DC investment design: How to ensure good member outcomes

To enable good financial outcomes for their scheme members, it is crucial that trustees focus on the investment strategy of these funds.

Perhaps in time, as DC matures and scale is achieved through a consolidated range of providers, we will see more sophisticated investment propositions in DC pension provision

While the adequate level of retirement provision will largely be determined by the level of member contributions, the next greatest determinant is the return generated by the default investment approach and taking the appropriate level of risk.

Good outcomes dependent on good governance

Ongoing changes in pensions have seemingly become the norm as a torrent of regulatory changes to governance, administration and legislation has focused trustees’ attention in recent years.

Whether it relates to the charge cap, freedom and choice, transaction costs, the DC code, chair’s statements or a plethora of other duties, trustees have been required to oversee the implementation of a vast array of policies. Set against a backdrop of auto-enrolment that has seen millions of workers save towards retirement for the very first time, trustees are often the first line of defence when it comes to members’ benefits.

The fiduciary role is demanding and given low levels of member engagement and inadequate average contribution rates, achieving good member outcomes is dependent upon a well-governed default fund that is designed to achieve maximum value for the member, as opposed a low-cost solution.

KPMG surveyed “off-the-shelf” default strategies of 15 leading DC providers and found a variance of 40 per cent in terms of the level of pension income a 25-year-old today could receive at retirement.

At present, low-cost and off-the-shelf solutions are prevalent for a generation of workers who remain largely disengaged. Barriers to more sophisticated investments relate to the charge cap (or low-cost propositions) and a perceived requirement for daily liquidity, yet it is these types of strategies that can deliver the best outcomes.

The underlying conditions that have facilitated strong, multi-year returns from equities and bonds have served a typical investment approach or lifestyle strategy well since the start of auto enrolment. However, will these conditions hold?

An impactful market drawdown is not unthinkable and heavy exposure to stock markets requires a high tolerance to volatility. As the most junior and riskiest part of a firm’s capital structure, equities have high levels of uncertainty attached to them. Trustees should question whether their members can endure equity price volatility and assess the holding periods that have historically been associated with markets recouping losses.

Set realistic objectives

A well-governed, diversified and dynamically managed approach represents a means to achieve decent returns over the long term with significantly reduced volatility. Active asset allocation within a diversified growth fund, which may aim to achieve a target such as ‘inflation plus 4 per cent’ or ‘cash plus x’ will help achieve a smoother member journey to retirement and a more meaningful long-term performance objective.

As evidenced by the Pension Policy Institute’s research, The Future Book 2017: Unravelling Workplace Pensions, solidlyperforming diversified funds are least likely to deliver very low returns.

Of course, one size does not fit all. The DC journey needs to account for member choices at retirement.

This will vary across and within workforces and default funds must now account for the likely intentions of their members. While most schemes have adapted their decumulation strategies, this should not be a ‘set and forget’ approach. As members become more dependent on DC savings in the future, the way retirees access their pension pot will evolve and trustees will need to adapt investment objectives accordingly.

Furthermore, low earners may have different requirements and attitudes towards risk than higher earners, so a single investment strategy might not be suitable for everyone. Setting realistic performance objectives within a suitable risk framework enables regular assessment against these goals.

Investment is a critical part of DC, particularly during the accumulation stage, but also to and through retirement. Trustees play a key role ensuring their scheme’s default fund maximises members’ ability to achieve a good (and expected) outcome in retirement.

It is not an easy task, but perhaps in time, as DC matures and scale is achieved through a consolidated range of providers, we will see more sophisticated investment propositions in DC pension provision.

Andrew Brown is institutional business group director at Columbia Threadneedle Investments