Multi employer DC schemes must reach £25bn, but is bigger always better?

UK policymakers are committed to driving consolidation in all areas of the UK DC pensions market. The most prominent headline for me from the Pension Schemes Bill was the £25bn minimum assets under management threshold for multi-employer DC schemes by 2030. This “scale requirement” combined with new powers which can impose minimum required allocations to so-called “qualifying assets” including private equity, private debt, venture capital and land, means there is seemingly no escaping the government’s plans for DC savers to invest in UK productive finance.  

The scale of Australian DC schemes is an often-cited driver of the success of the system down under. But does Australia’s experience really endorse an industry comprising of a small number of £25bn+ mega funds?

A decade of consolidation in Australia

Australian DC consolidation over the last decade has witnessed the number of default fund products reducing from 116 in 2014 to about 55 at the end of last year. The pace has increased slightly over recent years, primarily due to a regulatory environment that has been increasingly assertive in forcing perceived underperforming schemes to merge.

Interestingly, over this time the size of the average default fund has increased from AUD 3.4bn (£1.7bn) to AUD 19.2bn (£9.6bn). Substantial change, yes, but far below the £25bn minimum set by the Government.

That said, the number of Australian default funds running assets of more than £25bn has risen from 1 in 2014, to 8 in 2024, of which 2 are over £50bn. This trend is likely to continue with further consolidation and high minimum contribution rates for the majority of the Australian population. The UK government has made it clear that it wants to follow in these footsteps but at a faster rate, expecting schemes to reach the £25bn minimum threshold by 2030.

Let’s start with the good news

Firstly, it’s right to recognise that scale has been very beneficial for the Australian pensions industry. It’s allowed asset owners to build high calibre internal teams which in turn has enabled the construction of robust portfolios in a cost-controlled way. For example, many asset owners now manage traditional asset classes such as cash and bonds in-house; whilst more complex and expensive asset classes, including some private markets, are partially built utilising low-cost co-investments. Scale has also been beneficial in funding the often-significant development cost of building quality post-retirement solutions.

Now for the bad news

The benefits of scale are well documented but what about the challenges (or diseconomies). These have received less airtime. So to redress the balance, I’ve outlined some key examples below:

1. Domestic listed market capacity constraints - Australia has instituted strong tax incentives to encourage domestic investment, which have achieved their policy aim with Australian schemes investing over 20% in domestic equities on average. However, larger schemes often find it challenging to allocate to some areas of their domestic stock market. Meaningful allocations often involve owning a very high proportion of available shares which can result in liquidity challenges, particularly for small cap stocks. This also leads to concentration risk for the investors, not to mention substantial subsidy costs for the government.
2. Private market capacity constraints - capacity challenges also apply to private markets. Whilst some private market managers raise very large vehicles, areas of increasing interest to Australian DC schemes (e.g. energy transition investments) involve fund managers raising relatively small amounts. Fund management organisations value a diversified client base and may push back on individual DC scheme requests to take up large proportions of their investment vehicles given the business concentration to one customer this presents. Hence when investing privately, having an enormous pool of capital doesn’t necessarily lead to better deployment compared to medium sized schemes. There is a school of thinking that a small number of mega funds would be best suited to purchase large private assets being brought to market, e.g. a large infrastructure asset such as an airport. However, these large projects may represent too concentrated an investment even for a mega fund. A case in point is Thames Water, where large asset owners learned this lesson the hard way, when they had to write off the entire value of their equity. Canadian scheme OMERS lost almost £1bn on this one investment, a big number no matter how big your scheme.
3. Policymaker interest - there are examples where the size of the DC industry in Australia has received attention from policymakers who see them as a means to meet wider policy objectives.
   1. During COVID, the Australian government introduced measures to allow savers experiencing financial hardship to access AUD 20,000 from their DC savings.
   2. More recently, a key election pledge from the same political party is to allow early access to the pension scheme to fund a house deposit.

This uncertainty causes challenges for DC decision-makers as it influences the patterns of behaviour that might be anticipated from their members.  For example, the potential for more significant outflows resulting from changes in policy might necessitate greater caution when investing in illiquid assets.

The answer?

There is rarely an easy answer in investments but in this case there might be. One key component is changing how success is defined and measured, with a move towards clearer performance disclosure and accountability of decision makers, creating scope for underperformance to be addressed satisfactorily.

This will naturally accelerate with uplifts to the Value for Money framework and improvements in peer-based competition.

Based on my own experience across a breadth of DC schemes, poor performance can usually be more directly attributed to inadequate governance, than to size. Whilst poor governance and insufficient size can be correlated, if you address the governance through appropriate measurement of performance, there’s plenty of room in the DC industry for well-run small, medium and large schemes.

With a change in mindset more towards a focus on performance, I’m confident that bigger can be better, and the benefits of consolidation will materialise via natural means. However, it is this change that is needed to bring the results, rather than the arbitrary minimum of £25bn, which largely misses the point.