Schemes have dropped equity trackers for better performing multi-asset and target date funds over the past five years, according to research published this week
How to improve your DC funds
The DCisions report offered a series of conclusions on DC investment, including:
There is a disparity between who schemes and asset managers think is responsible for asset allocation. Half of managers consider it their job, while seven in 10 schemes see it as the sponsor or trustees' responsibility.
Medium-charging funds – those with a total expense ratio of 50-100 basis points, typically multi-asset funds – have delivered the greatest risk-adjusted performance over the past three years.
There is a mismatch between the funds used by DC schemes and those recommended by managers. Passive trackers make up just 8% of managers' recommendations but 48% of schemes' defaults.
Schemes hold 78% UK and overseas equities, while managers think this allocation should be much lower at 54%.
Schemes need to drill down to the individual member's exposure to volatility and whether it is suitable for them.
One in three defined contribution schemes have adopted target date and multi-asset funds, which provide better risk-adjusted returns than their passive equity counterparts.
The DCisions report Calibrating DC Outcomes – released this week in partnership with schemeXpert.com and its sister title Pensions Week – found 32% of schemes now offer target date and multi-asset funds to members, up from 12% in 2006.
This comes at the expense of passive equity trackers, which have reduced from 63% use to 48% over the same time period.
DC schemes have been urged to make sure they have an adequate understanding of the volatility to which their members are exposed.
Helping members to invest in funds that better suit the level of risk they can afford to take gives them a better chance of an acceptable retirement income.
“That is a trend that has accelerated more recently,” said Nigel Aston, business development director at DCisions.
Aston called on schemes to continually monitor their asset allocation to ensure they are taking an appropriate level of risk for their members.
He added: “What doesn’t seem to work is deciding on day one what the asset allocation split should be and then sticking with it regardless.”
Protecting members
The report surveyed 30 pension schemes, including Kingfisher, Lafarge and IBM.
It found there was a “mismatch” between what they were offering and what asset managers were recommending.
Target date and multi-asset products were recommended to schemes 84% of the time by the 18 managers surveyed, indicating this trend still has a long way to go.
You can look at a particular fund and say how does that compare against other funds like it in terms of the risk taken
Nigel Aston, DCisions
But a difficulty of multi-asset, target date and lifestyle funds is a lack of coherent benchmarks for pension schemes to assess their returns against the risks they are running.
DCisions has developed risk-adjusted benchmarks to enable fund managers to show the value of their default products on a risk-adjusted basis.
Aston added: "By defining objectively what a fair return is for a given level of risk experience, that enables all sort of different funds to be benchmarked against each other in a fair way.
"You can look at a particular fund and say how does that compare against other funds like it in terms of the risk taken and has it delivered to the consumer a fair return for the amount of risk."
DCisions data show multi-asset funds have returned 7.9% over three years on a risk-adjusted basis, compared to 5.6% with equity trackers.
Explaining costs
Damian Stancombe, director of DC at investment consultancy P-Solve, said it was essential members understand the reason why multi-asset funds might be more costly.
He said: "Make them understand it is going to add additional value in the future."
Any communication should phrase these choices in a way members will understand, such as "we are looking to beat inflation by x", he added.
Stancombe said most savers understand the impact of inflation, and schemes should explain investment returns to them on this level.
He added: "[They] understand the price of petrol goes up and the price of bread goes up."
Schemes should check performance of their DC funds against the following criteria, he added:
Look at the performance of the fund against its own benchmark over three and five years.
Consider whether the funds have remained within their risk parameters over the short term.
Judge whether the fund manager successfully protected the fund against the downside and capitalised on the upside.
