Talking Head: Defined contribution schemes could pool assets and risk to improve returns, says the Society of Pension Professionals' Duncan Buchanan.
Historically, trustees operating DC arrangements have provided members with a range of investment fund options in which they could put their allocated pots of savings.
Is such an approach in the interests of members, particularly for larger DC occupational pension schemes, some of which now have more than £100m in assets (and growing)? Is it not time trustees considered adopting a new approach to investing assets in the interests of their members?
Over five years an average large DB fund would turn £1,000 into more than £1,500 – which is £340 better than a low-performing DC default fund might produce
I am reminded of the award-winning Smash Martians instant potato television adverts of the 1970s, in which a group of aliens came to earth and laughed at us humans for spending time peeling and boiling potatoes.
Might the same Smash Martians coming to the UK in 2016 laugh at DC pension trustees and say something like: “First they divide their fund into tiny little pots, then they boil them in a passive equity fund for thirty years!”
Comparing DB and DC returns
Trustees of DB schemes have similar legal duties to act in their members' interests, yet invest assets in a completely different way.
Instead of earmarking assets to a particular member, a DB fund is operated on a pooled basis and invested among a wide range of asset classes. This allows for more diversification of risk and produces a greater level of investment return.
Figures from Barnett Waddingham show that over the last five years larger DB schemes have achieved an investment return of about 9.5 per cent a year.
Figures on the average returns for DC plans are not as easy to come by. One report suggested that the return on some default funds could be as low as 3.5 per cent annually over the last three years.
Albert Einstein appreciated the power of compound interest, which he compared to the eighth wonder of the world.
To put that into context, over five years an average large DB fund would turn £1,000 into more than £1,500 – which is £340 better than a low-performing DC default fund might produce.
Shared pain, shared gain: Will risk-sharing get its day in the sun?
Collective DC schemes have been put on ice by the pensions minister, though the idea could return to the agenda in the future. But are UK employers ready for risk-sharing?
Of course, there would be administration challenges in substantially changing the way DC plans invest on behalf of their members.
But there is no legal reason why it could not be done, and the complexity is unlikely to be greater than that involved in implementing a liability-driven investment strategy for a large DB scheme.
Surely we owe it to DC members to take up the challenge.
If we stay as we are, DC member outcomes could be significantly lower, and we run the risk that industry standard default funds are reliant on FTSE tracker funds, inflating equity values and creating a monster Ponzi scheme.
Then again I am just a lawyer, so what do I know?
Duncan Buchanan is president of the Society of Pension Professionals and partner at law firm Hogan Lovells
