U.K. automatic enrollment surge not a sure thing

Huge pool of assets expected, but where it goes still uncertain

As British employers began automatically enrolling an estimated 10 million workers into defined contribution plans in early October, money managers with U.K. operations were seeing more question marks than dollar or pound signs.

Uncertainty surrounds everything from the extent to which auto enrollment will boost inflows industrywide to which managers will benefit from those flows. Some experts suggest the impact from auto enrollment won't be fully felt before 2015 and that business opportunities for all but the megasized players might be few.

Auto enrollment overall “has got to be good for the defined contribution industry” in the U.K., said Emma Douglas, partner and leader for Mercer Workplace Savings, the investment consultant's DC plan management arm. “Over time, this will be a huge asset generator for DC schemes and managers.” According to manager estimates, auto enrollment could add about 10 billion ($16.1 billion) every year to flows into DC plans in the U.K.

But experts attach many caveats and unknowns to flow estimates; for example, opt-out rates, which are hard to predict, will have a considerable impact by decreasing the number of participants. And a hunger for lower costs — about 100 basis points for investment and administration — is cutting into how big of a slice of the asset pie for which active managers will compete.

“Clearly the quantity of money will increase. But where it goes is less clear,” said Hugh Ferrand, head of institutional sales and service at Invesco (IVZ) Asset Management Ltd., London.

Newly created low-cost providers, such as the National Employment Savings Trust, will compete alongside three existing models of DC plans in the U.K.: contract-based, trust-based and master trust plans, each of which outsource different levels of assets to managers. Trust-based plans tend to offer more of an opportunity for consultants and active managers to win business.

Six months ago, Ms. Douglas said, she would have thought contract-based plans would be playing a bigger role than they have. Instead, “we are now seeing much more interest in the master trust concept,” she said.

And relatively new diversified growth funds are claiming about half of default fund assets, making it even harder for active equity managers to make a business in DC.

Time factor

Another factor creating uncertainty is time. Fidelity International Ltd., the international arm of Fidelity Investments, expects its British DC business to approximately double in participants to 500,000 and boost assets under management by 50% to 15 billion, over the next four years, according to company data.

“It's not going to be something that happens overnight,” said Richard Parkin, executive director and head of proposition, DC and workplace savings, at Fidelity. “The phasing in” of companies into auto enrollment will mean the growth of assets available to manage “will take some time,” Mr. Parkin said.

Experts agree that three types of firms stand to benefit the most from auto enrollment: low-cost providers, such as NEST; large platform providers such as Fidelity, BlackRock (BLK) Inc. (BLK) and insurers with investment management arms such as Legal & General Group PLC and Standard Life PLC; and passive managers.

BlackRock has increased the number of DC members it serves by 20% to 208,000 in the past year, adding 15 large clients, said Paul Gilbody, director and head of DC consultant relations at BlackRock in London.

“We're seeing a huge number of tenders coming our way with auto enrollment now live,” Mr. Gilbody said. BlackRock runs 9.1 billion in its platform and investment-only businesses.

But even big players like Fidelity and BlackRock are scrambling to capture as much of the business through their bundled service offerings. Both firms have created diversified growth funds that use passive underlying components to attract plans bent on keeping costs low. In June, BlackRock introduced a master trust offering, a sort of bundled service that lets employers outsource plan oversight to a third-party trustee. Fidelity has considered doing the same; however, “we've held off because no one's been able to produce a business case to make it look worthwhile,” Mr. Parkin said.

For smaller active managers, most of the action will be for diversified growth fund managers or providers of investment components within a default fund. Default funds attract 80% or more of the assets in most DC plans, and executives at some of the larger plans manage default funds similar to the way they would manage a default benefit — setting asset allocation themselves and hiring managers for various investment mandates.

“If you're a component manager in a default fund, you'll see good flows into your strategy,” Mercer's Ms. Douglas said.

Rash Patel, director of institutional sales at MFS Investment Management, London, estimates the size of the pure active management from U.K. defined contribution plans to be 25 billion. He's been happy to grow DC assets to 400 million in recent years, admitting that “the absolute number isn't big, but the growth has been (fast).

“We don't expect our growth to reach what it has been in the past” as the firm landed on investment consultants' buy lists and made an early foray into the market. “We don't have the brand awareness that some of our competitors have and don't have passive products,” Mr. Patel said.

Pressure on small players

Invesco (IVZ), which runs more than 1 billion in DC assets in the U.K., has seen firsthand the pressure large-scale managers are putting on smaller players in DC. Invesco sold its DC platform to Threadneedle Investment Services Ltd. in 2008 (which in turn handed its business, which lacked scale, over to Legal & General in 2011). “I can't see us going back into DC, no matter how big it gets,” Mr. Ferrand said.

One area where U.S. managers hope to take advantage of their expertise and experience is in target-date funds. Said Tim Bird, vice president and head of U.K. and Ireland institutional business at T. Rowe Price International Ltd., London: “We're thinking long and hard about what we could do in the U.K. to offer something similar” to the firm's U.S. target-date offerings. “We recognize that over the next three, five or 10 years that DC will absolutely be a big part of (managers') business in the U.K.”

Despite being a major player in DC in the U.S., T. Rowe Price runs 8 million in the U.K. — a figure Mr. Bird said the firm is “working really hard to improve.”

Because NEST offers target-date options, U.S. managers are watching very closely whether other DC plans follow their lead. U.S. target-date experts like Fidelity and T. Rowe Price would have an upper hand in selling target-date funds in the U.K., Mr. Bird said, adding that “ AllianceBernstein (AB) has done a terrific job at talking about the concept of target-date funds (in the U.K.).”

Promoting its customized target-date approach, AllianceBernstein has grown its U.K. DC business to 1 billion, a figure the firm looks to extend to 5 billion to 10 billion over the next three to five years.

“We want to make this a big business,” said Timothy Banks, London-based director of DC sales and client relations at AllianceBernstein LP (AB). “We know we have a very scalable solution and that we will very quickly get to break even. But we have ambitions way beyond that.”

This article originally appeared in the October 15, 2012 print issue as, "U.K. automatic enrollment surge not a sure thing".