Defined contribution pension schemes could improve employee returns while reducing risk by incorporating alternative assets into default funds, according to the Pensions Policy Institute (PPI).
The report, sponsored by the Association of Investment Companies and titled ‘Could DC pension default investment strategies better meet the needs of members?,’ looks at how far DC default investment strategies can be redesigned to better meet the needs of specific groups of scheme members.
It found that pension savers with specific characteristics may benefit from the inclusion of alternatives, which could result in higher returns, lower volatility, or a combination of the two. People who work for longer and earn more, those with irregular work and contribution patterns, those who stop contributing at younger ages, and those without supplementary savings could all benefit.
Association of Investment Companies public affairs director Guy Rainbird says: “This research from the Pensions Policy Institute should reassure pension trustees that alternative assets can offer benefits to a wide range of savers, including those on lower incomes or who stop contributing early.
“It’s particularly helpful that the report modelled the impact of adding a range of assets to the mix, such as private equity, direct lending, infrastructure and property. All of these have different risk/return characteristics and different degrees of correlation with equities and bonds. All can offer benefits when building a portfolio for beneficiaries and there is no ‘one size fits all’.
“How default funds should access these assets is a key question. Investment companies are tried and tested vehicles for investing in illiquid assets. They have a closed-ended structure that protects funds against fire sales and suspensions while offering liquidity through their listing on the stock market. They have a track record that in some cases extends back beyond the global financial crisis. This does not apply to other proposed solutions for allowing pension funds to access alternatives, such as the Long-Term Asset Fund (LTAF), which would rely on notice periods to resolve liquidity mismatches and could run into problems if those notice periods prove too short.
“The fact that investment company shares are traded on public markets provides the ability to adjust a scheme’s exposure, perhaps because of a change in strategy or in response to operational needs. These qualities could make investment companies particularly worth considering for smaller funds or those wanting to test the water and build their interests over time.”
PPI head of policy research Daniela Silcock says: “DC pension default investment strategies play a vital role in protecting members from high charging or overly risky funds. They also provide a safety net for members who cannot or do not want to make active investment decisions. However, changes could be made so that default strategies meet the needs of a wider variety of members through data gathering and tailoring strategies.
“Increased investment in illiquids and alternatives could increase the opportunity for returns while reducing volatility, though there may be extra costs for members associated with this course. Schemes looking to improve their strategies should explore the degree to which these options could help to better meet their members’ needs.”
