Research proves DC funds underperform during dips

Trustees need to rethink their defined contribution investment strategies if they are to get the most for members in a post-Budget pensions world.

Conventional pre-retirement thinking was turned on its head when the government freed DC savers from the annuity stranglehold. However default funds must now be updated to better enable individuals to take advantage of the new flexibility.

No longer will a classic move into bonds ahead of an annuity purchase prove the ultimate strategy, instead many savers will choose to remain exposed to the markets while drawing down their retirement income.

However DC funds are prone to significant dips during economic downturns leaving members vulnerable to catastrophic losses at the end of their saving life.

“Historically, lifestyling did an adequate job but it will be much more difficult in an environment where we don’t know whether members will be buying an annuity or taking cash.”

Research from Towers Watson shows DC plans underperformed their DB counterparts by 2.68% in 2008 and 2.6% in 2000, as their reliance on equities left them exposed.

Andy Cheseldine, partner at consultant LCP, says: “The Holy Grail is a structure that manages fundamental risk of loss closer to the time that benefits are taken. Historically, lifestyling did an adequate job but it will be much more difficult in an environment where we don’t know whether members will be buying an annuity or taking cash.”

Asset managers claim they are developing products that are better placed to equip members in the final stage of the pensions savings journey.

Tim Horne, defined contribution investment solutions manager at Schroders, says the focus is on still on return but with greater risk management.

Horne says: “The pre-retirement phase is where it needs to change. We should look at delivering returns above inflation but also a focus on managing the downside. We are thinking about employing techniques that go beyond the active management, that reduce risk and give members a target of not losing more than X over the time they are invested.”

However Andy Seed, executive director with J.P. Morgan Asset Management’s DC team, claims the firm’s target date funds (TDFs) supersede lifestyling already since these strategies allow for a ‘more intelligent’ approach to investment.

“Traditional lifestyling sees members disinvested [from return seeking assets] irrespective of whether it’s a good time or a bad time. TDFs provide a level of tactical asset allocation using an active manager so if it’s not the right time to come out of equities you don’t have to,” Seed says.

While strategies may exist to cater to the post-Budget pensions world these may not be implemented universally.

It will prove challenging for insurers running contract based plans to engage with members and ensure they move their amassed pots to the most appropriate funds, since existing savings cannot be switched to a new strategy without the member’s permission.

Seed says: “That is a big problem if the scheme has a lot of people aged over 55 who are already gliding towards the wrong place.”

DC saving became far more attractive post-Budget but the new appeal could be pretty limited if outdated investment strategies mean members find they can’t take advantage of life outside annuities.

Once again the focus must be on member engagement to keep DC saving on track.