After contribution levels, investment performance is arguably the biggest determinant of outcomes in retirement for today’s DC savers. That performance will to a large extent be determined by the asset allocation decisions made on behalf of savers by the board of trustees or the Independent Governance Committee of the scheme.
Reflecting on the wide range of asset allocation approaches revealed by Corporate Adviser’s Master Trust Defaults Report, opinions of delegates at the event were divided as to which approach was best, with equity exposure one of the most hotly contested topics of debate. The Report showed that equity exposure for members in the growth phase of saving ranged from 38 per cent for the LGIM WorkSave Pension Mastertrust’s default, to 100 per cent in SuperTrust UK’s default, although advisers were quick to point out that the LGIM default has other diversifying assets with equity-like growth potential.
Aon Risk Solutions head of DC investment James Monk said: “The L&G default fund has a low exposure to equities, but it actually targets two-thirds equity risk so it is broadly similar to a two-thirds equity default. We have done analysis around the efficiency of returns based around the return for units of risk and on that basis the LGIM Multi Asset Fund is looking very competitive.”
SuperTrust UK’s aggressive approach had, not surprisingly in a rising market, delivered the highest 5-year annualised returns in the sector, an annualised 12 per cent in the five years to 31.3.18, compared to the Corporate Adviser Pensions Average (CAPA) Index mean of 8.5 per cent. Standard Life’s default returns were sub-7 per cent. Now: Pensions’ five-year figures are unreliable as an indicator of manager skill, but their three-year figures showed a mere 2.4 per cent annualised return, barely beating inflation, provoking strong debate amongst delegates.
Baroness Altmann said: “What the report highlights is that it is really important to look at these numbers and try to understand what is driving the performance, because ultimately that is what was is going to make a difference in the long term.
“I remember in the early days of the 1980s with defined benefit when you had performance management driving fund managers not necessarily in the best direction, because there was no real measure of risk control. Back then it was all about return. We have to look not just at bald return numbers, but asset allocation, diversification of assets and risk controls.”
How much is too much equities?
Performance is not of itself necessarily an indication of a well-designed default fund. The 100 per cent equity fund would have looked very different if markets had performed badly. But the spread of outcomes provoked a debate as to whether SuperTrust UK had or had not made the right call when it comes to investors with a long, long way to go to retirement.
Several consultants at the debate argued they had. Willis Towers Watson senior investment consultant Chris Smith said: “My son is 25 and he’s just been enrolled into the LGIM WorkSave Pension Mastertrust at work. I suggested it to him that he should go into something with a higher equity content, which he has done. I wanted him to have quite a high equity exposure and I didn’t want him paying away money on currency hedging, because he has got a long way to go. So we ended up going for the Future World fund. He has got a 50 to 60 year window and ESG factors could have an impact over that time.”
Hymans Robertson head of DC design and provider evaluation Jesal Mistry said: “The pound-cost averaging makes such a contribution to the smoothing of the return that they could be invested in something that is hugely volatile, and they wouldn’t necessarily know about it. Later on, when funds start to get bigger, things are different.”
Mercer solutions leader, DC & individual wealth Philip Parkinson said: “The volatility people experience 30 years out is actually not important and you could in fac take a higher volatility position but reduce the risk of not providing the income in retirement.
Do young savers need stability?
This aggressive attitude is at odds with some industry views that members cannot handle volatility. “Some of that is driven by policy,” said Chase de Vere principal consultant, online and flex Sean McSweeney, who added that this caution is unnecessary as in reality members rarely even notice contribution increases, let alone fluctuations in fund value.
“We work with a lot of payroll providers who provide automatic enrolment solutions for micro businesses. Several had hardwired the statutory contribution increases from 1 to 3 per cent into their systems. Not one single employer or employee noticed when the increases took place. I wonder whether we are being too sensitive to the idea that the great unwashed will opt out at the first negative experience,” said McSweeney.
JP Morgan Asset Management executive director, UK DC Annabel Tonry said: “Most people don’t even understand that they are invested in markets. The Quiet Room did some research for the DCIF that spoke to different members, and asked where their money was, and they said ‘in Switzerland’. Why? ‘Because we got a letter from Zurich’. And where in Zurich is the money? ‘In a vault’, came the answer. There is a huge disconnect between the disproportionate concern over what the member is actually going to do if they see volatility in their asset allocation.”
JLT Employee Benefits head of DC investment consulting Maria Nazarova- Doyle asked former pensions minister Baroness Altmann: “Why is there only a requirement to disclose costs, and not to also disclose performance? Because that is far more important than cost. Will the government do anything about this?”
Altmann said: “The reason was the resistance from providers. It was an extraordinary difficult task to get disclosure of charges, and we still don’t have full disclosure of charges. All the providers are set up to resist disclosure. Which is why I think what Corporate Adviser has done is so useful and, because up till now nobody has dared to look at relative performance. Corporate Adviser has presented these numbers and that has started the conversation and will make people think a bit more about the performance of these schemes.
“Corporate Adviser has been in a relatively privileged position to get this information. Life offices have to get this information anyway, but master trusts do not and as Corporate Adviser is the media, to refuse would have been more difficult. They often refuse the Regulator more willingly than they would refuse the media.
“I have always believed that we have to have transparency in pensions. What gets measured gets managed. There has been no real pressure to have a particular performance level for defaults because there hasn’t been that much scrutiny.”
The pros and cons of benchmarks
Delegates debated the extent to which a benchmark for defaults could have positive or negative impacts.
Smith said: “We don’t want to just anchor to a benchmark. We don’t want people to say ‘I’ll go an extra half per cent overseas equities to get that bit of extra performance.”
Parkinson agreed. He said: “I am nervous about the use of peer group benchmarks because of the herding, the inevitable short-term mentality. Members understand income, they understand what they might get in retirement if it’s framed like a salary. If you tell them that your fund did well or badly, its red or green. It’s too binary. You’ve lost the link to ‘what’s the chance of extra income in retirement?’. And that’s where a peer group benchmark will inevitably pull us away from income in retirement goals.”
Smith added: “Over time this research will become more and more useful, and that’s great. And we will read this and other people will read this but that doesn’t mean that this is what we will put in front of members.”
Mistry said: “I’m not saying benchmarks are a bad thing to do, but there are dangers that we need to manage across the industry and particularly with members. Because they might make rash decisions based on league tables. But is there another form of benchmark that we could operate? How these funds are performing in relation to an income at retirement. Or the kind of steady return someone might need, such as inflation plus X, over a 30 horizon to get to an outcome that is right for them?”
At-retirement allocation
Delegates debated the range of allocation strategies applied in decumulation right up to the day before retirement, with support for annuities strong, and criticism of cash vocal.
Hawley said: “The annuity is the only thing out there that will protect against longevity risk. Yes it is expensive, but less so at age 75 rather than 65. And if it is wrapped up in some post-retirement product, and forms part of a more flexible solution, I think annuities have got to be part of the answer as otherwise we are going to have people running out of money.”
McSweeney said: “Our house view is that we cannot see any rationale for targeting anything other than annuity at the moment. If you have got somebody who does not have access to advice, they probably haven’t got great pension savings, actually what they need is a secure income.”
But Altmann said: “ if you start to derisk at age 55 or 60 you are not doing the customer a favour because most people should not be annuitise in at that young and age. They could get ill soon, they could die soon, and there are opportunities in the market that they won’t benefit from. I cannot see how, especially in the face of QE and the exceptionally low interest rates today, it makes sense to stop trying to improve the value of your savings when you have on average got 20-plus years left.”
Smith says: “To have a default that is 100 per cent cash the day before retirement is insane. Are you telling me that nobody within those organisations is going to reinvest any of their money? And if you have 10 pots, you are not going to take them all in the same tax year. So some pots are going to be sitting in cash for 10 years.”
Smith described an interesting debate being had internally at Willis Towers Watson. “Should the objective of the drawdown part be a risk based objective or a return based objective? Is it more important that we can generate, let’s say, CPI plus 2 per cent, or that we have a maximum one in 20 drawdown of 8 per cent, or whatever the number is. It feels like the answer is a bit of both of those.”
