The trustees of the industry-wide Combined Nuclear Pension Plan have added target date funds to its defined contribution scheme, having put the move on hold when the pension freedoms were first announced.
TDFs are a series of funds with a maturity window of one or more years; member contributions are invested in one based on their preferred retirement date. Unlike lifestyle options, members remain invested in the same fund until they retire or move their retirement date significantly.
TDFs are a future-proof structure, you don’t have to change the funds when regulation changes
Maria Nazarova-Doyle, JLT Employee Benefits
While TDFs are common for DC schemes in the United States, anecdotal evidence suggests they have not gained much traction in the UK market.
The CNPP's £168m DC arrangement is an early adopter. Its investment subcommittee had already decided in 2013 “that a target date fund approach would provide increased flexibility for members, diversification, reduced investment risk and simpler and cheaper administration for all the section”.
But the move was then put on hold until September 2015, in light of the announcement of freedom and choice in March 2014.
TDFs were put in place for the Combined Pension Scheme section of the CNPP at the end of 2016, with BlackRock.
Different sections follow different derisking paths with their TDFs. The default of the New Joiners DC Structure now targets drawdown with a "flexi option", while the default of the Shift Pay Pension Plan targets cash withdrawal with a "capital option".
A review of the default for the GPS section has been delayed following the decision of scheme administrators Aon to withdraw from standalone admin services. However, a revised approach for this section “is expected to follow”.
The trustees will review the suitability of all the defaults again this year.
Just one of several
TDFs are just one of the options DC schemes have in terms of their structure, said Richard Butcher, managing director of professional trustee company PTL.
“You see a proportion [of schemes] going for them. The advantage is you build an investment portfolio designed to mature at a particular time,” he said.
“The disadvantage is that you might get the individual’s retiring date wrong and can’t tell they’re on track until you reach target date.”
TDF demand remains low
Butcher said he has not seen any increase in demand for TDFs among pension schemes recently.
But Laura Myers, partner and head of DC investment at consultancy LCP, said about 5 per cent of LCP clients use TDFs, noting an increase in schemes wanting to explore this option.
She said the main reason TDFs have not gained more traction in the UK so far is that lifestyle funds are the incumbent.
“Given both provide similar solutions to each other, many have decided that the differentiation is too minimal to warrant a change,” she said.
Myers said TDFs are easier to communicate to members than a lifestyle option, and managers can adjust the derisking process to market conditions, rather than following a rigid pattern.
As members remain in a single fund throughout their journey instead of being switching into different funds, the administration is also less onerous.
On the downside, the manager risk is high, as all the assets tend to be managed by the same company. This creates issues including conflicts of interest if that manager underperforms, for example.
Most TDFs operate a passive, long-term glidepath with a relatively “fixed path” to retirement, said Myers, while others are more actively managed.
‘Next generation from lifestyle’
The pension freedoms are one reason why appetite for TDFs might be growing after all.
Maria Nazarova-Doyle, head of DC investment consulting at JLT Employee Benefits, said TDFs are more adaptable to ever-evolving legislation than lifestyle funds.
“Trustees just can’t keep up to speed, you can’t forever keep changing a default strategy,” she said.
TDFs and lifestyle funds: What is the difference, and why?
Many DC trustees spend most of their time making decisions they deem to be in the best interests of members who will not make decisions for themselves – people whose investment contributions ‘default’ into a strategy chosen by the trustees.
“TDFs are a future-proof structure – you put them in once, you don’t have to change the funds when regulation changes. Managers will just change the asset allocation and the target.”
Nazarova-Doyle is a supporter of target date, and while TDFs are not “taking the UK by storm”, more schemes are implementing them, including one of JLT’s largest clients, she said.
She criticised traditional lifestyle strategies for being “not very cost efficient and not great for members”, and noted that the Pensions Regulator has been putting more emphasis on membership needs in terms of the outcomes targeted.
But there are things to watch out for with TDFs. “If you go into an ‘off the shelf’ TDF, normally when managers design them they target a UK average… but there could be schemes that are very different from average in terms of their population.”
She advised schemes with specific membership needs to consider bespoke solutions, or seek out managers that offer different versions of their TDFs.
