Defined contribution schemes should pay more attention to the retirement objectives of their members rather than the market benchmark when assessing the effectiveness of their default strategy, according to a report.
Commonly, schemes assessing achieved returns consider whether the funds are positive or negative in absolute terms and whether the fund is ahead of the benchmark.
If you take advice and the advice suggests making changes, you need to be able to make those changes
However the report by Towers Watson states: “A more important question when considering an objective-based analysis is whether the returns are better or worse than the assumptions used when setting the objective. If meeting the objective requires a 6 per cent rate of return, a 5 per cent return is an adverse outcome even if it is better than the market benchmark.”
Schemes should think about the objectives of their members, including the age at which they would like to retire and the return they expect.
Alistair Sutherland, director at professional services Deloitte, said too often schemes take a mechanistic approach to setting and monitoring their default strategy.
“The trouble with that is that it doesn’t link back to why you have the assets in the first place,” he said.
Often, schemes will move away from allocating assets to equities to protect returns once members come within seven years of retirement, he said.
However this means account is not taken of whether, say, equities have fallen and alternatives have risen, therefore a scheme would be automatically selling at a deflated price and buying at an increased price, he added.
Pragmatic approach
Schemes should take a more pragmatic approach when assessing the effectiveness of their default investment strategy.
This is something that modern defined contribution schemes are beginning to do as part of their governance procedures, according to Gurmukh Hayre, head of DC pensions at KPMG.
Hayre said schemes should consider three factors when monitoring their default strategy:
Whether the fund matches the risk profile of its members;
Member behaviour, eg when members would like to retire;
How the market is developing
If progress towards the objective has been poor and the chances of achieving it have been significantly reduced, the portfolio structure may need to be changed or members may need to consider revising contributions to meet targets, the report states.
Making changes en masse to the default strategy has been historically difficult for DC contract-based schemes.
While ultimate responsibility still rests with the provider to change the default strategy, more contract-based schemes are installing governance committees. The impact this has depends on how comfortable the provider is with taking requests from the employer or governance committee.
“It’s about having governance with teeth. If you take advice and the advice suggests making changes, you need to be able to make those changes,” said Hayre.
