DC Default Funds
The Lens’s attention turned to DC pension investing over the past week, particularly to default funds that capture auto-enrolled employees who have not elected another option. Here are a few interesting things we learnt.
For a start, there is a high level of passive investment by these funds, both in the growth phase and the latter so-called “consolidation” phase when funds tend to become more risk averse in order to protect the savings of employees approaching retirement. The use of lower-cost passive is not surprising, given the regulatory requirement for providers to manage default funds within a 0.75% price cap.
However, although returns from defaults have been overwhelmingly positive in recent years, this has without doubt been aided by the bull market and so the Lens cannot help but wonder if the same will be repeated during the next year should – as is the prevailing feeling – a significant downturn take place.
If there is a downturn, it could strengthen the case for active management and one more thing we learnt was that the rate of active investment within default funds is correlated to the business profile of the provider. If the provider (typically an insurance company) has its own asset management arm, usually the default fund will be more actively invested.
There are at least signs that asset allocation – the most important of all investment decisions, according to many – is becoming more dynamic in the default sector, and this is both in the growth phase and consolidation phase.
Similarly, allocation is perhaps becoming more thoughtful as demographics change. No longer, it seems, do these funds necessarily switch wholescale from equities to bonds just ahead of retirement. Growth assets such as equities are just as likely to be in the consolidation phase of defaults as they are in the growth phase. This is obviously linked to people living and working longer, and consequently able to take more risk.
International diversification is high (about 65% across assets) and there is use of alternative investment (6% on average).
The findings are from Punter Southall Aspire’s annual default funds survey and whereas we might expect most of these products to be similar, there were some significant differences. One fund had exposure to alternatives as high as 12% for example; another did not change its bond allocation along the entire ‘glidepath’.
One commonality was that de-risking does tend to take place much earlier than in the past. This, perhaps, is a lesson learnt from the dotcom crash, where many pension fund members saw their funds plummet just ahead of retirement.