TDFs and lifestyle funds: What is the difference, and why?

On average, more than 85 per cent of UK defined contribution members are in these default strategies, according to the Pensions Policy Institute's latest ‘Future Book’.

Trustees must navigate a difficult and increasingly complex set of challenges to find solutions that work for a wide range of members.

A significant portion of respondents said ‘something else entirely’ might revolutionise the DC default fund space

One of those challenges is how asset allocation, and in particular the balance between risk and return, should change over time as a member progresses towards retirement.

It seems fairly intuitive that allocations should change to reflect the member’s changing circumstances or prevailing market conditions. Yet, as many DC members do not make active investment decisions, that responsibility often falls to the trustees.

Two of the most relevant approaches UK DC schemes have taken to manage this problem are lifestyling and target date funds.

The pros and cons of both lifestyling and target date funds are well documented; however, it is important for trustees to understand the key features and drawbacks of each approach.

The ‘best’ approach will often depend on scheme-specific circumstances. We recently asked attendees at a DC event, who represent approximately 75 per cent of the UK DC market, which approach they thought would dominate in the next three to five years: lifestyle, TDF or something else entirely?

Interestingly, there was no clear winner, and a significant portion of respondents said ‘something else entirely’ might revolutionise this space, suggesting that perhaps there is yet more innovation to come in this area.

That could very well be a hybrid approach that combines the customisation and broader outcome focus of lifestyling with the dynamism and relative simplicity of TDFs. Trustees would be well advised to watch this space.

James Lindsay is director, consultant relations UK & Ireland, at MFS Investment Management