DC investments have come a long way

In the world of DC, the risk sits with the member but the vast majority of people do not understand investments at even a basic level. As a result they fail to make decisions, do not value choice and usually end up in the default fund and remain there.

The Holy Grail is to design funds or blend funds that will provide a real return over some reasonable measure, such as the consumer price index, while providing protection against losses

Alan Morahan, Punter Southall

Looking at the development of default funds over the course of the past 30 years or so, we have largely had a one-size-fits-all approach with imperfect solutions and varied success.

In the 1980s this was invariably a with-profits fund, and when this approach was found wanting, we moved to balanced managed funds, which then came with lifestyling. In the noughties we moved to passive equity, often 100 per cent UK or global equity, again with lifestyling.

The economic crash of 2008-2009 demonstrated what a blunt instrument lifestyling could be, and more recently we have seen the move to multi-asset and diversified growth funds.

For members, managing the downside risk seems to be valued more than shoot-the-lights-out performance. Behavioural science has shown the satisfaction that investors experience levels off pretty quickly when funds are in positive territory, but when funds are losing money the disappointment level increases exponentially.

So the Holy Grail is to design funds or blend funds that will provide a real return over some reasonable measure, such as the consumer price index, while providing protection against losses.

We also need to be aware of what is happening towards the end of the investment journey.

Freedom and choice

Ever since the concept of lifestyling was first introduced, the working assumption has been that members will take 25 per cent of the fund as their tax-free cash lump sum, with the balance used to purchase an annuity.

However, since April 2015, these assumptions may not be appropriate as there is wider choice as to what we do with a fund at retirement.

It is still early days for the pension freedoms, but the signs are that the number of people purchasing an annuity is greatly reduced, and the vast majority of people are taking their pots as cash, although that is usually where they have quite small values.

Others are removing part as cash and leaving the balance invested to draw it down, either on a regular basis through a drawdown plan or on an irregular basis, as and when needed, directly from the fund.

Clearly the fact that funds are staying invested for much longer creates a fantastic opportunity for the asset management industry, particularly if it can come up with solutions that will pay regular streams of income while providing some protection to the capital. 

Alan Morahan is a principal at consultancy Punter Southall