Analysis: Defined contribution pension schemes could learn from their big brother defined benefit – one lesson being how to calculate liabilities and match them with savers’ assets.
Index provider MSCI is in discussion with two consultancies to develop a tool that can do just that for both old and new DC savers.
Traditionally in the UK, many savers have either chosen or been put into a default lifecycle fund, which invests in equities and derisks into bonds and cash as the chosen retirement date approaches, the idea being that members then buy an annuity.
This assumption no longer applies, begging the question of how DC members should save for retirement.
Phil Beattie, head of MSCI’s DC strategy for EMEA, said savers might still want a regular income from an annuity, but could at the same time want to take part of it as drawdown.
I think we’ve got to give them better information about the chance of achieving their goals
Phil Beattie, MSCI
He said a forward-looking index based on annuity rates could help DC members understand what they need to do to achieve their chosen retirement goal.
“What we are talking about with a couple of people is designing something that looks at the chances of achieving what you want and benchmarking the cost of your future liability, because people treat DC as if there isn’t a liability; but there is, it’s what you want to spend in your retirement,” he said.
TIAA-Cref veteran develops DC indices
MSCI managing director and head of multi-asset applied research Brett Hammond is developing the DC indices for the index provider.
Hammond, a veteran of DC investment, spent 18 years as chief investment strategist of TIAA-Cref, the world's largest DC scheme, where he developed their target date funds and worked on inflation-linked bonds, individual financial advice models, an international non-profit pension investment consortium and Social Security reform.
“So what we want to look at is things like deferred annuity-based indexes… Based on what you’ve got, how much income are you going to get, but based on what you want, how much income do you need now, and then trying to make those two meet in the middle.”
Beattie said such an index could give people more clarity on pensions: “We’ve got to give them better information about the chance of achieving their goals.”
The indices are still works in progress. Beattie said MSCI might look at whether to introduce guarantees by buying futures and swaps, or whether they should remain indicative and based on current rates that are updated on a constant basis.
Such an index could be unique for each individual but initially MSCI will work on a scheme basis and look at the characteristics of the membership.
A series of DC indices was introduced last year by FTSE and Elston Consulting, measuring performance at different points in savers’ lives, and was adopted by mastertrust Lighthouse Pensions Trust earlier this year.
Member outcomes are key
Joanna Sharples, investment principal at Aon Hewitt, said individual outcomes are the best way of measuring DC pensions.
How UK mastertrusts are designing DC benchmarks
The growing mastertrust sector has created a range of investment benchmarks, but consultants call for greater focus on performance yardsticks that reflect scheme memberships.
Aon’s preferred approach is to calculate the replacement ratio at retirement and regularly assess how it is performing, which Sharples said was “potentially very powerful for trustees to look at”.
“[We] track how that’s performing, then we split that down: what’s market impact, strategy impact or active manager performance,” she said.
However Mark Fawcett, chief investment officer at mastertrust Nest, was less warm to the idea of DC indices and said in some cases they could in fact hamper a fund’s performance.
He said a fund’s success should be measured against its stated objectives rather than indices.
“Generic default fund indices may give the impression that all investment strategies are pursuing the same objectives, taking the same level of risk and applying the same approach,” he said.
“This could also have the adverse effect of encouraging herd mentality among pension providers because they are being ranked against each other – this is what we have seen in Australia.”
