DC default funds: Experts divided on best strategy

Research carried out by pensions and savings provider Punter Southall Aspire showed significant differences in the levels of diversification by asset class, active management, and volatility targeting.

Steve Butler, chief executive at Punter Southall Aspire, said the report highlighted the importance of employers and trustees keeping a close eye on the value being provided by default offerings.

“Obviously the employee has no input into who their pension provider is and therefore no input into the default that they have,” he said.

He added: “It’s very much dependent on the look of the insurance company that [employers] end up going with as to what investment solution they get as the default, so that’s why I think it’s a risk.”

Butler argued that a “rush to the bottom on price” had seen fund providers stick with “old school” peer group performance measures and in some cases eschew volatility targeting.

Research suggests that the pain of experiencing losses on an investment are, on average, 2.5 times the pleasure associated from a gain of the same magnitude

Chris Wagstaff, Columbia Threadneedle Investments

Risk tolerance is logical but...

Perhaps unsurprisingly, experts disagreed over whether ultra low-cost passive strategies, or strategic allocations with underlying active funds, would drive the best outcomes for default savers.

Member engagement emerged as a key consideration when deciding between complex and simple default strategies.

“I’m very passionate about keeping things utterly simple so my mum can understand them,” said Nick Dixon, investment director at Aegon.

He said a fixed high allocation to equities remained a “perfectly adequate” solution for most default savers, provided their pots are derisked as they near retirement, owing to the length of investment cycles.

“Even a 40-year-old or 50-year-old, if they’re thinking of retiring in their mid-60s, can afford to be taking quite a lot of investment risk from a time horizon perspective, and indeed it may be reckless of them to be excessively cautious,” he said.

...Loss aversion is powerful

However, others pointed to the findings of behavioural economists such as Shlomo Benartzi, who has highlighted the loss aversion exhibited by retirement savers as evidence that volatility should be avoided through active strategies, even in funds designed for largely inert members.

Chris Wagstaff, head of pension and investment education at Columbia Threadneedle, said: “Research suggests that the pain of experiencing losses on an investment are, on average, 2.5 times the pleasure associated from a gain of the same magnitude. That is, most investors are loss-averse.”

He added: “Therefore a fit-for-purpose default fund should seek to create an asymmetric upside/downside return profile that appeals to loss-averse investors which calls for skill and insight.”

One size does not fit all

Another potential hurdle to successful default provision is savers' wide range of needs. Overseas funds like Australian superannuation fund QSuper have attempted to collect information from members in order to divide them into cohorts and tailor default strategies accordingly.

However, many members remain crucially uncertain about information such as their planned retirement date well into middle age, according to Alistair Byrne, senior DC strategist at asset manager State Street Global Advisors.

“We don’t think significant numbers of people can make those choices, so what we have designed is a single path that meets the needs of most people,” he said, advocating a single fund incorporating a derisking “glide path”.