Cost constraints are likely to continue limiting the development of master trusts’ investment propositions, according to a report from the Defined Contribution Investment Forum (DCIF).

The report, titled Growing Pains: Master Trusts Beyond Auto-Enrolment, noted that back in 2017, when the DCIF had published its last report on DC master trusts, the schemes’ focus had been on making auto-enrolment work and their investment offerings were “relatively simplistic”.

The new report observed that this priority had changed to improving member outcomes and, consequently, focusing on investment.

Of the 18 master trusts examined in the report, 15 spent less than 50 per cent of the fee on investment and just seven of the schemes expected the proportion of the fee spent on investment to increase.

The report pointed out that master trusts with lower average employer and member values would find non-investment costs taking up a higher percentage of member account value, as the need to keep schemes competitive and keep within charge caps offered them limited headroom to expand charges.

It added that providers “generally feel more emphasis is placed on the cost rather than the quality of investment”, which meant that it was “not obvious that we’ll see investment budgets increase any time soon”.

The report noted: “Charges are an important factor in determining member outcomes and it is absolutely right that cost is a key consideration in managing member assets.

“Nonetheless, the differences in cost between schemes are becoming increasingly marginal and the benefit of lower costs can quickly evaporate in the face of relative investment returns. Focusing on investment cost rather than value will not serve members well in the long run.

“Moreover, a race to the bottom on cost has the potential to destroy value for master trust providers. As a recent report from the Pensions Policy Institute highlighted, the economics of the sector remain challenging with break-even and payback on many schemes stretching many years into the future. A diverse and financially secure sector is key to ensuring effective competition and choice for employers and delivery of member expectations.”

The report said it expected the real focus of investment proposition development over the next few years to be the implementation of environmental, social and governance (ESG) factors, with all schemes examined stating that they were looking to make further progress in the area over the next three years.

It was noted that this could eat up further costs, as some of the master trusts expressed concerns about the costs of ongoing management and transitioning to new ESG strategies, and pointed out that passive ESG fund costs were markedly higher than those for tracking traditional indices.

As well as examining investment costs and charges, the report looked into consolidation, noting that the coronavirus pandemic is likely to accelerate consolidation due to the virus’ impact on the labour market and asset values.

The report stated: “The membership and assets of master trusts have grown significantly over the past three years. During this time, master trust authorisation has forced consolidation of the market and further consolidation is inevitable.

“This concentration of the market into fewer, larger players will inevitably bring benefits for members in the form of better resourced and governed schemes with the scope to develop better investment solutions and so deliver better outcomes for members.

“Consolidation will increase competition for mandates and, to the extent that vertically integrated schemes employ their affiliated asset managers, will potentially reduce accessibility to certain parts of the market. However, deeper asset pools and more sophisticated investment approaches will potentially put the DC market back into the reach of a wider group of asset managers.”

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