Defined contribution (DC) megafunds have the potential to be a “game changer” for pension savers and the UK economy, according to research from WPI Economics, but only if policymakers and regulators properly manage the broader ecosystem.

The research, commissioned by Phoenix Group and People’s Partnership, found that if the minimum fund size of £25bn in assets under management (AUM) was introduced, by 2030 the trust-based DC market could consolidate from 30 master trusts to between four and 10 master trusts, with the contract-based DC market having six group personal pensions providers.

This is in the context of the UK government’s aim for the future of DC pensions to consolidate the market into a series of megafunds of this size, first announced as part of the Chancellor's Mansion House speech last year.

The research estimated that, depending on the growth rate in the trust-based and contract-based markets, there could be between £821bn and £976bn of AUM in the DC market in 2030.

Based on testing various scenarios, the modelling revealed that by 2030 the majority of savers are expected to be invested in funds with assets exceeding £50bn, with the potential for much of the market to be concentrated in funds over £100bn.

The modelling estimated that between 73 and 100 per cent of savers and between 54 and 100 per cent of assets in the trust-based market could be in funds with over £50bn in total AUM.

It also predicted that 87 per cent of savers and 92 per cent of assets in the contract-based market could be in funds with over £50bn in total AUM by 2030.

However, WPI Economics warned that several “critical enablers” are essential to unlocking the benefits of megafunds and ensuring they achieve higher returns and greater investment in private markets.

These include bulk transfers without consent, implementation of the value for money agenda, and market management to support a shift from cost to value.

WPI Economics said that if the market undergoes these “fundamental shifts”, savers currently in the smallest funds could benefit from 12-24 basis points in higher net returns annually.

It said that this means that those with an average salary could have an extra £12,000 in their pension pot at retirement, while those currently in larger funds can expect a smaller increase in returns.

The research also showed that over the longer term, this could mean between 17-24 per cent of AUM in the trust-based market and 22-23 per cent of AUM in the contract-based market could be invested in private markets.

This could deliver between £61-£110bn (trust-based) and £100-£120bn (contract-based) of private market investment.

However, WPI Economics pointed out that due to the extent of change needed to DC pensions in the UK today, these changes would likely take effect over a longer time horizon than 2030 - the date the government set for consolidation.

WPI Economics director of policy, Joe Ahern, said this is an “ambitious vision” for megafunds and highlighted the substantial contribution they could have on the economy by 2030 if the appropriate conditions are established.

“The potential improvements in returns from scale, which provide an ongoing benefit to savers, should more than offset the short-term transition costs that would arise from the move to a consolidated market,” he said.

Adding to this, Standard Life retirement savings director, Mike Ambery, said: "The industry has been set a clear roadmap and direction of the travel by the government’s Pension Scheme Bill and Investment Review.

"This report identifies key enablers and considerations for that direction that can enable consolidation, scale and value to savers."

Ambery also suggested that the government’s push for fewer, larger schemes is grounded in a belief that they will deliver better outcomes for savers and society more broadly.

He said that this analysis adds weight to these arguments by showing the range of outcomes that could be achieved and the scale of benefits that could be unlocked.

People’s Partnership chief executive officer, Patrick Heath-Lay, said the research showed “clear, potential benefits” of the government’s reform agenda to both savers and the wider UK economy.

However, he warned that the challenge now is for the government, regulators, and industry to work together to ensure that the outcomes align with what the research predicts.

“Success of this ambitious reform programme will require continued effort, even after the legislation is passed,” he said.

---