Most private sector defined contribution (DC) systems globally have not been able to provide effective vehicles for generating investment returns as defined benefit (DB) systems according to an article in Towers Watson’s annual Global Investment Matters publication.
It says that DC schemes will only be able to create value for participants if they can address their implicit disadvantages such that they can compete for investment returns with other investors. Nico Aspinall, head of UK DC Investment at Towers Watson, said: “To join the competition for investment returns, DC schemes must face up to their disadvantages and be clear about the mission and investment objectives so that risk can be clearly framed. In order to do this governance needs to be addressed first, which is why we very much welcome the UK Government’s ratcheting up of governance requirements with the explicit intention to close schemes that fail to demonstrate value for members’ money.”
In the article, Towers Watson says the wide variation and uncertainty in each participant’s objectives makes it less clear how funds in aggregate should be best invested. These include questions over whether the plan offers a savings vehicle up to retirement or invests for members in retirement. Nico Aspinall said: “The ongoing debate about whether a plan is designed for retirement, whether it should try to secure an income stream or provide an ongoing savings balance reflects the fast-changing long-term investment marketplace. This is coupled with the complexity created by a large number of individual members, each with communications, accounting and transaction needs. It is no surprise then that DC schemes and their fiduciaries face difficult decisions about not only purpose and mission but how, and if, they should compete in global investment markets.”
According to Towers Watson the retirement savings industry continues to evolve – through its growing scale and pooling solutions – to overcome the inherent disadvantages associated with DC. It cites as progress the design of appropriate default investment strategies for individual members although they are still gaining scale and are at a relatively early stage of investment sophistication. Nico Aspinall said: “It is reassuring that default investment designs and governance approaches that enable competition for investment quality at better cost are increasingly being implemented. However, as the benefits of the scale of defaults grow, a difficult balance must be struck between using this increasing scale to reduce costs or improve the quality of the investment design. This is a key choice for fiduciaries.”
In the publication, Towers Watson says the interplay between the number, size and financial interests of the players in the retirement savings industry has shaped it so far, but that the UK Government’s hard cost limit of all default funds – 0.75 percent a year from April – will be highly influential going forward. Nico Aspinall said: “The UK’s charge cap will most likely lead to an increasingly passive multi-asset investment approach, still changing with age to retirement, but unable to compete for many of the return drivers available to other institutional investors. As a result many schemes will consciously decide not to compete, but seek alternative ways of providing good outcomes for members through a focus on pooling and cost effectiveness. Others will continue to compete by translating DB investment innovations, such as smart beta, into the DC space. Interestingly, there is a potential positive unintended consequence of the UK’s low-fee benchmark: if successful, it may well start forcing down DC fees throughout the global investment industry.”
The article compares the DC markets in the UK, US and Australia and concludes that despite the difficulties faced by DC schemes, participants’ experiences in general continue to improve as more competitive approaches and solutions – as defined by cost-effectiveness, member focus and increased investment sophistication – are implemented.