Is the Mansion House drive to “limit defaults” driven by a greater focus on scale to accelerate value? Is it part of the regulatory focus to make the UK DC pension structure more like Australia and Canada? Or is it simply the difficulty of monitoring the workplace outcomes from a huge range of advised strategies?
While I think all the above is in scope for the Government, I believe there is a more fundamental question to ask here: are all these strategies required and do they deliver better outcomes?
Alternative defaults
We have seen the proliferation of defaults come from a few locations – if it isn’t advised defaults, it’s providers’ annuity- and cash-targeting strategies, risk-rated options and indeed more recently the launch of ‘premium’ strategies that offer better access to private assets.
So why are providers and advisers launching so many different types of ‘default strategy’? The answer is actually a very simple one – to appeal to as wide an audience as possible, driven by a commercial cop-out and a hollowing out of the investment beliefs, plain and simple. It’s hard to see any relationship with driving better member outcomes or conviction in their own investment beliefs.
The launch of ‘premium’ private market strategies and risk-rated options are easy to dispel as unsuitable. Each of those strategies will undoubtedly offer a different expected outcome based on your or your adviser’s beliefs. However, if you are a trustee sitting on a master trust offering both of these solutions to your membership, but with no evidenced and governed difference in each member’s objective and belief-set, how can you say that it is appropriate for Joe and Jane Bloggs to be in two different strategies? Are you okay with one member getting a worse outcome than the other? The answer is that you can’t justify the difference and the stronger the governance structure, the less it can be tolerated.
Let’s assume that clients, rather than advisers, are looking to set differentiated objectives on the membership’s behalf. In the vast majority of cases, members do not engage enough with investments to have beliefs except to talk on a principles basis (e.g. Sharia Law), but for many UK pension investors there is a simple objective – wanting the best possible retirement outcome.
Do they drive better outcomes?
Ten years on from Pension Freedoms, and a Trussonomics event behind us, you would be forgiven for thinking there must be a drove of evidence as to why annuity and cash glidepaths offer better retirement outcomes. But members continue to access tax-free lump sums at age 55, prior to de-risking, and members in annuity glidepaths were shouting from the rooftops about their losses due to being invested in long duration bonds at the end of 2022, even if their purchasing power of an annuity had improved. So what does this highlight?
Looking at a cash glidepath, assuming the member hasn’t already taken cash, a stochastic analysis shows that the majority of the membership get a better outcome with continued growth exposure and can better accommodate flexibility in their retirement date as a result.
For a member seeking an annuity at an intended retirement date of 2022, the best outcome would actually have been to continue in the flexible retirement default (or drawdown) and then purchasing an annuity, rather than being in the annuity glidepath. But for many members intending to purchase an annuity, they preferred to defer retirement than to lock in the previously intended income.
These decisions all highlight that members take the retirement product that offers them the best value at that point in time, and that de-risking toward a retirement target five years from retirement doesn’t even align with how members behave, as they are more concerned about absolute loss than relative loss.
Fidelity’s 2023 research in this space highlighted that where members do make active decisions in a scheme with alternative defaults, 97 per cent prefer to self-select rather than select pre-built retirement targeting strategies. Very few members sit in this middle ground of engagement, where they are engaged with retirement but not investments.
As the industry shifts its focus from cost to value, I believe we are starting to see greater emphasis on the value of a strong governance structure. The level of true independence across a master trust of provider default and the transparency with clients is fundamental to drive accountability and accelerate innovation.
As a result, looking five years to the future, there will be huge disruption where multiple defaults exist. In a competitive market, everyone’s default must have the objective of maximising outcomes making the purpose of an alternative mass market default moribund, albeit acknowledging that fundamentally different beliefs do still need to be supported. Furthermore, if your objective is to do the best you can for your membership, then what is the objective of your ‘premium’ strategy?
This is why Fidelity has always offered a single default strategy, FutureWise, and we don’t have any legacy strategies, because we believe that all members should benefit from a strong governance process and access to our best ideas in achieving a better member outcome at retirement.
