If you read nothing else, read this…
• 80% of DC pension members opt for their scheme’s default fund.
• There is some disagreement over whose role it is to set asset allocation.
• The Pensions Regulator expects improved investment governance.
• DC schemes are moving to spread investment risk outside pure equities.
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Case study: Marks and Spencer buys into master trust
Marks and Spencer appointed Legal and General to run a master trust arrangement which was set up in August last year to help the retailer comply with auto-enrolment.
Finding a default fund to work across a workforce of 75,000 was a challenge, but Julie Parker-Welch, reward manager, pensions at M&S, is confident in the asset allocation strategy.”The outcome of decisions will only be evident in the future but we believe this default strategy will meet our workforce needs,” she says.
Asset allocation decisions are taken by the master trust’s independent trustees based on guidance from the firm’s governance committee, which, in turn, uses external advisers.
The scheme offers members12 fund choices, from which they can select from a range of low-, medium- and high-risk funds, or invest in the default option, which includes two lifestyle funds based on target retirement dates.
Parker-Welch says that although the trust arrangement did not affect how asset allocations were made, it made it easier to communicate investments to members.
“Investments are a particularly difficult area to communicate effectively, but a trust scheme allows much greater flexibility in the way we explain things to members,” she says.
Marks and Spencer will continue to review the investment strategies and default fund choices as part of its regular DC governance process.
Choosing the right ingredients for an investment strategy is vital to the success of a DC pension scheme, says Gill Wadsworth
Nearly eight million workplace savers are members of defined contribution (DC) pension schemes, far outnumbering their 1.9 million defined benefit (DB) counterparts, according to research from MetLife Assurance.
Yet while DC dominates the future of workplace saving, it stands accused of lagging DB in investment governance, particularly when setting strategies and deciding asset allocation.
With auto-enrolment near for the largest employers, The Pensions Regulator has said it expects improvements in this area and in June issued guidance for “enabling a good member outcome in DC pensions”.
The first principle says good DC plans should be durable, fair and deliver good outcomes for members; something that can be achieved only if investment strategies and asset allocation are set effectively.
The May 2012 report by DC performance measurer DCisions, Calibrating DC outcomes, found that 80% of members opt for their scheme’s default investment fund, a figure that has not changed in six years.
Ultimately, this means individuals do not want to take asset allocation decisions and would rather leave this to their employer, trustees or scheme provider.
George Fowler, partner at employee benefits consultant Mercer, says: “In an ideal world, every single member within a DC scheme would take responsibility for their own asset allocation, but the average member wants to see either the trustees or corporate undertake the grunt work for them in terms of constructing a default.”
Setting asset allocation within the default fund is critical to good governance, yet there is some discrepancy between decision-makers as to whose role this is.
The DCisions survey found 71% of schemes believe the plan sponsor or trustee is responsible for setting asset allocation, but just 10% of asset managers feel the same. Contrarily, half the asset managers surveyed say they are responsible for deciding default funds, with 10% saying it is down to the employer or trustees.
Nigel Aston, business development director at DCisions, says: “You have a strange dichotomy where two different audiences believe it is their job [to set asset allocation]. This is further complicated by the involvement of investment consultants, who advise the employer or trustees.”
Principle three of the regulator’s guidance says DC schemes must establish a comprehensive scheme governance framework from the outset “with clear accountabilities and responsibilities agreed and made transparent”.
Aston says making it clear who is responsible for asset allocation will help avoid problems later should members be unhappy with their investment outcomes when they reach retirement. “You don’t want to be reviewing this when people come to retire and their income is sub-optimal. Decide who is responsible for what part of the asset allocation decisions and make sure that it is documented.”
Once a party has claimed responsibility for setting asset allocation, the next challenge is to find a strategy that can serve an entire workforce.
The DCisions research shows more schemes are ditching the old 100% passive equity allocations typical of DC schemes. While these tracker funds had a ‘low cost’ appeal, the post-2008 markets delivered such a turbulent investment experience that there is a greater desire to spread risk.
The table above shows a trend towards multi-asset investing that offers members less of a bumpy ride and gives exposure to more investments outside pure equities. Increasingly, DC defaults are including diversified growth funds (DGFs), which invest across a range of asset classes, or target date funds (TDFs), which are diversified funds that take into account when a member is expected to retire and gradually move to a more conservative asset allocation over time.
Increase in fees
Mercer’s Fowler says including DGFs may cause a threefold increase in fees, compared with investing in pure equity tracker funds, but he suggests members are less likely to abandon pension saving if the investment is more predictable. “The inclusion of DGFs can see costs increase, but that ignores the members’ experience. It is important to remember the value members place on certainty of outcome.”
While DGFs and TDFs, which are favoured by the government’s auto-enrolment default fund the national employment savings trust, help take care of certain asset allocation decisions, some commentators think more work is needed.
Steve Rumbles, head of UK DC pensions at asset manager BlackRock, says: “It is tricky finding a universal investment strategy. You might have two 25-year-olds doing the same job and earning the same but they come from different lives, and there is no way a provider or employer can take all that into account.”
While still flawed, the DC market is making improvements. Advances in modelling tools that assess members’ attitudes to risk and encourage them to engage with asset allocation decisions can help HR departments better understand their workforce and tailor asset allocation options to suit their needs.
Laith Khalaf, pension investment manager at Hargreaves Lansdown, says: “People in DC schemes are responsible for their retirement income and it is incumbent on the industry and employers to support them by offering access to the right asset allocation tools.”
Pitfalls to avoid
DC investment specialists generally believe it is impossible to find an optimum asset allocation strategy for a diverse workforce, making this area of pensions management fraught with difficulties. There are three key pitfalls to avoid:
• Being seen to offer advice: employers need to balance effective investment communication with avoiding straying into offering unregulated advice.
• Failing to understand the workforce: find out what members expect from their DC scheme and their attitudes to risk.
• Trying to be too clever: asset allocation choices need to be simple and transparent.
Read more articles from the Workplace Savings Quarterly