Here are our conclusions:1. Default funds in principle are to be celebrated, they are absolutely right for the vast majority of members.2. The first problem is the name. The definition of default – “failure to act” – has negative connotations.3. The second problem is the industry experts who bemoan the fact that 85%+ of the membership is in the default. This is viewed by most as a failure to get members to make active investment decisions, however the reality is that this is entirely appropriate and should be viewed as a positive.4. “Default” fund design from the market has, to date, been immature and new solutions are required.
Whilst space doesn’t allow for a full explanation of the research behind these conclusions, I have summarised the most telling evidence.
Inertia Rules
We know that less than 10% of members will ever change their underlying investments, this is based on AXA’s data and US data from over a million policyholders in 401k plans. So those members who opt out of the default and who make an active investment decision will tend to stay in that asset allocation and fund manager selection until retirement. This cannot be a sensible, active decision making strategy. Myths and half truths abound, some of my favourites include, once the pension fund exceeds annual salary members take more interest or, even better, the compact rule; once the value of the pension fund exceeds the value of a small car then members take more interest. Both sound plausible and it would be nice if they were true, however the evidence based on scientific analysis of member investment behaviour shows it, sadly, isn’t the case.
The graphs below, based on detailed analysis, track member behaviour in the recession and questioned if employees were panicking and switching assets at the bottom of the market. They show a slight increase in requests for information, but there was no material increase in switching behaviour. Is this a rational response or another demonstration of inertia?
Web Visitors in Thousands
The less scientific, but insightful, review of telephone calls suggest that many employees believe that their employer/adviser or provider is actively managing their investments on their behalf.
Call Volume in Thousands
Anchoring and ‘1/n”1/n’ is the academics’ way of saying too many investors simply split their investments between the available fund options.
Of those who do make an investment decision, most are influenced by the current state of the stock market. An analysis by the Vanguard Group in 2002 showed that the percentage of investment being directed to equity funds was directly linked to the stock market performance at time of investment. Equally telling was the stickiness of this initial decision; even when equity markets subsequently collapsed, members kept their existing assets and future contributions in the same percentages.
The future of default funds
The industry needs a new name for default funds, perhaps Corporate Adviser could run a competition? The underlying investment solutions are becoming more sophisticated with blended fund solutions and target date solutions bringing new asset allocation and diversification models to market.
DC is still maturing, the typical default fund in the 80s was the mixed fund, in the 90s passive (UK biased), 00s global passive / DGF. It’s up to industry to drive the future; my suggestion is blended funds with strong governance as the core, the actual flavour will be driven by the adviser and their client. My personal preference, based on the evidence, is a well constructed target date solution. This combines strong investment design, active governance and management of the managers and will appeal emotionally to employees. is Head of Consultant Relations at AXA