Volatile markets call for new investment strategies to minimise risk to DC pension default funds and members must be kept informed, says Nicola Sullivan
Market volatility caused by the eurozone crisis has made it more important than ever for employers to review the default funds of their defined contribution (DC) pension schemes, and ensure that employees understand the impact of the investment decisions they make.
The most popular ways in which default funds seek to minimise risk is by using lifestyling, whereby younger savers are exposed to a greater proportion of high-risk growth assets, namely equities, while those approaching retirement are moved into lower-risk assets, such as bonds and cash. Rob Fisher, head of marketing DC workplace savings at Fidelity, said the protection offered by lifestyle arrangements could provide assurance to pension scheme members, but the current climate made it important for employers to consider a diversified growth strategy.
“It is very clear at the moment in markets that the cycles are much more short-lived than maybe they used to be,” he explained. “There is a lot more government intervention [which] we have all seen on the news. This means it is a good idea to spread your money around and [not] put all your eggs in one basket.”
The current instability in the stock markets makes diversification essential for all investors, no matter what their age, according to David Hutchins, head of DC investments at Alliance Bernstein. The asset management firm is stabilising the investment portfolios of young DC members by buying government bonds, and is moving older savers into growth assets.
“While equity returns might look like they could be good over the medium to long term, over the short term at the moment we are concerned about a big fall, and the best way to protect against that is by owning government debt,” said Hutchins.
Conversely, high levels of long-dated government debt or bonds may not be the best bet for employees who are closer to retirement. This is because thesewill reduce in value if large proportions are sold off when the markets improve. High inflation levels could also result in a reduction in the real value of government debt.
Hutchins added: “If you look at older people at, or near to, retirement, their portfolio is normally dominated by long-dated government debt, which is pretty scary. UK government debt has very low yields associated with it now.”
Ken Anderson, head of DC solutions at Xafinity Consulting, said employers need to develop a strategy that is easy to understand and that underlines the level of that investment risk. This can be achieved by offering employees three lifestyle fund options: cautious, balanced and adventurous.
“Employers need to try to build investment strategies that allow individuals to engage,” he said. “They can be clever investment strategies, but they are not so complicated that people can’t engage with them. It is about understanding conceptually what they do without having to understand in detail how they work.”
Employees that take complete control of their own investments need to understand the impact of their decisions in the current economic climate, said Anderson. To avoid over-complicating this, employers should be wary of offering too much choice. “Some group personal pension schemes offer 200 different investment options. How helpful is that?” he asked.
But explaining the impact of stock market volatility to employees can be a challenge, especially in workforces where knowledge of pension investment is low and most members are in the default fund. “The majority of the workforce will not want to engage at that level,” said Anderson.
Employers may find it easier to communicate the actions they have taken in relation to their pension scheme to help minimise the risk associated with the unpredictability of the markets. This could include the diversification of asset classes.
Read also Don’t panic on pension funds as stock market falls
Read more about DC default funds