From the blog: The week of August 24 was a particularly interesting one, with global equity markets experiencing their most significant fall since 2011.
And while the size of the impact on defined contribution schemes and their members will of course be very specific to the arrangements in the scheme, the market turbulence brings into sharp focus the risks inherent with equity holdings – a key component of all default arrangements.
And while the size of the impact on defined contribution schemes and their members will of course be very specific to the arrangements in the scheme, the market turbulence brings into sharp focus the risks inherent with equity holdings – a key component of all default arrangements.
What caused the market falls?
It has been widely commented that the cause of the market falls was perceived to be growing concerns about Chinese growth.
The pressures for a correction had indeed been building for some time, reflecting a number of interrelated developments such as the continued slowdown in emerging markets and, of course, the uncertainties associated with the widely anticipated official interest rate increase by the US Federal Reserve.
What does this mean for DC schemes?
From a strategic perspective, the unexpected push to new lows in global yields, the plunge in oil and other commodity prices, the surge in the US dollar, and the poor performance of emerging markets over the past year, highlight that we are still in a very uncertain economic and market environment.
Interest rates and yields are likely to remain lower than previously anticipated and returns on growth assets will struggle to match historical long-term average returns.
Longer-term returns from ‘market beta’ are to remain modest.
Step forward diversification
With the recent market turmoil, trustees and governance committees should include an investment strategy review in their business plan that specifically focuses on reviewing the quality of the scheme’s diversification in their default arrangements, in particular equity funds.
Of course, equity holdings will continue to make up a significant proportion of default arrangements. However, in a more uncertain return future, diversification in equities and across asset classes is likely to have greater and greater value.
Schemes should understand overall portfolio biases and stress-test the quality of diversified allocations at each stage of the member savings lifecycle.
By doing this, schemes will improve the efficiency of returns for members, increasing the value-for-money aspects of the default arrangements and the investment range.
Stephen Budge is principal in Mercer's DC and savings team
