Analysis: How have defined contribution schemes been adjusting their scheme design and investments to reflect the reforms?
Providing savers with flexibility
It’s finally here. Those who are 55 or older can now access their pension pots to do as they see fit. So, what will most of us do when we reach retirement age? And, more importantly, what should we be doing in the meantime?
The likelihood is most of us simply do not know. Alliance Bernstein’s consumer research indicates people do not tend to plan what they will do with their pots – or when they will decide to gain access.
The uncertainties of modern working life mean that pension providers can expect only short notice from savers who want access to their funds.
For us, the key consideration is to look after the 80 per cent of members of defined contribution schemes who take a hands-off approach and are consequently using default funds.
Those who have not yet decided what to do with their pension pots – the overwhelming majority – need clear guidance on the choices available under the new rules. They also need suitable interim options, so they can be confident their pensions are being appropriately managed before they decide which course to take.
And despite all the recent changes, we cannot assume the new situation will be static. March’s Budget, which put forward the right for pensioners to sell existing annuities back to the providers, was a salient reminder that the government will likely continue to tinker with the pensions system. Whatever the outcome of the general election, we can expect that tinkering to continue.
So, with old certainties gone and the new situation in flux, savers need flexibility above all. We think the best way to achieve this is through a target date fund. As TDFs are actively managed, changes to clients’ schemes can be executed almost instantly.
After the 2014 Budget, for example, we were able to implement changes to our TDF strategies within a few hours of our investment team’s final decision on how best to respond – and at no cost to our clients or their members.
At the same time, TDFs give scheme members reassurance that their pension funds are in responsible and responsive hands, rather than being subject to automated trades, as with lifestyle strategies.
And while the managers are free to respond to developments immediately, they do so under the oversight of the scheme’s trustees. So, as we enter a brave new world of pension freedoms, we believe the TDF provides the best route through this uncharted territory.
Tim Banks is managing director, pensions strategies group, at Alliance Bernstein
However, for the most part this has simply meant a short pause, as employers and providers waited to see how members would react to the rollout of the reforms in April.
But what is changing is the structure of the lifestyling phase of the DC journey as schemes have sought to incorporate members’ additional at-retirement choices.
A briefing note from the Pensions Policy Institute in March said the number of people in the UK saving into a DC scheme is set to increase to around 14m by 2020, up from just 4m in 2012.
It anticipates that by 2030 there could be around £480bn of assets in the sector. This compares with the current £310bn of assets estimated by research consultancy Spence Johnson.
The shape of how these assets are invested remains to be seen, but the PPI says that of the 90 per cent of people in the default fund, around 60 per cent of assets will be held in lifestyling strategies while 20 per cent will go to target date funds – though it says the line between these terms is blurring.
Lifestyling changes
Alan Morahan, principal at consultancy Punter Southall, says there have been no dramatic shifts in the design of DC schemes yet, as there “is not enough hard evidence out there” in terms of what members are likely to do at retirement.
But he says some funds have had to change their investments to fall below the 0.75 per cent charge cap. “Some have had to move out of more esoteric investments like commodities,” Morahan says.
Mark Futcher, head of DC at consultancy Barnett Waddingham, also notes the majority of change in DC is happening at the lifestyle end.
“Generally this has been to a higher-equity, more diversified approach, to ensure that whatever retirement option the member chooses then it is not a bad choice,” he says.
Where risk assets in the growth phase would have previously dropped from around 75-80 per cent to zero in the lifestyling phase in preparation to purchase an annuity, Futcher says, schemes looking for a one-size-fits-all approach might now only reduce their equity allocation to around 35-50 per cent.
Multi-asset marches on
Despite the increasingly significant role multi-asset funds play in pension scheme investment strategies, the charge cap is changing how they are used.
Dave Lowe, head of corporate propositions at provider Zurich, says some of its high-end clients have been forced to reduce allocations to the more active diversified growth funds in favour of ‘lite’ versions, while the threat of further cap reductions is affecting other clients’ outlooks.
“Those at the cheaper end of the spectrum are now likely to get more traction relative to their peers than they might have enjoyed previously,” Lowe says.
“Further into the future, it is possible that alternative methods of risk mitigation may become preferable in the search for solutions with a lower headline investment cost.
“The investment freedoms may be a trigger for innovative thinking that aligns with this aim of cost reduction.”
Trinity Mirror Pension Plan uses a DGF, but Laurie Edmans, chair of the scheme, still wonders whether DGFs “are a solution looking for a problem”.
“We use one... but only after some real heart-searching about the likely sacrifice of investment returns as a result of seeking a quite modest element of derisking,” he says.
Steven Robson, head of pensions at the United Utilities scheme, said while the use of multi-asset funds will increase in DC, the worry is the charge cap will lead to an increase in “passive content” within those funds.
Generally this has been to a higher-equity, more diversified approach, to ensure that whatever retirement option the member chooses then it is not a bad choice
Mark Futcher, Barnett Waddingham
“This could have the effect of increasing their correlation to other asset classes and water-down the diversification – the key reasons that they started to be introduced,” he says.
But Futcher says the result depends on how that passive equity is used.
“Some are just adding a slug of passive equity which will dilute the benefits of diversification,” he says.
“Others are keeping the asset allocation as their core belief and getting the exposure to the various classes via passive investment rather than active. I suppose it is down to the scheme in question and the charges.”
To and through
The PPI says the new flexibilities are likely to lead to more ‘to and through’ pension products alongside standard accumulation default funds.
Its March briefing note added: “This may also lead to some debate of what a ‘target date’ is, if investment is likely to continue beyond the traditional ‘retirement’ date.”
Multi-employer schemes are expected to play a major part in DC’s growth in the UK, but there are concerns they could struggle to respond effectively to the new flexibilities.
Futcher says: “I would argue that multi-employer schemes were not intended to offer tailored solutions to different employer segments.
“They need to offer the members a range of solutions, but in order to keep the economies of scale and benefits of a multi-employer scheme they cannot bespoke these to each employer segment.”
However, Darren Philp, head of policy at mastertrust The People’s Pension, says that while tailoring to the individual demographic of an employer could be difficult, multi-employer schemes can tailor their investment strategies to their membership and still benefit from scale.
“This may or may not include the use of triggers to put people on certain glidepaths depending on their characteristics,” Philp says. “A person with a very small pot who is a deferred member might default to a cash fund at a certain age.”
