The Covid-19 pandemic has presented the defined contribution sector with its first big challenge since the full implementation of auto-enrolment.
The FTSE All-Share index lost 18 per cent in the calendar year to 27 May, according to FE Analytics, and other asset classes took heavy hits in March as lockdown measures swept across the global economy – although many major indices have recovered during April and May. By June 2, 2020 the MSCI World index was up over 12 months.
How this asset price volatility has affected DC savers has varied widely across the industry and between age cohorts – largely as a result of lifestyling strategies.
Lifestyle approaches
Premier head of employer services Sue Pemberton says: “Well- structured lifestyle approaches have managed to shelter members that are closer to retirement from the bulk of the market falls.
“Lifestyling really has helped those people who are approaching retirement, who at the end of the day are going to be the ones most concerned about this,” she says.
“If you’re on the cusp of retiring, then you’re really quite worried about how this downturn is going to affect your retirement plans. Looking at some of the changes in asset allocation as they approach retirement, these seem to have demonstrated that risks have been reduced and the drops have been much smaller.”
Younger members of pension schemes will likely have experienced higher levels of volatility than older members, if their DC lifestyling strategy is working properly.
Redington head of DC and financial wellbeing Lydia Fearn says her company has observed “good risk management generally for members” in lifestyling funds, even though they will still have experienced losses.
“Diversification has helped generally, and for those closer towards retirement in particular, strategies that have managed and reduced their equity allocation have fared better,” Fearn says. “While younger members in higher equity investments will have seen losses, they will also hopefully benefit from the volatility over the long term.” Data from the Corporate Adviser Pension Average study, published in May, showed that those with 30 years to state pension age lost on average just over 8 per cent in the 12 months to 31.3.20. For those with five years until state pension age, the average 12-month loss was less than 4 per cent.
River & Mercantile Solutions head of DC Niall Alexander says not all DC providers have implemented asset class diversification in this way. Some still use passive equities for the majority of portfolios even in the later stages of saving, which Alexander says could have cost members in recent weeks.
The end of ‘set and forget’?
Passive equity approaches have “failed” DC investors through the pandemic crisis, Alexander argues. Some global equity indices fell by more than 15 per cent in the first quarter of this year.
For this reason, Alexander believes a major lesson from the Covid-19 crisis for DC operators is the need for a dynamic investment strategy.
“Investment performance determines whether people retire rich or poor,” Alexander says. “‘Set and forget’ passive equity strategies have been shown to be unsuitable for all ages and not reliable in all market conditions. Just because younger members can afford to take more risk, doesn’t mean they have to suffer losses.”
Active management of passive allocations and rebalancing towards assets such as gilts or high-quality equities “could have protected from the worst of the losses”, he adds, while still allowing members to benefit from the recovery in stock and bond markets.
Alexander also argues that an active approach is achievable despite the constraints of the 75-basis-point fee cap for auto- enrolment DC funds.
Redington’s Fearn agrees that investment strategies should be adapted to “incorporate new thinking on a regular basis”.
“Risk management is important and when thinking about investment strategy we should consider what could happen over both the short and the longer term, and help members through their journey towards retirement,” she says.
However, Pemberton points out some providers have suspended their quarterly or monthly rebalancing programmes to avoid “compounding the issue and making the downside worse”. Others have postponed planned changes to asset allocations given the dramatic pricing movements.
For those investing in property funds, rebalancing is particularly an issue as several bricks-and- mortar products were suspended from trading temporarily to avoid fire sales of assets. Managers including Legal & General, Janus Henderson, Standard Life A b erd een a n d Co l um b ia Threadneedle have all gated their property funds.
ESG post-Covid
Fearn emphasises tha t implementing environmental, social and governance (ESG) investing principles within DC funds “continues to be important and should not be overlooked”.
The Pensions Regulator introduced new requirements last year specifying that all schemes had to have a policy regarding how they considered “financially material” ESG factors.
In a December 2019 report, campaign group ShareAction highlighted that seven of 16 master trusts had implemented an ESG or climate-related investment approach to at least some of their equity portfolio. Only the Atlas Master Trust had applied this approach to its entire equity portfolio, however.
The emphasis for most master trusts was on environmental issues, ShareAction’s reports showed. However, a recent survey of DC members conducted by the DC Investment Forum (DCIF) indicated that the social aspects of investment will play a bigger role in investors’ thinking following the pandemic.
Three quarters of the 1,000 DC savers polled by DCIF and research group Ignition House said they would consider boycotting brands or companies that “have not treated their employees well” during this period.
Hilary Inglis, chair of the DCIF, says: “We think that Covid-19 could accelerate an already growing momentum which is propelling the pensions industry towards responsible investment.
“As more and more people realise that their pension savings are invested in companies which power the world around us, pressure will grow to make sure their money invests in well run companies, which are more supportive of the environment and wider society.
“In turn, this will put pressure on pension scheme decision- makers like trustees, finance and HR directors to consider these issues when they choose their pension scheme.”
Post-pandemic priorities
C ommu ni c a t i on be t w e e n employers, scheme members, trustee boards and advisers is vital during a crisis to ensure that people do not make hasty decisions.
“I think it is sometimes taken for granted that default funds are there for people who don’t want to make decisions,” says Premier’s Pemberton. “But default does not equal ‘no risk’, and default does not mean no losses when the market falls.
“This sort of thing does focus the attention, so having the correct messages available to members, corporates and advisers is really important.”
Messaging should focus on the long-term nature of pension saving and the target outcomes of DC investment, advisers agree.
“Based on conversations we’re having, the industry is starting to realise that neither ‘set-and-forget’ investment strategies nor the race to the bottom on costs we’ve had in recent years have been in members’ best interests,” says River & Mercantile’s Alexander.
“Instead a focus on the end outcome for members is paramount to ensuring not just the presence of value for members, but that DC schemes are fundamentally fit for purpose.”
The recovery from the Covid- 19 crisis will likely be long and difficult. But with the right investment strategies and clear, up-to-date communication, DC providers can ensure that pension saving is one thing employers and members do not need to worry about.