Is there a place for smart beta in DC portfolios?

Robert Holford: I suspect the world of relative performance versus benchmarks is, at the very least, under question, if not dying.

No one with a defined contribution pot has the foggiest idea what the FTSE 100 did this year; maybe 5 per cent of them do. The rest of them see how much money they have and they do not want to lose it. What you are really going to get tagged for in the future, I believe, in areas like DC, as a trustee, is losing people money, not not making them enough.

We are all calling it workplace savings. And the more people on the street hear that, the more they think, ‘Why is it not in a bank account?’ I suspect smart beta has some answers for that, in terms of improving the risk-return profile, protecting on the downside and doing that in a fairly systematic, low-cost way.

Simon Hill: There is a big issue around people who are not on the trustee board understanding what it is they have. For most DC trustees and DC governance committees, the risk that someone might be investing in a product that they think is one thing but is in fact something else, is something trustees are very worried about. They would rather have something that is less than optimal but is clear, or reasonably clear, what it is.

Holford: But that is why I would say things like minimum volatility, minimum risk, are the sorts of things that are attractive because the label matches up with the DC context.

The difficulty is in translating what may be great ideas into something that members can have confidence in

Jonathan Reynolds, Capital Cranfield

Jonathan Reynolds: As a DC trustee, I am actually very interested in smart beta. With DC it is all about contributions. We have to get them to pay in, and the crucial thing about that is confidence. We need the members to have absolute confidence, and one of the key things there is how we can ensure that members get a good experience when they look at their statement each year. Because the worst thing is when this pot is worth less this year; and not only is it worth less, I have put X in. That really, really hurts.

If smart beta has a role to play, great, I would like to see it. Because at the moment you have serious difficulties where your default strategy is still pointing towards annuity purchase.

At some stage, as and when gilt yields turn, all the defined benefit trustees will be cheering, and all the DC ones will have a massive problem in that what they thought was going to be moving towards lower volatility is actually heading south rapidly.

Scott Richardson: I do not envy you the governance issue as a DC trustee at all. But this is a portfolio allocation choice, so, strategically, what should you be doing with your limited assets that you are contributing to the scheme? Diversified market exposure should be the core of that, and then alternative risk premia can be an add-on on top of it.

Reynolds: The key thing for me here is this whole thing about confidence. The difficulty is in translating what may be great ideas into something that members can have confidence in and think, ‘I am going to get up to the 15–20 per cent savings rate that I need to, to get a good outcome’, because without that, the whole thing trips up.

Richardson: They have to understand this is an investment, that is key. It is not a savings account.

Holford: A lot of members do think that and that is the point: they will not contribute if you lose their money. If we allow ourselves to say, ‘There is an investment solution that will work for this’ and we push that message too aggressively, it will be heard as, ‘This is completely safe and you told us it was in the first place’.

Steve Artingstall: I think there are new robo-advisers that actually may have a role to play in the DC space in the same way that computers and quantitative approaches have come to the fore in the alternative risk premia, smart beta space. They can simplify things. I have seen one that gives you an option between low, medium and high risk and it then gives you a sort of automatic, highly diversified, portfolio of lots of different asset classes, and I am presuming you could insert smart beta strategies into that as well. That way you do not actually have to try to educate people about complex stuff in terms of risk premium strategies, it just gets bundled into the overall solution.

When you buy a car, no one spends their time working out how the engine works, they just drive the car out

Robert Holford, SpenceJohnson

Hill: There is one key problem in DC we have not talked about, which is that risk and return have been turned on their heads. I happen to have one pension pot that has been my best performing pot for the last three years – I have been a holder of gilts. I do not think a lot of DC members have quite clicked onto this one yet because not all that many are in the final stages of DC at a level that matters to their overall retirement, but it is coming.

Pensions Expert: Might it be difficult to reconcile the aim of simplifying DC saving for investors through robo-adviser platforms with the complexity involved in smart beta?

Reynolds: Taking the lay approach does not have to be complex. It is the presentation to the member that matters and if that can be nice and simple, it does not really matter how much difficult work is going on underneath.

Holford: People do make the analogy that when you buy a car, no one spends their time working out how the engine works, they just drive the car out. But because in finance, to a certain extent, it is ideas and also because we have been quite badly behaved as an industry, people do insist on checking how the engine works. So it is being hampered partly by past failings, by the requirement to give that level of transparency.

Richardson: You have to tailor how you communicate what is under the hood to the individual, and sometimes it has to be to a very high level and you have to be humble. We are not selling crystal balls, these are alternative risk premia. They can, at times, be painful, but if you have people understand that, when that pain inevitably comes you have a much more fruitful relationship, because they will be in it for the long haul. Sometimes it might be impossible, you cannot explain that to some people.

Reynolds: It is a real challenge, but my feeling is generally positive. When Nest came out with its investment strategy, a lot more thinking went into that than I had seen almost ever before.

And the DC world is improving rapidly. If smart beta has a role to play, great, I do not see why it should not, and I think if you can get the descriptions of the funds right and explain to people what they do, rather than necessarily how they do it and why it works for them, or why it is in the default strategy, then fine.