Why the government’s proposal for a £25bn limit for DC mega-funds is unlikely to work

When Chancellor Rachel Reeves announced that the Government was to consult on requiring workplace DC arrangements managing less than £25bn to merge with larger schemes, it was heralded as one of the most significant reforms announced to the DC workplace industry.  

In her Mansion House speech late last year, the Chancellor proposed imposing a minimum £25bn default fund size requirement on providers. She believed that this scale was required to encourage more investments in productive assets, including asset classes such as infrastructure and private equity.  

Given the UK economic backdrop, the government’s imperative to kick-start growth through investment in productive assets is understandable, particularly as DC investment in UK private markets is minimal.

But, the announcement has triggered more questions than answers among the pension community, and one big question lingering in the DC market is, “Will this £25bn minimum threshold do anything to increase investment in UK productive assets?”

Will it work?  

One factor to consider is that any significant policy shift like this will require years of coordination and may not bear fruit in this parliament. In fact, the FCA’s value-for-money regime and general market forces are more likely to drive consolidation in the short term.

I am not convinced that forced consolidation will lead to greater investment in productive assets or necessarily be positive for DC scheme members. Most of the master trusts left in the market have already achieved scale and could invest in UK private markets. That they do not has more to do with the market focus on price and the availability of suitable investment opportunities. Given the industry's adverse reaction, the current proposals will likely require a rethink, which is expected once the consultation results are published.  

Shifting the buyer's mindset from cost to value is one key to driving increased productive asset allocation and greater portfolio diversification. This means recognising that higher charges can lead to better risk-adjusted returns and, ultimately, better member outcomes.

The consultation recognises that solving this issue is an important part of driving investment diversification. The authorisation of advisers working in this area was an important part of the government’s proposals that should be welcomed by the industry. It will help drive improved professional standards and a move to a more holistic evaluation of value and, in particular, investment strategy.

Of course, there must also be a suitable pipeline of investment opportunities available, and given the rate of DC asset growth, it is by no means clear that there is sufficient opportunity to satisfy what could become a huge market demand. So, ultimately, whether these proposals will come to fruition or be successful depends on several variables, many of which are unknown as they currently stand.  

With that landscape in mind, what do these proposals mean for trustees? 

What this means for trustees  

Trustees' primary fiduciary responsibility is to their scheme members, not to drive UK economic growth. There is no reason for trustees to invest in UK assets unless doing so delivers the potential for better member outcomes compared to investing overseas.  

Of course, the government could offer fiscal incentives to encourage home market investment, but it appears to have ruled this out. This leaves a hard or soft mandate as the only alternative.

Future legislation may mandate that master trusts invest a proportion of their portfolios in UK productive assets. An alternative approach would be to allow master trusts to voluntarily commit to raising the proportion of their assets invested in UK private markets, with the implication that policy will be reviewed if this does not occur.

Trustees will need to carefully consider how they respond to this new policy environment, balancing fiduciary duty with the government policy direction and potentially new regulations. With dashboards, value for members and the advice guidance boundary review, coming at the same time, its set to be a busy period for Trustees and their advisers.  

It is positive to see the government’s commitment to driving greater diversification in DC investment portfolios alongside a desire to move the market from a cost-to-value mindset, but I remain unconvinced that forced consolidation will lead to more investment in private markets. The consolidation proposals, as they currently stand, risk creating a provider oligopoly, stifling innovation, and creating market uncertainty. Scale will grow for the best-governed master trusts that win in the market by offering outstanding value and good member outcomes.

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