Chapter 2: Investment strategies
65.At the start of this inquiry our call for evidence asked “Do higher-cost providers deliver higher performance, or simply eat into clients’ savings?”. Much of the evidence received in response to this question pointed towards research by the FCA. The FCA’s Asset Management Market Study found that “there is no clear relationship between charges and the gross performance of retail active funds in the UK” and that funds cluster within a narrow price range but often deliver very different levels of return.53 The FCA’s Retirement Outcomes Review also looked at investments made by non-advised drawdown customers, and their associated total charges (not just fund charges) and Sharpe ratios54 to understand whether the difference in charges could be explained by consumers getting better investment returns. This found that higher charges were only weakly associated with higher performance.55
66.In a February 2019 speech at the Trade Union Congress,56 the Minister for Pensions and Financial Inclusion announced a consultation on proposals to encourage defined contribution pension schemes to consider a wider range of investments—including infrastructure and housing investment.57 These types of investment can have higher costs than those associated with the more traditional investments made by pension funds. The consultation included proposals:
requiring large schemes to report their policy on these types of investment;
requiring smaller schemes to assess, every 3 years, whether they should consolidate into a larger scheme;
changing how schemes calculate charges.58
The consultation closed on 1 April 2019 and the Government response is yet to be published.
67.The All Party Parliamentary Group on Alternative Investment Management suggested in February 2019 that the Government:
Improve pension scheme trustees’ awareness of alternative investments, and their incentives to consider allocating to such investments;
Explore ways in which DC schemes could better access investments that do not offer daily liquidity;
Provide guidance on how to combine investments in order to meet the charge cap of 0.75% for DC default funds, and explore ways of accounting for performance fees in the cap.59
68.The Pensions and Lifetime Savings Association told us that “Some assets such as infrastructure or property are also intrinsically more expensive, often attracting higher charges and levels of transaction costs” and that “The illiquid nature of some of these asset classes is also particularly suited to a pension scheme’s long-term time horizon and investment approach.”60
69.The ‘Implementation Taskforce for Growing a culture of social impact investing in the UK’,61 which was commissioned by the Prime Minister in March 2018, said that “Many investments with a social and / or environmental impact are into infrastructure, such as property (e.g. affordable housing) or renewable energy projects” but added that “infrastructure investments often involve higher charges and transaction costs because they are more intensive to structure.”62 It may therefore be more difficult to make investments with environmental, social and governance impacts within the current charge caps.
70.We asked the Minister for Pensions and Financial Inclusion whether or not these types of investment give better performance, given that they may have higher costs. The Minister disagreed with the view that these types of investment do not necessarily produce higher returns and told us:
… if you want to get greater member engagement, invest in something that members are interested in. Secondly, if trustees wish to invest in something for the long-term future of this country and wish to make a positive investment, particularly if they could localise it to Devon and Cornwall or Wales or to the West Midlands or wherever, such that I am a member of that organisation and I know that my pension fund is invested in that social housing project built there on a 30 to 50-year basis, I personally think that is a good thing.63
71.When we asked about the difficulty of getting schemes to invest more widely in areas such as housing and green energy, the Minister said:
No disrespect to the Work and Pensions Select Committee, there is an understandable timidity on the part of trustees to go outside the traditional approach, whether that is because they fear regulatory, or Government, or Select Committee criticism, or because everything has been based upon secure performance and steady return on behalf of members. I believe that there is a way ahead whereby you can still achieve secure performance and steady return for members, but you can diversify your portfolio.64
72.Several evidence submissions said that increasing transparency in pension funds’ approaches to environmental, social and governance investments could help to engage savers, by communicating the real life relevance of investments. The Transparency Taskforce told us that this was an important driver of decisions for the younger generation, citing research which shows “that 86% of millennials say they are interested in socially responsible investing, and 55% want their pension invested in organisations that reflect their social and environmental views.”65
73.ShareAction similarly told us that many millennials will have started saving for a pension for the first time as part of the automatic enrolment rollout. It noted that:
68 per cent of 25–34 year olds say it is important that people use their money for the good of society and the wider world,66 and millennial investors are nearly twice as likely as non-millennials to invest in companies or funds that target specific social or environmental outcomes67 However there is little information available to inform savers on how their pension savings are invested.68
74.The Low Income Tax Reform Group stated that it is probable that the vast majority of savers “do not realise that their funds may be invested in companies that are involved in areas that conflict with the person’s own values and ethics—for example are involved in tobacco or weapons, say, or that damage the environment or co-operate with countries with ‘a bad human rights record’” and added that “Investment transparency therefore needs to be improved so that people fully understand where their funds are being invested and can make an informed decision as to whether they are content with that or wish to change for ethical reasons.”69
75.In September 2018, the Government announced that from 1 October 2019 trust-based schemes will be required to:
a)set out how they take environmental factors (etc) into account;
b)publish a statement on members’ views;
c)produce an implementation statement setting out how they have acted on the principles and views from the previous year.70
76.The FCA told us it was “considering changes to our rules to require IGCs to report on their firms’ policies in relation to environmental, social and governance (ESG) factors, including climate change, how they take account of member concerns, and stewardship.”71 Since then the FCA has proposed a “new duty for IGCs to report on their firm’s policies on ESG issues, consumer concerns and stewardship, for the products that IGCs oversee” in its consultation paper on Independent Governance Committees: extension of remit.72
77.We have not received compelling evidence that higher-cost providers provide better performance. However, there are justifiable reasons, depending on value for money goals, for some schemes using higher-cost providers, including investment in infrastructure, diversifying portfolios and matching long-term investments to long-term savings. We are encouraged that the Minister is seeking solutions better to enable investment by defined contribution schemes in infrastructure and other illiquid assets whilst not fundamentally undermining the charge cap.
78.We recommend that the FCA should introduce requirements for contract-based schemes, corresponding to those introduced for trust-based schemes, to report on environmental, social and governance factors as proposed in the FCA’s consultation on Independent Governance Committees: extension of remit.
53 Financial Conduct Authority, Asset Management Market Study, Final Report, June 2017, para 1.12
54 The ‘Sharpe ratio’ is a measure of performance that takes into account volatility - unlike other measures- Financial Conduct Authority, Asset Management Market Study, Final Report: Annex 4 - Assessing the relationship between the price and performance of retail equity funds in the UK, June 2017
56 DWP, Speech: Investment innovation and future consolidation for occupational DC pension schemes, 8 February 2019
57 DWP, Consultation, Defined contribution pensions: investments and consolidation, 5 February 2019
58 Ibid.
59 APPG, Alternative Investment Management, UK Pension Schemes and Alternative Investment, February 2019
61 Social impact investing aims to enable individuals to support more easily the things they care about through their savings and investment choices.
66 ShareAction, Pensions for the Next Generation: Communicating What Matters, March 2018, p13
67 Ibid.
70 DWP, Clarifying and strengthening trustees’ investment duties, September 2018
72 Financial Conduct Authority, CP19/15, Independent Governance Committees: extension of remit, April 2019, para 2.27
Published: 5 August 2019