DC providers’ default funds vary significantly on benchmarks, allocation and risk. Employer scrutiny must increase to ensure good retirement outcomes for employees.
Default investment funds operated by the UK’s largest defined contribution pension platform providers contain an unexpectedly wide variety of approaches and aims, according to new analysis by Punter Southall Aspire. This is creating a risk for employers, many of whom assume default funds are constructed in similar ways and aim to achieve similar outcomes – a belief not matched by the reality according to this analysis.
The data is the first in a new quarterly series tracking the default funds market. It reveals large variations in the risk and volatility profile, return benchmarks, asset allocation strategy and level of active management, among nine default funds run by the UK’s major DC platform providers. This suggests significantly different outcomes could occur for the increasing number of employees saving via these funds as a result of auto-enrolment.
On asset allocation for example, some funds hold as little as 35 percent in equities, while others hold up to 85 percent. Likewise, two funds take a narrow view on asset allocation, investing in less than five asset class buckets. Others take a completely different approach, investing in as many as 20. Unsurprisingly, many of this latter group of default funds take a partial or wholly active management approach.
The benchmark used for investment returns also differs significantly and there appears little common ground between funds. Two of the funds use an investment return target of cash plus 3 percent, while others use a return based on inflation, or more general equity benchmarks. The level of volatility and risk that each fund is prepared to expose its members to also varies hugely. Given these and other differences, it is little surprise that the range of performance over the last 12 months between different default funds varies significantly as well.
Steve Butler, Chief Executive, Punter Southall Aspire, said: “Default implies a standard approach, but this analysis suggests Britain’s default funds are anything but. There’s massive variation here in terms of structure, objectives and the level of risk and sophistication. The market has tended to think of default funds as just that – largely similar in their construction and aim. The reality actually looks very different. That presents a risk for pension savers. Following auto-enrolment, the industry has focused on the idea of giving savers a smooth, reliable path to building up their pension pot. If the experience veers away from that, as could happen given the variety and volatility in some of these funds, we’re likely to see a greater number of savers dropout.”
“The clear takeaway for employers is that if you haven’t properly scrutinised your default fund previously, start now. What you’ve chosen may not be the right fit for your scheme members, their demographic make-up, or their attitude to and understanding of risk. DC default funds are still relatively new, so it’s fair to expect variety and experimentation on behalf of providers. What’s particularly disappointing though are aspects of their construction – too many are using outdated benchmarks while target returns are too vague too often. “Employers often just take the default fund offered by their pension provider. But the variety exposed by this data suggests far more investigation is required. While the focus in recent years has been on the charges of investing in these funds, more attention neds to be paid to what they’re delivering for pension savers too.”
