The fundamentals underpinning lifestyling are, at least on the surface, sound, but do they really hold up in an age of flexible retirement strategies?
Lifestyling has been a feature of the group personal pension market for over a decade and is a legal requirement within group stakeholder pension schemes.
The basic theory has remained more or less constant over that time. Clients’ contributions are invested in funds with very high equity weightings in the early years and then gradually switched into lower risk assets as they near retirement, typically ending up in cash and annuity-matching assets a year out from their normal retirement date to avoid any last-minute nightmare scenario that could see their retirement income fall significantly.
However, while the end remains the same, the means have changed over time with the sophistication of the modelling tools used to plot asset migration undoubtedly improving over the years.
Mark Andrews, managing director at Purple Circle Consulting says lifestyling is now generally seen as a safer default than a managed fund where there is no ongoing advice although advisers do have to choose carefully between providers, given the different approaches they take.
The two main differences between providers’ models centre upon how much equity exposure their funds have in the cumulative years and when the lifestyling actually kicks in.
Andrews says there is a strong argument that anyone 10 years or more from retirement should be 100 per cent invested in equities.
He says: “For anyone not looking to retire for at least 10 years, equity exposure is not only desirable, it is essential, no matter how cautious they are. It is imperative clients are made aware of the nature of risk and return and the considerably stronger growth potential of equities over the long-term.”
Hargreaves Lansdown head of corporate solutions Nic Nicolaou says problems with lifestyling can arise where a group scheme offers several fund choices.
Scottish Widows, for example, offers individuals the choice of cautious, balanced and adventurous strategies. Only the adventurous fund starts out with 100 per cent equity exposure and Nicolaou says given the choice of the three, most people will opt for the middle, in this case the balanced option.
He says: “Some 90 per cent of people should be 100 per cent invested in equities but given the choice, most people will opt for the middle ground and only end up 80 per cent invested in equities and so miss out on a lot of growth.”
This accusation can also be levelled at advisers, he says. Nicolaou says there is still a reluctance among many to recommend investors opt for 100 per cent equity exposure. A glance at the Barclays equity/gilt study should be enough to persuade advisers of the power of the stockmarket but some remain cautious.
This is reflected in many providers’ offerings. Legal & General’s group Sipp, for example, offers nine lifestyling fund choices. These range from just 60 per cent equity exposure to 100 per cent.
Andrews stresses the importance of communication to explain to clients the importance of having high equity exposure over the long-term.
This can involve a certain amount of hand holding in the short-term, particularly following periods of market volatility, as has been seen in recent months.
Nicolaou says: “You have to explain that if you do experience a bear market in the accumulative stages it is not necessarily a bad thing if you are investing monthly. This will protect you from the worst ravages and you will be buying at cheap prices when the market bottoms which will serve you well in the long run.”
If the bear market occurs towards the clients’ normal retirement date then that is where the benefits of lifestyling will really be felt.
The jury is out on when lifestyling should kick in though. Scottish Widows’ GPP lifestyling starts 15 years from normal retirement date after its research, carried out with Barry & Hibbert, found this to be the optimal timeframe.
L&G’s group Sipp offers adviser the option of a three or five year programme and five years appears more or less the industry standard.
Tony Filbin, managing director of corporate wealth at L&G says the insurer’s lifestyling uses programmed trades to switch assets at set points. The adviser can choose whether this is done on a monthly, quarterly or annual basis during the lifestyling although the more frequently it is done, then typically the higher the switching charges.
Mike Morrison, pensions strategy manager at Winterthur is sceptical of this approach and suggests, if, for example, a programmed trade occurred on the day of a large stockmarket fall, then the damage could be significant.
He says: “There is a real danger you can move out of the market at exactly the wrong time.”
Filbin counters this, saying it is a case of swings and roundabouts. “If you do not have access to advice then a programmed trade makes sense,” he says.
A number of providers have built flexibility into their systems to enable the fund managers some discretion about when to switch assets. These include Axa and Fidelity (see box).
Peter Hicks, head of IFA channel at Fidelity says the fund house is actively looking at building DC versions of its Target retail funds, which in there existing form are lifestyling vehicles designed for longer-term financial planning.
He says Fidelity favours both actively managed asset allocation and underlying funds.
“In terms of investment, you are talking about building in the probability of delivering the most favourable outcome,” he says. “We think this works better with active fund management because the modelling is then updated constantly and the manager can react to changes in investment conditions.”
Hicks says the Target funds continue to have equity exposure until the retirement date but this will be in equity income rather than more risky investments.
“This is recognising that going forward, a lot of people will be going down the income drawdown route where equity exposure at retirement is appropriate,” he says.
The growth of drawdown is a challenge to traditional lifestyling tools. Investors are being asked to select their retirement dates perhaps 35 or more years from retirement and with legislation encouraging people to work beyond 65, there is a risk that lifestyling can let people down if they do not move their normal retirement date.
“If you are going into drawdown lifestyling is absolutely worthless and the time people are most let down is when they are not informed the lifestyling mechanism is kicking in,” Nicolaou says. “If your normal retirement date is 55 and you end up working until you are 65 you are in the wrong funds for the most important part of your pension accumulation and it can be a complete disaster.”
Similarly, if the normal retirement date is brought forward, the investor can be exposed to stockmarket volatility with no time to make up any losses, Morrison warns.
For this reason, Filbin recommends advisers check that insurers allow investors to turn off the lifestyling function and that they notify the client of when this is about to be switched on to enable them to access advice, if needed, about whether it is still suitable.
This once again comes back to education, but given the long timeframe of pension investing it is inevitable that both insurers and advisers will lose contact with some clients.
Morrison says this is the trade-off when there is no advice.
He says: “It is a fine line between using lifestyling for convenience and developing a profile that suits the individual.”
Adviser view – Choosing your lifestyle
“It is imperative that advisers write to notify their clients five years before their normal retirement date to see if they would like to use the fund’s flexibility to elect a later retirement date”
Nic Nicolaou, head of corporate solutions, Hargreaves Lansdown
The choice of lifestyling option for a defined contribution scheme can potentially have a significant impact on member’s benefits, so it is important that advisers research the products available thoroughly.
Nic Nicolaou, head of corporate solutions at Hargreaves Lansdown says he has recently set up a group arrangement using Axa’s lifestyling fund as a default option.
He says the fund is 100 per cent invested in equities until the client is five years from their normal retirement date and the lifestyling option kicks in. Unlike offerings from many other providers, clients can nominate a retirement date different to the scheme normal retirement date.
He says: “What I really like is the fact that it is 100 per cent invested in equities until five years from normal retirement date. Although the lifestyling is a fairly standard, automated process, the fund manager does have some discretion about switching assets if they are not happy with the prevailing market conditions.”
The manager can delay the decision to switch a portion of the fund out of equities by 14 days, so enabling them to potentially avoid the worst ravages of a market sell-off.
Nicolaou does however warn that unlike many DC providers, Axa does not write to inform clients about when the lifestyling process is about to start.
He says: “It is imperative that advisers write to notify their clients five years before their normal retirement date to see if they would like to use the fund’s flexibility to elect a later retirement date if appropriate.”