Better Business: How can advisers benefit from the DC gold-rush?

Magnus Spence, director at Spence Johnson, says a growing DC market in the UK could open up opportunities for advisers.

Few people would associate the UK DC market with a gold rush. For providers, somewhat underwhelmed by the scale of DC opportunities and somewhat overwhelmed by fierce price competition, the idea may provoke a wry smile. Asset managers have so far mostly avoided DC and they will do a double take at the idea this market offers anything but pain and sorrow. And advisers, whether the large EBCs feeding off the larger schemes, small IFAs helping to build small schemes, or the corporate IFAs in the middle-sized territory, none have reason to see the DC market as a crock of gold.

Now may be the time for a rethink. We think the measures of UK DC assets today are much smaller than some suggest because UK DC is so immature. But we predict an acceleration of growth in assets among large schemes which will generate the ‘gold rush’ of our title. We go so far as to suggest the DC gold rush could throw up a new pool of £600bn in DC assets.

Incredibly, no one really knows how big the Defined Contribution pensions business is in the UK. Defined Benefit is measurable enough. But DC? There are no agreed measures.

We do not have the space here to show the range of estimates we have collected. The main point is they tend to suggest the DC market is very large. One source which defines the market in similar terms to us argues at the end of 2007 the market was £550bn in size. Other
measures, albeit using different definitions, offer even larger numbers.

In contrast, we estimate the size of employer sponsored DC Pensions in 2007 to be £360bn. But even our lower than average market size estimate is, in our view, misleadingly large. There is a ‘core’ element to this market that is much smaller still. By ‘core’ we mean the Trust or Contract based DC schemes sponsored by companies with more than just a handful of employees. We think this ‘core’ element is possibly only £70bn.

So, the starting point is surprisingly small. But it will grow very fast. We identify this growth coming from one source in particular – large company schemes.

In mature pension markets like UK DB pension funds and US 401K pension schemes, large firms tend to dominate the DC asset pool – a small number of large schemes hold a very large proportion of the total pool of assets.

However, the UK DC market is quite different. The vast majority of assets are in the hands of schemes with small numbers of members. The reason for this is the UK DC market is still very immature – the schemes of large firms have not yet started to collect large pools of DC assets. In a recent Mercer DC survey 81% of US scheme respondents were over 10 years old, while only 34% of UK ones were.

The large firms have now turned up to the party, and are starting to collect those assets. Eight out of 10 FTSE 100 firms give DC pensions to their new employees according to Watson Wyatt. The implication is very clear. Large firms in the UK have the most members, so in future (unlike the past) they will see the greatest growth in assets.

The growth in DC pensions in the UK in the future will have quite different characteristics to its growth in the past. Our prediction is within 10 years the UK DC asset pool will evolve to match the profile of today’s US asset pool – heavily weighted towards the schemes of larger firms. If this prediction is correct the large schemes with more than 5,000 members will grow in size in proportionate terms by a multiple of nearly four times.

Imagine total DC assets today are the same as our estimate for 2007: £360bn. And imagine also UK DC assets will grow at approximately 11% (asset growth + contributions) each year to become £1,000bn in 2019. This projection seems reasonable to us.

Increasing assets

If we are also right the share of the larger schemes will grow to be like it is in the US, then we predict schemes with more than 5,000 members will increase their assets over the coming decade by £600bn, or around nine times what we believe to be their current size. We call this the DC gold rush.

Larger schemes have quite distinct characteristics. For example they tend to be Trust based rather than Contract based, and they tend to be very demanding in terms of service, and can be very difficult to serve. So the market will be distorted by this change, and this in turn will be to the advantage of some suppliers and providers and to the disadvantage of others.

Assuming these characteristics do stay the same, the main beneficiaries of the DC gold rush will include the asset management DC full-service providers (who tend to focus on larger schemes) and passive fund suppliers (who tend to be in strong demand among large Trust based schemes). Unless they take action fast, the losers will be the insurance providers, whose historic strength has been medium and small sized schemes, not the larger ones.

What of the advisers? The obvious beneficiaries of the gold rush will be the large fee-driven EBCs, whose client base is mainly drawn from larger companies. They will win very strongly if large schemes remain Trust based, but could find life a little trickier if there is a strong shift towards Contract-based that many predict and which the EBCs are so obviously keen to avoid.
The medium sized schemes are also set to grow, and this will benefit the advisers in the middle ground – the corporate IFAs who exist in a half and half world of fee and commission based business and who are evolving fast as a new energetic and innovative force in these markets, some already nibbling at the toes of the EBCs.

Commission hungry smaller IFAs who have been able to benefit from the growth of DC to date (since most has come from smaller schemes), will in theory be looking forward to more of the same, since RDR seems unlikely to prevent them from continuing to draw juicy DC-related commissions from their corporate clients.

However, our prediction is the DC heyday of smaller IFAs is in the past – most small schemes will be sucked into the vortex of Personal Accounts, and will bypass them altogether from 2012. In contrast, we predict larger and smaller schemes will tend to use Personal Accounts for only very small numbers of employees.

The gold rush will see some lose out in the stampede, and it is too early to tell who will benefit. Nothing seems very clear in the murky world of DC right now.