DC governance: How to ensure your scheme is on the right track

This is where most members are invested and as a result constitutes the only lever in the hands of the plan where the opportunity is to grow a member’s savings beyond what could have been achieved in a far simpler deposit account.

Two key elements will ultimately define whether the strategy is well governed and hence delivering great value for members.

The first is how the objectives of the strategy are set and reviewed through time, and the second is how the money within the strategy is managed to achieve these objectives. To achieve these elements, plan managers should focus on the following best practice for the default strategy.

Set robust objectives

Having a robust process for setting and reviewing investment objectives and beliefs for the strategy and its appropriateness for the membership profile ensures investments made on their behalves are fit for purpose.

Best practice involves providers undertaking analysis of the plan membership at least every three years, both data and survey-driven, to identify the objectives of the default strategies that are most appropriate for them.

In addition, this analysis should identify the cohorts for whom this may be unsuitable and how they can be offered better alternatives.

Independent investment oversight

An inherent governance flaw that exists in many DC plans today is where those setting the objectives and beliefs of the strategy also make the critical asset allocation decisions – essentially people reviewing their own performance.

Best practice involves documenting the investment objectives and beliefs for the strategy in a manner that enables all investment decision-making to be independent of those reviewing its performance.

A comprehensive reviewing framework

Providers will need multiple lenses to review the performance of the strategy. This is important to establish not only whether the strategy has and will deliver against its objectives over the longer term, but also over the shorter term to quantify the effectiveness of its implementation.

To put it another way, while the consumer price index plus benchmarks represent good measures of long-term value for money, they are useless in observing the value for money of the implementation of a strategy that may be largely invested in assets that are in no way related to this benchmark (for example equities).

Best practice involves establishing a simple asset allocation of low-cost passive components – for example equities, gilts and cash – with a risk profile consistent with the default strategy objectives against which shorter-term performance can be assessed and attributed to those decision-makers that drive them.

In addition, outcome orientated benchmarks, for example CPI+, can be used to assist monitoring longer-term performance and provide planning guidance to members.

More advanced plans create representative member journeys and target outcomes to evaluate progress against longer-term plan goals for real plan members.

Transparency is crucial

Finally, having established best practice in these three critical areas, the glue that holds them all together is transparency.

Ensuring providers are held to account is often overlooked but vital to good governance.

Open reporting of the performance of the default strategy at a member level, net of all costs and charges, including those incurred when they are switched between the elements of the default strategy, ensures that employers, advisers and members are able to hold providers to account.

Equally important is individual disclosure of the cost and charges paid to commercial entities related to the sponsor.

Good governance must be high up on the agenda for the whole pensions industry as it seeks to build trust among a wary membership.

It is important that we establish best practice that is not built around the conventions of the past, largely defined benefit, but focuses time and effort on where it can genuinely add value.

David Hutchins is portfolio manager, multi-asset solutions at AllianceBernstein