The government’s drive to benchmark investment performance and target poor performance highlights a number of challenges for the DC pensions sector – how much weight to be given to past performance, and how to set scheme objectives. These were some of the issues explored by delegates at the Corporate Adviser Master Trust & GPP Defaults round table at the House of Lords last month.
Delegates explored the issues of low contributions and risk management, and debated different perspectives on the trade-offs between certainty and growth potential, as well as the need for adaptable solutions to meet diverse retirement goals.
Performance benchmarks
Richard Butcher, client director at Zedra noted that metrics like performance benchmarks are not as important as meeting member-specific objectives. He expressed concern about government efforts to standardise investment approaches, citing the impracticality and potential recklessness of mandating a default investment strategy.
He recalled the competitive benchmarking culture in the insurance industry in the mid-80s, typified by the CAPS reports, and argued that there were drawbacks to having standardised benchmarks, arguing that it stifled innovation.
He said: “The government wants a more standardised approach. I can understand that, but they can’t get it unless they mandate what that is. Can you imagine how reckless that would be? A DWP-mandated default investment strategy? If you have a standardised benchmark, nobody’s going to be targeting the right outcome for vendors.”
Butcher also questioned the contradiction in expecting master trusts to be led by independent individuals while also expecting uniform behaviour. He emphasised the importance of diversity of thought and background among trustees, leading to varied outcomes in asset allocation.
He highlighted subjective judgment, personal biases, and differing investment preferences as factors influencing these decisions. He also argued that provider-to-provider comparisons are challenging due to these inherent differences in approach and outcomes.
Meanwhile, Maiyuresh Rajah head of investment strategy and proposition at Aviva shared his support of focusing on performance based on what providers aim to achieve, emphasising the importance of member outcomes set by each master trust.
He stressed the significance of performance to drive conversations about value rather than solely focusing on costs. However, he cautioned against blindly adopting models like Australia’s, which could stifle innovation and result in a more conservative approach to benchmarking.
Rajah said he supported a balanced approach that prioritises achieving objectives while maintaining innovation and fairness, to avoid regressing to ineffective balanced funds.
He said: “I think there needs to be a balance for this sort of drive towards performance. We need to do it in a fair way, where you don’t lose innovation and you don’t lose what you’re trying to achieve because you’ll go back to those sort of balanced funds which are of no use.
“What are the outcomes for members, and what are the innovations in terms of future-proofing?” He said these were important, rather than simply comparing performance against other providers?
“I think it makes it very simplistic and doesn’t achieve what providers set out to deliver, which is a good retirement outcome for individuals.”
According to Corporate Adviser’s Master Trust & GPP Defaults report, over five years there is a 54.5 per cent difference in returns delivered to young savers, with National Pension Trust returning 79.7 per cent, while Now: Pensions returned 25.2 per cent, assuming a 0.5 per cent AMC.
Butcher defended Now: Pension’s master trust board: “They all want to do the right job. Now, subjective judgment might get that wrong from time to time. Maybe their asset allocation is wrong but they’re trying to do the right job and your judgment of their performance is relative to others.” he said.
He said the mastrer trust may be looking to reduce volatility across the portfolio due to their membership, which may be skewed towards “low earners and blue collar workers” when compared to the market as a whole. “Maybe all they wanted was something low risk and as a consequence, they’re targeting deliberately a low return,” he added.
Risk
Mathew Mitten partner at Secondsight drew attention to the problem of low contributions, describing it as a “perennial challenge”. He said that by yielding larger returns for members, investments can make up for this deficiency.
But he questioned whether providers should choose risk-managed strategies that push for moderate results, or whether they should prioritise obtaining the highest returns possible.
Mitten argued for aiming for high-return outcomes for members, in relative terms, even if that means assuming greater risk. He said: “It is subjective but I think as a member what I want to see is my fund coming out on top every year.”
Butcher disagreed and said, “…what members want is some certainty”. He argued that a defined benefit pension plan offers assurance by guaranteeing a fixed sum, but the amount varies under a defined contribution plan, making planning difficult. He emphasised that the predictability of a set amount is frequently preferred by people over the flexibility of a DC plan.
Stuart Arnold, DC consulting new business director at WTW argued that while people may value a fixed sum up front, they may later favour the possibility of larger returns. He emphasised that in order to maximise long-term growth potential, taking risks is crucial, “particularly at the younger phases, growth should be more much more important than volatility.”
Meanwhile, Rajah warned against only aiming for top performance without taking into account broader risks.
He said: “Make sure you’re thinking about volatility at the right time. Make sure you’re thinking about diversification every time… But when you’re in the de-risking retirement piece, you need to be much more nuanced, much more aware of your risk.”
Rajah emphasised that an individual’s full life journey and retirement goals should be taken into account when discussing investment and when trying to balance growth and retirement.
He underlined the need for adaptable solutions to meet shifting demands and emphasised the range of goals people may have, such as drawdown or cash withdrawal.
Chris McWilliam, principal consultant at Aon expressed the view that some providers, particularly in the growth phase, have been overly cautious in their investment approaches. He noted a trend of providers increasing equity exposure in default options to address this and recommended that members can afford to take on additional risk for possible benefits.
Allocation
Anish Rav director of global pensions policy at Capita highlighted how DC schemes are designed with an emphasis on investment options and the improved flexibility and choice available, noting the growing interest in exploring alternative assets in addition to equities. But he expressed doubt regarding bonds’ long-term returns, suggesting that they will struggle to outperform equities.
Meanwhile, Rajah pointed out that increased exposure to illiquid assets in default investments should be expected, going beyond just private equity to include multi-asset private debt and infrastructure. This shift towards diversification, aligned with the Mansion House Compact, aims to improve member outcomes, he said.
He said: “We’re not simply looking at how we incorporate 5 per cent into unlisted equities. That will be one part of this wider portfolio because that’s what’s going to help improve customer outcomes; 5 per cent on its own isn’t probably going to do enough. So we want to have one of our default solutions at 10 per cent, and then look at whether we push that out to 15 per cent. This isn’t all private equity though, this is illiquids as a wider asset class.”
Personalisation
Butcher addressed the limitations of a single default investment option in pension schemes, saying that it may not suit everyone’s needs, as it is optimised for only a portion of the population. He proposed a model that included several investment defaults with varied risk levels, influenced by employers.
He suggested utilising data analysis techniques to establish personalised defaults based on individuals’ circumstances, taking into account credit ratings and location.
He said: “We can get to a point, where in the same way that we used to use postcode analysis to help us understand mortality or the longevity of our members in the DB world, we could do exactly the same in the DC world and then start to have standardised algorithms to produce personalised defaults.”
Rajah agreed that personalised defaults are the “holy grail” and expressed confidence in technology to eventually facilitate them. But he argued for the need for member engagement alongside this: “AI is not going to change everything because you’re still going to need to engage to start that process.”
Faith-based
Delegates discussed the successes of faith-based funds which have done particularly well for the last five years. Stephen Budge partner at LCP emphasised the opportunity to capitalise on past successes in investment funds, particularly those focusing on US tech, but warned about risk. He said: “Those funds have done really well because they’ve been vetted in the US and invested in US tech but that’s running a massive amount of risk.”
Arnold noted the lack of inclusion in default pension schemes, particularly where auto-enrolment could result in aligning an individual with a default approach that may not reflect their beliefs. He called for structures that better meet varied needs, arguing that the current system is not inclusive enough.