An increase in active management in the DC pension universe is not only desirable, it is essential. This is arguably truer today than at any other time in the relatively young DC market, given the quite different resources devoted to it and to its DB counterpart, both with the same broad outcome as an objective: to provide investors with an acceptable level of income in retirement.
Active management is of course much less prevalent in DC pension schemes, given the desire of members to keep costs to a minimum. There is a strong case for arguing, however, that in at least some instances they should switch their focus to value for money rather than absolute cost.
Scheme members do not always have to settle for the cheapest option on offer. A few extra basis points paid in fees to a quality active manager could in the long run deliver just the growth that all pension schemes need. Contributions on their own will not be enough to generate an adequate level of retirement income. Pension investors need to view their individual arrangements through a more realistic prism.
It is in this context that default arrangements within DC schemes surely need to be placed firmly under the microscope, dissected, and acute observations made. Default arrangements have become enormously popular by, well, by default, accounting for an estimated 80 to 90 per cent of all assets in any single DC scheme. Schroders own Diversified Growth fund, which aims to replicate equity-style returns with less of the associated risk, has around £1bn of DC assets invested in the fund. These are from scheme default arrangements.
Some industry participants will describe them with some elegance as ’the primary option for those who are inert or lack confidence in their investment picking ability’. Many others describe them, with much justification, as ’the place where people who don’t want to make a choice end up’.
The sheer volume of people who have chosen the default option, and the assets held in them, make it important. If 80 to 90 per cent of contributors and their assets are in the default arrangement, the default arrangement should command that ratio of investment management attention.
All investment strategies should have an objective that is clearly stated and strictly adhered to. The starting point in constructing a default arrangement should be to ask: What is it trying to achieve? What is the objective? As all members will want to achieve sufficient growth to provide a retirement income, the fund will need a robust combination of growth assets and risk management. Particularly in recent times we have been reminded of the need to pursue an appropriate risk-return balance rather than focus only on return.
Once the objective has been determined, thoughts can turn to the investment approach that will be needed to achieve that objective.
Diversification should be at the core. Equity volatility of the last four years and more has emphasised again and again the dangers of holding all one’s cash in a single asset class. But not only do investors want to diversify; they also need a manager to decide how to allocate assets, and when to buy, and when to sell. And, as already referred to briefly, they need a certain minimum volume of growth assets in their portfolio.
The easiest and arguably the best way for a DC-based pension scheme to access diversification mixed with another key ingredient, a healthy dose of risk management, is via a multi-asset fund, with a skilled manager or team of managers making the key asset allocation and timing decisions. Membership of a DC corporate scheme can deliver access to institutional levels of service at a modest cost.
Multi-asset funds are thus becoming a key part of the investment solution. Multi-asset funds offer diversification across a wide range of traditional asset classes and alternative asset classes such as hedge funds, private equity, property and commodities. While alternative asset classes are highly unsuitable for the direct investment needs of most investors, in a properly maintained actively managed fund they balance risk, reward and the need for growth.
Take our Diversified Growth Funds for example. Its core fund DGF began life as Schroders own DB fund for its corporate pension offering, then was opened up to other assets in 2006. At the end September 2011 the fund had more than £4bn funds under management, of which approximately £1bn are from DC Schemes. This clearly reflects the strong demand for such strategies in a manner that investors recognise.