The industry faces serious and difficult questions about the design of default glidepaths towards retirement, which have failed to protect savers or shelter them from volatility in current market conditions.
Speaking at the Corporate Adviser summit, Redington’s head of DC and financial wellbeing Jonathan Parker said that schemes faced difficult questions in the coming weeks and months regarding asset allocation, with most schemes relying heavily on fixed income for members at the cusp of retirement. The members will be in for a shock with the current difficult economic conditions particularly hitting returns on bond and gilt markets.
Parker says this may prompt questions about future scheme design but he cautioned against any sudden changes to asset allocation in the current febrile conditions, which risked crystallising losses by selling assets at the bottom of the market.
Parker said that those making decisions on asset allocation for DC schemes faced the challenge of low economic growth, higher inflation, rising interest rates and a weakening pound.
He said: “To be facing all four of these challenges at the same time is virtually unprecedented and certainly not something I have not seen in my lifetime. In terms of asset allocation this is a scenario that not a lot of people have thought through.”
Looking at historical data, he said there are relatively few asset classes that have outperformed in an economic scenario of falling growth but higher inflation. Those that have done relatively well in such situations include index-linked investment and commodities, both of which are fairly under-represented in DC funds. He pointed out that looking across equity and bonds both momentum and trend investment strategies have also performed slighted better in these conditions.
When it comes to younger savers at the accumulation stage Parker said that the lessons of history suggest that it may be best to do nothing. Those at the start of their savings journey are less impacted by asset allocation decisions. However these is a much more marked difference for older savers who have accumulated more money in their pensions.
Parker said that advisers and pension providers also need to ensure that effective communication is provided to those taking benefits via drawdown on the impact of volatile markets. He gave the example of two savers, both of whom have a £100,000 pension fund and are taking £1,000 income a month. Both see average returns of 6 per cent per annum over a 10 year period. However he says the sequence of good and bad years of investment returns is critical. The saver who has good returns initially, followed by some poor years towards the end of the 10-year period can still have a fund of £100,000 at the end of their first decade of retirement. This is not the case for savers who have several years of negative returns at the outset. In some cases these savers could be sitting on a fund of just over £50,000 after 10 years – even though the average returns are the same over this period.
Parker says: “There is a generation of people who have benefited from freedom of choice and are using drawdown as a vehicle in retirement who may be unaware of the potential ramifications this sequence risk when it comes to the ups and down of the market.”
However Parker said that while there was considerable economic gloom at present there were one or two areas of potential upside. He said he was expecting considerable innovation in the annuity market which was looking a lot more attractive with rising interest rates.
He added that there was also potential for DC schemes to consider wider diversification – with a number of providers, including Nest, Mercer, Cushon and LGIM already making moves into this areas in a bid to hedge against global inflation.
Questions about future asset allocation remain difficult, particularly for savers at or in retirement, but he cautioned against knee jerk reaction to difficult markets.