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Defined Contribution

Managers re-examining U.K. master trust market

Largest firms likely to be big winners from DC plan consolidation

Emma Douglas said the lack of scale for plans currently has made it a challenge to include alternatives.

New regulations soon to take effect are changing the defined contribution landscape in the U.K.

That's prompting money managers, record keepers and other service providers to take a new look at business opportunities and where they want to focus.

Multiemployer DC plans, known in the U.K. as master trusts, are merging after the government earlier this year required plans to obtain new operating permits in an effort to weed out poorly governed trusts. According to The Pensions Regulator's predictions, a third of the 81 multiemployer plans in the 12 billion ($16 billion) master trust market will be acquired by larger master trusts after the new rules kick in Oct. 1.

Industry sources said smaller plans are not expected to be able to afford the new permits: The government will impose a one-time authorization charge of 41,000 for existing plans and a fee of 23,000 for master trusts that are entering the market for the first time.

They expect the coming consolidation to solidify the position of the largest money managers that already run a large chunk of DC assets — either through their existing master trust platforms or as an outside manager — and have the expertise to tackle integration issues through their record-keeping businesses.

"It is fair to say that the largest (manager) players in the DC market will have a monopoly over the master trusts' assets," said Laura Myers, partner at consultancy firm Lane, Clark and Peacock LLP in London.

The U.K. market, she added, "will look a lot like the Australian market," where fewer but larger multiemployer plans hold a majority of their investments in-house and hire outside managers for their expertise in, say, illiquid investments.

With a larger pool of assets to invest, master trusts are expected to look to access new asset classes and require more robust investment strategies.

Sources said many master trusts now spend the majority of their operating budgets on governance rather than on money managers. Joining a larger multiemployer plan will provide economies of scale and should cut governance costs, freeing up the operating budget to expand investments, said David Hutchins, senior vice president and head of multiasset solutions ​ business in Europe, Middle East and Africa at AllianceBernstein (AB) LP (AB) in London. "At the moment some master trusts are spending up to 80% of their budget on running the plan's governance and administration."

In the U.K., DC plans' costs of operations and investments are capped by law at 0.75% of assets under management.

According to a forecast by consulting and research firm Spence Johnson, U.K. master trust assets will increase to 306 billion by 2026, boosted by corporations transferring DC plans to master trusts and increased employer and employee contributions.

Like in the Australian model, some 50% of the portfolio of a typical multiemployer plan will be managed in-house, including global core equity and (government) bonds. Added-value areas such as emerging markets equity, global credit and real estate would be outsourced, Mr. Hutchins predicted.

For DC multiemployer plans, consolidation might give them the scale to add more active elements into their investment strategies or bring in new asset classes. In time, such scale also could allow them to invest in more illiquid assets, such as infrastructure.

An official with Legal & General Investment Management in London, which operates the Worksave Pension Mastertrust with 4.8 billion in assets, said such alternative investments have been a challenge to implement so far simply because the plans don't have the scale. "We are trying to get more plans to access private equity, venture capital and infrastructure investments," said Emma Douglas, head of DC solutions. "This trend is starting to happen, but it is not in itself accelerating."

Legacy headaches

For some firms, the prospect of sorting out potential record-keeping issues will determine whether they want to chase more master trust business.

Absorbing a smaller master trust might create additional issues during the integration process, sources said. A poorly run master trust might have had poor participant data quality, or the data might have to be cleaned by the administrator charged with integrating the assets.

In extreme cases, record keepers might be required to track down contributions that were not deducted from an employee's pay, or managers might have to make good on employer or employee contributions that were allocated incorrectly by the previous record keeper, Ms. Douglas said.

"We are not particularly planning for that," LGIM's Ms. Douglas said. "We hope that these master trusts can be absorbed by the market, which would mean that a nightmare scenario is less likely to occur," she said.

Another potential snag could be investment strategies. Some master trusts might not want to change their default investments to be consistent with the acquiring master trust, said Roy Porter, group director of sales and marketing at the 4 billion People's Pension, a master trust in Crawley, England. A money manager would have to have the investment strategies and record-keeping capabilities to accommodate those wishes.

"Some small plans serving participants who for ethical or religious reasons require a different investment approach will struggle to have a default replicated and may find the disinvestment process of their fund almost impossible," Mr. Porter said.

People's Pension's investment manager is State Street Global Advisors.

Aiming to avoid such potential integration headaches, some managers are targeting transfers from corporations' group personal pension plans into master trusts.

"Transfers to master trusts from group personal pensions are on the rise," said Daniel Smith, head of DC business development at Fidelity International in London. Fidelity's own master trust, Fidelity Retirement Master Trust, with about 2 billion under management, has been focusing on absorbing these plans. "We have been targeting large employers with good quality benefit programs."