UK pension funds must expand investment, warns new regulator

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Trustees of UK pension funds must consider increasing the range of their investments, including in start-ups or other illiquid assets, or face “robust” intervention, the UK regulator has warned.

Nausicaa Delfas, new chief executive of The Pensions Regulator, added that it was important that administrators of defined contribution schemes had the expertise to value more complex assets – and advised that if they did not, they should seek to consolidate or even wind up their schemes.

“Trustees have a duty to investors to act in their best interests. This means properly considering the full range of investment options.

The remarks, in Delfas’ first interview with the media since taking office in March, come with a push by the government to release billions of pounds of money from public and private sector pensions for investment in British businesses.

Earlier this month, Chancellor Jeremy Hunt unveiled a pact with nine of the UK’s largest corporations and pension funds to allocate up to 5% of their portfolios to private equity.

Hunt said his “Mansion House” reforms could unlock an additional £75bn for high-growth businesses, while a wider package of DC pension reforms would increase a typical worker’s pension pot by 12% over a career.

Unlike traditional “defined benefit” pension plans, where retirement income is guaranteed, newer “defined contribution” plans offer no certainty of eventual retirement income, with results largely dependent on investment performance.

Delfas, who was previously executive director of governance at UK regulator Financial Conduct Authority, said the DC market was focused on the cheapest fees rather than overall value, which meant trustees weren’t looking for assets that could deliver the best results over the long term.

“We expect those plans that have the scale and the expertise to be able to invest in a diverse range of assets,” she said, adding that “productive finance,” such as illiquid investments, start-ups and growth assets, had a role to play in a diversified portfolio.

“Obviously some of the more sophisticated investments cost more, but we feel that even now, even within schemes, they’re not really using the full range of costs (available to them),” Delfas said.

“The challenge of the last decade was how to get people to save. And now the challenge for us is how do we make sure they get the right value from their savings. »

Some fund managers have expressed concern that the Mansion House pact amounted to an overreach of ministers in their duty to act in members’ interests, adding that the financial gains from private equity investments had been overstated by the Chancellor.

But Delfas defended the pact. “This is a voluntary agreement between the parties and it shows the intention to look at a diversified portfolio of assets.

“We expect DC administrators to consider whether or not they are competent to conduct this type of [illiquid] investments and when they don’t, they really should be looking to shore up their plan or wind it down,” she said.

Ensuring that trustees overseeing investment decisions have the skills to assess more complex assets and to challenge advisers who may recommend them is a key issue for the regulator.

The explosion in the UK gilt market last September, which was sparked by then-Prime Minister Liz Truss’ disastrous ‘mini’ budget, exposed a lack of knowledge of complex investment strategies among some corporate boards. It also revealed shortcomings in the regulator’s assessment of how these strategies were used by pension funds.

Delfas said she would like to see a professional administrator on every board “but that’s hard to do at the moment with the number of plans that exist.”

One of Delfas’ top priorities is to accelerate the consolidation of the DC market, which is dominated by thousands of smaller plans, which would see the emergence of larger, more professionally governed plans.

Data released by the regulator last month showed that only around a quarter (24%) of DC schemes met the requirement to assess member value, with larger schemes, such as master trusts, being more likely to meet it.

“We believe that larger programs, with this greater scale and expertise, can produce better results,” she said.

“Directors who are not doing what we expect can expect us to step in more vigorously and be more assertive about the need to consolidate if they are not improving or failing to meet regulatory requirements,” she added, warning that “we intend to make full use of the powers available to us.”

The regulator can pursue enforcement actions against trustees who fail to meet their obligations, and the government is considering expanding these to include forced consolidation of plans in the most egregious cases.

Ensuring that investments in areas such as private equity, which typically charge performance-based fees, do not erode returns will be critical for fiduciaries. Government analysis released this month showed that typical private equity fees could make things worse for some young savers.

Delfas warned that trustees should also consider “carefully” whether city fund managers could cut fees to reduce risk to savers.

“My feeling is there has to be a market solution,” she said. “The value-for-money framework will provide that leverage for competition, and that clarity between programs and markets will naturally evolve.”