Auto enrolment has hit a landmark; three million people have now been registered into workplace pensions since the scheme was launched in October 2012. But for auto-enrolment to plug the pensions gap, contributions have to be sufficient and pension funds have to be profitable.
And the funds with the most pressure to succeed? Default funds. According to Towers Watson, 80 per cent of FTSE 100 employees have been enrolled into their workplace pension’s default fund and Nest says 99 per cent of its members are in its default offering.
The presence of three target date funds in the top 10, and the fact that the Schroders Dynamic Multi-Asset Fund was ultimately voted the winner of the pack, reflects a swift evolution in both provider and adviser opinions. Schroders’ victory, against a backdrop of a fierce debate on low charges, is particularly noteworthy.
Last month the 10,000th employer joined the auto-enrolment register according to the Department of Work and Pensions – and thousands more medium sized businesses will follow over the next six months, which will mean tens of thousands more employees joining default funds.
A sizable proportion will doubtless end up in Nest’s default fund – the default option’s default option. According Towers Watson, master trusts such as those offered by NEST appeal to employers looking for a “half-way house” between the greater fiduciary burden and cost of trust-based schemes, and the perceived lower level of control offered by contract-based schemes.
These workers at least, may well be in good hands – that is, if you cast any sway on Corporate Adviser’s Ultimate Default Fund Award. NEST’s Retirement Date Funds made it onto the shortlist – alongside a diverse list of nine other default funds.
The Ultimate Default Fund accolade is awarded to the default fund that best matches the needs of a company with 1,000 employees with an average spread of ages, skill sets and incomes, for the growth stage of their pension saving, after which the fund is expected to be used in conjunction with some form risk management in the years before retirement.
Ultimate Default Fund – the Shortlist*
Schroder Dynamic Multi Asset Fund (WINNER)
Aegon MI Workplace Savings (HIGHLY COMMENDED)
AllianceBernstein Target Date Funds
Birthstar age-based funds
WorkSave Mastertrust Default Fund – Legal & General
Friends Life My Future Plus
Nest Retirement Date Funds
Scottish Life Balanced Lifestyle Strategy
Balanced Pension Investment Approach – Scottish Widows
Active Plus III Default Fund – Standard Life
*As voted for by the Corporate Adviser Panel
The criteria
The Ultimate Default Fund award will go to the single default fund, or fund solution (including governed default fund solutions) that best matches the needs of a company with 1,000 employees with an average spread of ages, skill sets and incomes, for the growth stage of their pension saving – the fund is expected to be used in conjunction with some form of process to manage risk in the years before retirement. At least 80 per cent of members are not expected to be getting individual face-to-face advice and are likely to end up in the default option.
The Ultimate Default Fund is to be offered through either a contract-based or trust-based scheme and its objective is to achieve maximum returns for members without taking risks that employers are likely to find unacceptable.
Judges will consider, amongst other factors, price, clear definition of roles, track record where possible, attitude to risk and desiring, robustness of process and benchmarking.
The judges considered the cost to members, clear definition of roles, the track record where possible, attitude to risk and desiring, robustness of process and benchmarking. This year, the 10 funds on the shortlist range included target date funds, passive investment and an actively managed multi asset offering. The breadth is representative of today’s market – divided between the low-cost approach and chasing alpha, and whether time stamping an investment strategy is effective.
The Department of Work and Pensions recently issued guidelines dictate that a pension scheme’s default option should be aligned with an overall objective that takes account of the suitability of the option, its affordability and potential risks. These guidelines will now have to be tweaked since Chancellor George Osborne turned the at-retirement process on its head, making annuities no longer the obvious default option.
Scottish Life’s Lorna Blyth says that this guidance, in its pre-Budget form, had a major influence on the range of investment solutions that providers must now offer as potential defaults.
“Default strategies should now meet defined criteria such as the need to offer solutions that are diversified, affordable and de-risk the closer a member gets to retirement,” she said.
The guidelines also state that there should be diversified asset allocation, and the investment strategy should consider the age of the member.
This former point is indicative of how much the default fund market has changed in recent years. Five years ago the Ultimate Default Fund was an 100 per cent equity fund – and while there are concerns that pricing pressure will limit the ability of pension funds to invest in alternatives, what segregates todays funds is not whether they diversify but how.
In fact asset allocation now drives investment decisions.
Nest chief investment officer Mark Fawcett says when it comes to constructing Nest funds he believes that asset allocation rather than stock picking is generally a more consistent driver of performance. Although he admits that, “in certain markets the active manager can add value”.
Schroders head of DC Stephen Bowles, champions active management far more loudly, but is equally fanatic about diversification.
“The historical rationale behind adopting global equities as the DC investment solution of choice was one of accepting high levels of volatility in the belief that over the long term it would deliver long term growth. That is, it would all turn out alright in the end,” he reflects.
“This was reinforced by a short sighted bias towards ‘cheap’ solutions and an irrational desire to focus on solutions that would definitely achieve their objective regardless of how inappropriate that objective might be. Hence equity index funds dominated. There is now a gradual shift and recognition that volatility can have devastating effects on pension savings.”
This year’s shortlist can be broken down into three broad categories; target date funds, lifestyle strategies and multi-asset funds – all of which feature diversified portfolios.
“At their heart they all look to diversify the types of assets that plan members will be invested in with, at a high level, the multi-asset funds doing this based on market conditions, the lifestyle strategies doing this based on term to retirement and the target date funds aiming to achieve this based on both market conditions and term to retirement,” says Aon Hewitt senior DC investment consultant Ryan Taylor.
While some of the lifestyle strategies do include multi-asset funds within their portfolio in order to initiate members onto the glidepath to retirement, Taylor says their fixed switching mechanisms still mean that they don’t quite have the complete flexibility offered by target date funds – from an investment perspective.
Alongside asset diversification, one of the key developments in the default market is the improvement in governance – and the industry waking up to the importance of aligning schemes and members’ investment objectives.
Scottish Life’s shortlisted default fund the Balanced Lifestyle Strategy puts objectives front and centre. Blyth says that their lifestyling mechanism is not simply bolted on to a strategy right at the end, but a “gradual and fluid de-risking tool” that changes the asset mix on a monthly basis in the 15 years a member approaches retirement.
Nest’s language is similarly rousing. The firms Statement of Investment Principles declares that understanding members’ characteristics, circumstances and attitudes is essential to developing and maintaining an appropriate investment strategy.
Two years ago – in pre-auto-enrolment times – the Pensions Institute at Cass Business School released a report warning that DC pension schemes were putting employees’ retirement prospects at risk unless they improved the quality of default funds.
In its report, Dealing with the Reluctant Investor, it found most traditional default funds did not match members’ needs in terms of asset allocation and risk profile.
Since then a paper from the National Association of Pension Funds concluded that governance within the default fund industry had improved – but that more could be done.
It has at least been prioritised by the powers that be. The DWP’s own guidelines dictate that the default investment option should be reviewed at least every three years, with the performance of funds checked informally regularly.
Much debate in the industry revolves around the introduction of the price cap and how this will affect the investment strategies of pension funds.
Towers Watson’s 2013 FTSE 100 Defined Contribution (DC) Pension Scheme Survey questions what constitutes good value and whether cost should be the only consideration.
“More sophisticated investment strategies cost more to design, implement and communicate. Better communication is not free,” argues the report. “Assessing what constitutes value for money should therefore look at all aspects of a pension scheme, not just the headline level of charges.”
The waters will appear less murky when the cap is eventually rolled out in April next year – albeit 12 months after the initial launch date.
Bowles hopes that in the near future the active versus passive argument will soon been put to rest – despite pricing pressure – and that the debate will move onto what he calls “the real investment issues”. The flood of cash expected in 2018 – when auto-enrolment is fully implemented and minimum employer contributions jump from 1 per cent to 3 per cent – should see advisers negotiate further economies of scale – although there are concerns about what it will mean for smaller employers’ financial health to cough up the extra cash for every worker.
“We should be asking ourselves what the right investment objectives are for our default funds and how we communicate these to our members in a way that they understand,” he said. “What are the right tools for those objectives, and what is a reasonable price to pay for those tools?”
This focus on better outcomes – using a blend of active and passive management and solutions will be under pressure as number of defined benefit plans falls away.
There will also be a shift in priority from acquiring members, once auto-enrolment has been fully implemented, to managing their futures.
“Whilst there will still be a focus on encouraging members to invest in the first place and how that investment should be managed, the greater emphasis will be on how the member accesses that investment and how it should continue to be managed to provide an income for life,” Taylor says.
“Therefore future default options will need to start taking this in to account now, so that they are able to adapt and change to meet this requirement in future.”
