Kevin Openshaw explains why the new 75bp cap will force a change in pension fund infrastructure
The seismic shift in the UK pension landscape away from defined benefit (DB) and towards defined contribution (DC) will force a similarly radical movement in pension fund infrastructure.
At the moment, most pension funds still use investment platforms that were designed for a bygone era and built to support mutual funds, they simply do not have the sophistication required to meet the future complex fund needs of the DC market place.
Until now, this has been manageable - just. But in April, things will change when the Government’s new charge cap of 75 basis points on default schemes comes into play. Trustees and employers will be faced with the challenge of delivering an appropriate investment strategy supported by the best funds, while also selecting an appropriate platform, all within this charge.
Platforms will need to demonstrate an ability to operate within this dramatically reduced cost structure. This squeeze will force a move to more sophisticated, automated investment platforms that are able to deliver a new standard of efficiency for a new marketplace.
Efficiency, however, is only one piece of the puzzle. For investment platforms to deliver in the new world of DC, they will need to offer flexibility.
Platforms will need to demonstrate an ability to operate within this dramatically reduced cost structure
Put simply, this means that platform limitations should not constrain the funds that can be selected for a scheme. It is imperative that a suitable range of funds is available for all members. The flexibility to add or remove underlying funds quickly in response to changing blend investment strategies and market conditions will therefore be a key consideration for any modern platform.
Flexibility also means the ability of an investment platform to manage and reconcile any differences between underlying funds in an automated manner. Unfortunately, the fund market doesn’t have uniform working practices and many mangers use a variety of methods to deal into funds.
On top of this, they need to accommodate different price types, fee structures, and offer different valuation points for their investments. An investment platform that cannot handle these differences is essentially the same as one that constrains fund selection.
Where blended funds are used, further complexity is just round the corner
Where blended funds are used, further complexity is just round the corner. Many existing platforms either constrain the structure of blended funds to prohibit investment in assets without a consistent dealing cycle, or restrict the frequency of rebalancing which can force a black out on member transactions while the rebalance occurs. Neither option represents effective use of cash to deliver optimal fund performance, and so neither option tallies with trustees’ obligations to their members.
The financial risk associated with missing dealing cut off points due to manual process limitations will no longer be tolerable. A forward looking investment platform will need to resolve these and other limitations of current platforms.
Of course, the 75bp cap is just one immediate milestone in a wider revolution of the DC marketplace currently underway. The radical change to annuity rules means that providers will now need to develop post-retirement investment solutions, meaning there will be an explosion of more complex fund structures.
Of course, the 75bp cap is just one immediate milestone in a wider revolution of the DC marketplace
All this additional complexity will only sharpen the need for more flexible and efficient investment platforms. But this isn’t just about survival. The future scale of the DC market – means that those that can get this right, early, will find themselves well positioned to take advantage of the increased opportunities that the new landscape will afford.
Kevin Openshaw, head of life, pensions and platform, Milestone Group