Could the proposed VFM framework do more harm than good?

The Financial Conduct Authority (FCA) has now published a consultation on its proposed value for money (VFM) framework, providing the perfect segue for the next post in our DC blog series. 

First, let’s recap. In our blog post, 'The dangers of following the herd', we argued that an overreliance on passive investment products could spell disaster for the master trust market. The premise of our argument? If more and more master trusts funnel money into passive investment products—to reduce their fees and fulfil an overly-simplistic definition of ‘value’—then a number of risks come to the fore.

One such risk is that of underperformance. Our first post largely explored this at the fund level, by showing that passive funds—even those tracking supposedly global indices—are often concentrated in very few names and regions. By lacking diversification, these funds are potentially exposed to greater losses.

In this post, we’ll talk at the provider level. If, as part of their investment strategy, the majority of UK master trusts are relying on the same underlying passive managers, then what could this mean for their collective investment performance? And are the risks not heightened by the FCA’s proposed VFM framework, which encourages market consolidation, but without duly encouraging competition?  

How similar is risk-adjusted performance from one master trust to another?

Consider the chart below, which focuses on the growth phase of retirement saving.¹

What’s notable is that whilst risk-adjusted performance varies substantially between the top-performing and worst-performing master trusts, the majority look strikingly similar. We believe the reason for this likely comes down to investment strategy—there’s probably little variety between one master trust and another:

Several master trusts look remarkably similar from a risk/return perspective

Source: Hymans, SEI. The chart reflects net performance and volatility up to 31 December 2023, as submitted by each of the providers, and pertains to their default lifestyle options. Please note that the performance figures relate to actual performance, with the exception of one master trust that has provided its performance figures based on a static allocation. Past performance is not a reliable indicator of future performance.

Think about what this means: if master trusts are performing similarly today, then they’ll be performing similarly in the event of a market downturn. This is compounded by the use of passive investment products, with a ‘significant proportion’ of the market currently investing ‘wholly’ in passive funds during the growth phase, and the dominance, within this, of just a few passive managers.²

So, to summarise: if an index drops in value, then any passive fund tracking said index will also fall in value. This, in turn, will impact the members of master trusts heavily exposed to passive investment products.  

Does the proposed VFM framework do enough to encourage competition?

The simple answer is no. Whilst the proposed VFM framework acknowledges the risk of investor herding, it does very little to address the above, insofar as it does very little to discourage master trusts from flocking to the same investment products. 

Historically, fees have driven this kind of behaviour, with advisers and consultants promoting low-fee providers above all others, in turn driving demand amongst providers for passive investment products. It’s likely the proposed VFM framework will perpetuate this kind of groupthink—to avoid a red or amber rating, providers may shy away from anything that could cause them to be seen as an outlier. In other words, we could see continued use of very similar investment strategies from one master trust to another, rather than anything innovative. 

And acknowledging this also means acknowledging that the proposed VFM framework somewhat misses the mark, insofar as it doesn’t fully articulate what constitutes true value. Likewise, instead of giving advisers and consultants pause for thought—or rewarding providers willing to push boundaries, and invest for the long term—the framework runs the risk of doing the exact opposite.

Shouldn’t we set the bar higher, encouraging providers to outdo one another on a risk-adjusted, net returns basis? If one of the framework’s underlying objectives is to encourage market consolidation, then we need to simultaneously raise standards. Otherwise, we risk overlooking the thing that should matter most: member outcomes.

Put simply, spending power in retirement is determined by how much a member contributes, and the way those contributions are invested. So the most important criteria when evaluating a master trust should be net investment returns. To think otherwise misses the point, and shrugs off the reason people have a pension in the first place.

In the next post of the series, we’ll look at how the investment approach underpinning the SEI Master Trust helps members achieve better outcomes. 

¹For more information, see ‘Master Trust Default Fund Review’, Master Trust Insights, Hymans Robertson, July 2024. 

²‘DC Governed Default Investment Strategy Insights for 2024’, Barnett Waddingham, 29 April 2024, p.9.

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