DC default funds: Is there too much focus on cost?

Paul Todd: The whole debate about lower cost is unhelpful. It should be about value for money. I think you need to be careful on going both ways. You can go very, very low cost, but that can lead to a less intelligent way of investing. However, you can also get led into a trap of paying more and more in fees in order to chase performance.

Lydia Fearn: I completely agree. Because of the charge cap in the last few years it has been a lot more about the cost being driven down, and I do not think that is necessarily a bad thing – you need to get value for your money. However, the definition of what value for money is differs for different people, so some sort of consistency is really helpful here.

It is also about holding investment managers to account on what they are delivering for the members overall, and having an understanding of what that is doing to their overall outcome through retirement.

Everyone hangs their hat on this wonderful option of a deferred annuity which does not exist in the UK

Lydia Fearn, Redington

Todd: The advent of indexing over the last 15 to 20 years is driving costs down throughout the industry. The challenge for active managers, whatever the asset class, is to see that as the new baseline. What value can they add beyond what you could get from an index provider?

By having scale, and not just scale – it is also about having expertise in terms of being an intelligent customer of asset management services – you can drive some pretty good bargains. I do not think the aim is to get costs down so low that the asset management industry cannot make a profit.

Keith Stephenson: Another aspect that is important within the cost cap is the quality of service, putting to one side the investment performance.

Pension participants need a reasonable quality of service in the sense of a reasonable amount of information and explanation – with probably more emphasis on the explanation than the information, otherwise reams of paper can come your way.

I know that even the very intelligent colleagues that I have will be scratching their heads thinking, ‘What does this mean?’ A pension provider that can provide some sort of explanation as well is good. That probably all has to come within the cost cap.

Fearn: When you are looking at contract-based schemes, the administration and paperwork is included within the charge cap.

However, there are some bigger schemes where the members may not have to pay administration. They get a bit of a bigger budget in terms of investment design.

For a lot of the mid to smaller ones, they do not have that, so you are right. Getting decent communication and a good member journey experience is really important. I think as a pensions industry we know that it is something where we are not quite there yet, and there is a lot to be done.

Pensions Expert: Are DC default members monitoring the performance of their investments?

Stephenson: I am honestly not sure that the members of a pension scheme are monitoring performance at all. We try and get the message across: this is your money and you need to take an interest.

However, there is a danger that if there is a consistent period of poor performance, members become very, very risk averse and the focus then is to find a fund that simply does not lose value.

Todd: A lot of the research we have done backs up the whole concept of prospect theory, that people massively overweight losses compared with gains.

We did some interesting research that looked to see how strong inertia was, and it is an incredibly powerful behavioural driver. That is why you see so many people in the default strategies and why auto-enrolment has been so successful.

I think in the coming years, as quantitative easing kind of unwinds, we are in for a period of much higher volatility and harder-to-find growth. It will be a real test of different default funds’ strategies and how they perform in more volatile markets. The danger is that if people see a lot of volatility and in particular their funds falling, it might drive the kind of behaviour that is probably not in their long-term interests.

I am honestly not sure that the members of a pension scheme are monitoring performance at all

Keith Stephenson, Association of Commonwealth Universities

Pensions Expert: How have pension freedoms affected default fund design?

Todd: The obvious way in which we have made some changes is to do with our glidepath – so what we call the consolidation phase.

When members get to around age 55 what we had been doing before was derisking people into a portfolio that is trying to track annuity prices, to try and manage that conversion risk between investment and the purchase of an annuity.

Everything that we have seen would suggest that the number of people who are going to buy annuities is going to be pretty low. We have therefore changed our glidepath and we have changed what we are targeting in terms of a mature target date – what the last asset allocation will be – to be much more a kind of mid point, allowing people to minimise the conversion risk if people want to go into drawdown, take their money as cash or purchase an annuity.

Fearn: It is definitely around the growth part at the moment rather than the through-retirement piece. There is some innovation in the through-retirement piece and there is some thought about it.

Everyone hangs their hat on this wonderful option of a deferred annuity which does not exist in the UK at the moment. However, there has been thought given to how you would structure that in the UK. People do want an income but they do not necessarily want to lose control over their savings.