The investing approach of UK defined contribution (DC) schemes needs to be reviewed and refined due to changing member needs and market conditions, according to Aon.
According to Aon’s 2022 UK DC Survey, schemes must now shift their attention from tracking investment performance against market indices to focusing on savers’ retirement outcomes.
Only 30 per cent of 109 UK DC schemes with more than half a million members and £35bn in assets frequently evaluate individual fund performance as perceived by members, compared to 90 per cent of schemes that monitor performance against market indices/benchmarks, according to the poll. Even fewer schemes, almost 15 per cent, track performance against specific goals aimed at providing a positive outcome for members.
Aon head of DC investment advisory Chris Inman says: “While the concept of a good outcome is generally recognised across the pension industry, no clear definition of it currently exists, and which can therefore be incorporated into investment strategies. With the diverse nature of DC scheme members only increasing, greater clarity is needed to aid in targeting a sustainable level of retirement savings.
“Setting specific targets for the aggregate default investment option allows schemes to see the bigger picture and understand whether their default investment is delivering a good outcome for members. This will be increasingly important amid the uncertainty in today’s investment markets.”
Inman adds: “We see this as an opportunity for schemes to enhance and improve how they manage the savings of DC members as well as how they monitor performance. DC investment strategies are more effective when driven by target member outcomes, rather than de-risked along a pre-established path regardless of progress toward a target or investment market movements – as is the case with the typical lifestyle approach of automatic switching.”
According to the survey, four out of ten projects or 42 per cent now analyse all of their investment alternatives against environmental, social, and governance (ESG) criteria, compared to one out of ten two years ago. While responsible investment is gaining popularity among investors, the findings reveal that there is still a wide range of approaches to ESG among schemes.
Aon Dc solutions chief investment officer Jo Sharples says: “Over the past few years, schemes have spent more and more time on ESG. We are seeing real progress here, with 56 per cent offering one or more ESG options within the wider fund range. That said, we know most members use the default option for a variety of reasons, ranging from apathy to not wanting to have the responsibility of making investment decisions.
“We think this should be a real focus area for schemes to make better decisions. Unless ESG considerations are incorporated into default strategies – and currently just 15 per cent of schemes do this – they will not reach the majority of members. Furthermore, as public opinion on responsible investing becomes more high profile, and greater reporting is required from schemes, some may face difficult questions on management of ESG risk.”
While low inflation has prevailed for much of the last two decades, this is changing and will become more of a concern in the future.
Sharples says: “From an investment perspective, trustees and scheme sponsors will need to navigate this new volatility and evaluate the impact of higher inflation on their default strategy. They will then have to consider whether changes are needed in order to manage this risk for members.
“Over the long term, we see equities providing good protection for younger members. On the other hand, for those closer to retirement, default strategies typically include more defensive fixed-income assets, which are more sensitive to rising inflation. When combined with increased governance, more focus on ESG considerations and an uncertain market outlook, all of this means more work for trustees and scheme sponsors.
Sharples adds: “We suggest trustees and scheme sponsors go back to the basics in order to form a solid foundation of what they are trying to achieve for their members. They need to consider their principles and beliefs, and the objectives against which they will assess their success. This should allow them to reaffirm conviction in the current strategy and governance approach or highlight areas for change.”