The number of FTSE 100 trust-based defined contribution schemes using lower-cost, fully passive management for their default options has dropped by almost a half as diversified growth funds become more popular, research has found.
But experts have said the 0.75 per cent charge cap, which will come into effect next year for auto-enrolment schemes, may stifle the use of more expensive actively managed strategies.
Active strategies will be for those who self-select
Laith Khalaf, Hargreaves Lansdown
The research from consultancy Towers Watson found the use of passively managed defaults among the schemes has decreased to 35 per cent in 2014, from 62 per cent the previous year.
“I would be personally very surprised if the main rationale wasn’t [the use of] diversified growth funds,” said Andy Cheseldine, partner at consultancy LCP.
He added most such schemes are moving towards having a mix of active and passive management for their default funds, usually with a split between global equities and DGFs.
This was confirmed in the research, where 42 per cent of the same schemes reported using a mix of passive and active management for their default funds, up from 26 per cent in 2013.
“In our experience, this typically includes the use of an actively managed diversified growth fund as part of the default,” the report stated.
The number of schemes offering DGFs has increased to seven in 10, from one in 10 in 2009.
This was due to the fall in the value of equity-based default funds in 2008 and the perceived need to manage volatility, said Ryan Taylor, senior DC investment consultant at Aon Hewitt. DGFs are also more readily available to schemes, he added.
However, he said: “They are harder to get to the bottom of where they invest and how much their returns are.”
Greater diversification into alternative assets may also have contributed to the increased use of active management by these schemes, said Laith Khalaf, head of corporate research at investment platform provider Hargreaves Lansdown.
“So rather than just having active and bonds, using things like, for instance, property, infrastructure, hedge funds and commodities,” he said.
Active management is also being increasingly used in the pre-retirement phase – for example, strategies that protect against movements in annuity rates rather than simply moving into passive government bond funds.
“As part of your default you may have some passive funds in there but there are two key phases where you are using active management,” said Taylor.
However the 0.75 per cent charge cap on funds under management within the defaults of qualifying schemes from April 2015, may reduce the use of active management by DC schemes, experts have said.
The report stated: “While most schemes could retain their existing use of diversified growth funds if charges were capped at the levels proposed, a charge cap could impede significantly greater use of these funds.”
The charge cap will reverse the trend of increased active and mixed management by DC schemes, said Khalaf. “Active strategies will be for those who self-select,” he said.
The charge cap will make some schemes tweak their default funds rather than overhaul them completely, Cheseldine said.
“But I think there will be a number of schemes that use a mix of passive global equities, and DGFs that will move towards DGFs that have more passive elements,” he said.
