Scheme-specific benchmarks can give employers and trustees a false sense of comfort whereas industrywide comparisons can build broader understanding of performance, said delegates at a recent Corporate Adviser debate on investment strategy.
At the debate, hosted by Baroness Ros Altmann at the House of Lords in the Palace of Westminster, consultants and providers gathered to discuss the findings of the Master Trust & GPP Default Report, published by Corporate Adviser Intelligence last month.
Speaking at the event, Willis Towers Watson director of retirement Roy Edie said that currently many trustees set their own investment objectives and benchmarks for a trust. If returns are in line with these, then there is no spur to take any further action.
But he said this can give a “false sense of security”. As the Corporate Adviser research highlights there is a considerable gulf between the best- and worst-performing default funds – a difference of 7.3 per cent a year, compounding to 56 per cent over 5 years. Over a lifetime even differences of a fraction of that level will lead to a significant impact on retirement incomes.
Benchmarks
Edie said: “A trust may be beating its own narrowly set benchmark, but this could still be significantly underperforming the market as a whole.”
Barnett Waddingham head of workplace wealth Mark Futcher said the publicly- available industrywide data provided in the report should enable trustees and members of independent governance committees (IGCs) to ask fundamental questions about whether their investment objectives are correct, and whether the design of the default fund and its investment strategy — both at accumulation and decumulation stages — is delivering optimum outcomes for members, in terms of both risk and return.
Aon head of DC investment James Monk agreed and said it was important to focus on the efficiency of the return, relatively to the risk taken.
The data contained in the report, now in its second iteration, is an important industry benchmark said Baroness Altmann, campaigner and former pensions minister.
Altmann pointed out that regulators are not compiling this critical performance and investment data, which she describes as “tremendously informative”.
“The information contained in this report should help providers and trustees make better decisions, making markets work better and ultimately improving outcomes for members.
“We need people to have confidence and trust in workplace pensions. Auto- enrolment has been a success with opt-out rates remaining low. But this mustn’t be taken for granted.”
If employees are to have a more positive attitude to workplace pensions it is important to challenge the industry to come up with the best ways to manage their money over the longer term, she said. Being transparent about investment strategy, proposition design and performance are a vital part of this.
The delegates attending the roundtable debate agreed that transparency was increasingly important, particularly with the master trust sector growing at such a rapid rate.
Performance transparency
Consultants said such data gave them valuable oversight across the industry — including master trust and GPP propositions. While both providers and delegates agreed it provided useful benchmarking for trustees.
One issue the subject of vigorous debate was the asset mix of default funds during the growth phase, highlighted in the report through the data for members who are 30-years from State Pension Age.
As the report showed, there is considerable variation here, with some of the table-topping defaults taking a “full-fat growth” approach via 100 per cent allocation to equities and other growth assets.
Others took a more diversified approach, investing in bonds and cash, property, or — in a very few cases — alternative assets such as infrastructure and private equity.
There was disagreement among delegates as to whether it made sense to prioritise all-out growth, or aim to reduce volatility.
Royal London head of multi asset Trevor Greetham said the ability to add bonds to the asset mix gave investment managers more flexibility to invest tactically as underlying conditions change.
“Growth at this stage is obviously of critical importance but it’s also important to discourage members through unnecessary levels of volatility.
“We invest in a range of growth assets, including commercial property and high yield bonds. This helps us achieve acceptable levels of growth while targeting a lower level of volatility than a 100 per cent equity-led fund.”
He said this flexibility comes into its own during downturns, recessions and bear markets.
“These may be infrequent events. But when they occur that can be very bad. It’s important to retain the tactical ability to smooth returns, and retain investors’ confidence.”
The volatility question
Other pension providers agreed that higher levels of volatility can be problematic when it comes to default design and investment strategy.
Aegon investment director Nick Dixon said: “Over a 30-year time frame this money will be invested through different market cycles. Being fully exposed to equities during a market crash can have a significant impact on consumer confidence, and a direct impact on contributions.”
Nest director of investment development and delivery Paul Todd also challenged whether the sweeping statistical conclusions that can be drawn from data from reports like the Barclays Equity Gilt study — which shows consistent outperformance of equities over other asset classes over very long time periods — should be the only criteria used in setting a default investment strategy regarding asset mix.
He explained: “One of the key things we are trying to do with Nest is reduce the dispersion of outcomes we see. If you have two people putting in the same contribution levels but over different times periods this can result in significantly different outcomes, due to the underlying investment climate.
“Saying default funds should have 100 per cent equity exposure as this produces the best long term returns is nonsense, as it won’t produce the best outcomes for many members. A more diverse asset mix can address this issue.”
However, some consultants present did question whether higher volatility levels would lead to greater opt outs, particularly among AE members.
Howden Employee Benefits head of benefits strategy Steve Herbert said: “This isn’t going to happen. I don’t think we would see significant opt outs, or people looking to change investments due to poor returns or increased volatility. There is just not that level of engagement with pension returns.”
However he said this puts the onus on consultants, providers, and trustees to ensure that the investment mix is right.
“AE and pension freedoms are relatively new. There are still a number of unknown quantities so it is important to monitor this kind of data, and see what proves to deliver the best solutions for members.”
As Herbert, and many others attending the event pointed out, the launch of auto-enrolment has coincided with years of buoyant equity growth. This has favoured default funds which have prioritised growth via 100 per cent equity portfolios.
Different markets
Buck head of DC and wealth Mark Pemberthy said that after a period of more difficult returns it’s likely these results would be flipped around, with more cautiously managed defaults coming out on top.
The question for consultants — and the industry – is what is the right mix of assets to deliver over varying cycles.
Pemberthy said when looking at different propositions, one of the main differentials is how sophisticated the approach is: does it use a wider asset mix than just equities and bonds, for example, and how dynamically is this managed?
He said: “There’s a whole host of growth assets that can give this diversification without resorting to bonds or cash. Our view is though that growth has to be a priority.
“It goes back to the question of what is the most appropriate investment strategy. If you look at the wider picture then most of these schemes are ‘underfunded’ , when it comes to delivering an adequate retirement income for their members.
“If they are on track to deliver this, then yes, there is a strong argument for starting to prize volatility over growth and absolute returns. But for members in most DC schemes our view is that growth should be prioritised, particularly in the early years.”
Given this, he said, you would need to question why a significant proportion of a fund may be invested in ‘sub-optimal’ assets, such as bonds during the growth phase.
Behavioural risk
Todd said that while he welcomed the increased transparency on asset mix and investment performance delivered by the Corporate Adviser Master Trust & GPP Default Report, the data from which is hosted at www.capa-data.com, it raised one potential drawback.
“There is the danger that everyone will start to hug the benchmark, and providers, asset managers or trustees hold back from making bold decisions that could significantly improve member outcomes.” He says there is some evidence of this happening in Australia. “Trustees need to be focused on what is right for members, not spending too much time sticking to a benchmark,” he said.
Altmann agreed that this might be a concern, but transparency was important to shine a light on schemes, and pointed out that there are a number at present that are not currently delivering for members.
“This can be an early warning for action – for trustees, and for regulators,” she concluded.
