Inconsistency in approaches taken to default defined contribution offerings among large contract-based providers could threaten member outcomes, according to a new report, as separate research confirmed the importance of investment returns later in the savings journey.
Aegon research released on Monday showed that while contributions drive the majority of pension value for a model saver during the first 30 years of accumulation, in the final 10 years the impact of investment returns dwarfed that of payments into the plan, accounting for a third of total pension value.
But disparate attitudes to risk and asset allocation in the contract-based provider universe, revealed by workplace savings business Punter Southall Aspire, mean it is likely that some default funds will let savers down in terms of returns.
What we want as trustees is for members to have faith in pensions as a savings vehicle
Dianne Day, Independent Trustee Services
Control your volatility
The level of sophistication employed in the default offering varies significantly from provider to provider.
Some products incorporate volatility targeting, actively managed components, alternative assets, tactical asset allocation, and more than 20 asset class buckets, while others feature none of these components, and allocate to as few as four asset class buckets.
The research showed that three-year absolute returns varied by almost 6 per cent, while absolute risk varied between 5.2 and 10.2 per cent. Scottish Widows took more risk that the MSCI World total return index, and underperformed it in return at around 10.5 per cent.
Steve Butler, chief executive at consultancy Punter Southall Aspire, urged employers to check their default strategy and assess whether it delivers value for money.
“That’s concerning that there’s a fund that’s designed in a way that it’s taking more and getting less returns than the MSCI,” he said, noting that these default offerings are marketed as multi-asset products designed to limit volatility.
Scottish Widows said the unusual results were a function of its exposure to both equities and bonds during a time when equities have generated returns in unusually stable markets.
The default offerings that have delivered the best performance during the last one and three years have generally been those with the highest equity exposure. But Butler cautioned against copying these allocations, arguing that those strategies had not yet been tested in volatile markets.
Low equity allocations carry similar risks, Butler said, and investors should aim for between 60 and 65 per cent equity exposure.
“Those with default funds with a smaller amount of equities are questioning whether it’s the right fund for them,” he said.
Derisking journeys could be too long
Providers also held very different views about the appropriate time to begin the derisking phase of a default saver journey.
Friends Life, Scottish Widows and Royal London are beginning the derisking phase up to 15 years from retirement, while Aegon’s growth phase lasts until up to six years from retirement.
Nick Dixon, investment director at Aegon, said shorter glide paths are justified by the firm’s findings on the importance of investment returns later in the savings cycle to final pension value.
“It shouldn’t be too long. If you derisk too early then you’re going to miss out on that growth,” he said, adding that the increasing trend for drawdown use among members meant the end allocation should still involve some equity exposure.
Butler said that while funds with a very high equity allocations would need a longer glide path to decrease their risk, the prospect of 15-year derisking stages was “a bit terrifying”, given that many members will default to a retirement age of 67.
Butler said appropriate derisking lengths should be matched to the average length of a market cycle to give funds time to recover.
Friends Life and Royal London argued that their glide paths only gradually reduced the members' exposure to equities, and that this longer derisking phase would narrow the range of outcomes for members, meaning they have good protection in poor market conditions.
Lorna Blyth, investment strategy manager at Royal London, said: "Gradual derisking of the default fund begins 15 years from retirement in order to deliver a smoother journey to members over the later years of their plan... At any time a member is able to change the investment strategy, particularly if their retirement plans should change.”
Trust-based DC schemes will face similar dilemmas to their contract-based peers when deciding on the appropriate risk strategy for their default.
Dianne Day, a client director at Independent Trustee Services, said that while schemes could follow the broad principle that members with longer horizons can tolerate more risk, they should be aware of the behavioural influences of market shocks and seek to control volatility.
“What we want as trustees is for members to have faith in pensions as a savings vehicle,” she said.
