle.
- League tables will raise standards by encouraging weaker providers to merge or exit. We have seen this in practice in Australia.
- A focus on net performance will legitimise higher‑fee, higher‑alpha asset classes, including private markets.
- Scale is essential to access such assets and to do so competently.
- Fewer, larger players make policymaking easier and coordination with industry more manageable.
There is a certain internal logic to all of this. But whether these beliefs play out as expected is uncertain.
Will VfM achieve its objectives?
It’s hard to say if these performance metrics weed out the good from the bad. There are concerns around the design of the performance metrics themselves.
The proposed methodology looks across three notional cohorts along the glidepath, assessed over one, five and 10‑year periods. There is a ‘weakest link in the chain’ problem: a single year of relative underperformance in, say, the at‑retirement cohort, can disproportionately drag down a provider’s overall RAGG score, even if the underlying investment rationale is robust and appropriate.
The risk is that providers begin managing to the metric, not the member outcome. If the government is determined to see more DC capital flow into UK private markets, it will likely succeed. But it is highly debatable whether the VfM framework itself will drive schemes towards those investments.
Why? Because the consequences of falling into Amber or, worse, Red status are commercially severe. Providers will understandably seek to avoid drastic consequences such as having to close to new business.
The easiest way to manage performance volatility relative to peers is to herd around similar investment strategies. We are already seeing this behaviour, and the proposed VfM framework may entrench it.
The market is already moving towards fewer, larger players, driven mainly by regulatory minimum size thresholds and the government’s encouragement of ‘megafunds’. The VfM disclosures introduce yet another barrier to entry. Policymakers need to determine where the optimal balance lies between scale, competition, and innovation.
Most agree on the goal of delivering the best possible value for savers. Shifting the regulatory focus from costs to outcomes is an important step forward. But DC investment is inherently complex, and it’s difficult to distil long‑term decision‑making into a simple set of performance figures.
Service quality will play a role in the VfM assessment, but a relatively minor one. Performance will dominate. We are likely to see continued consolidation, increasing homogeneity of investment approaches, and strong policy pressure to allocate to favoured private markets.
We are moving towards a smaller number of very large providers, clustered around similar strategies, competing over costs – along with some collateral damage as perfectly good solutions fall unfavourably within the limitations of the performance assessment methodology.
Owen McCrossan is a member of the Society of Pension Professionals.
