New research has found that trustees think DC investments lack the sophistication of DB strategies. But should we be aiming for more intricacy? Or will we just end up over-complicating things? Sara Benwell explores
Forty-two per cent of defined contribution trustees believe that DC investment strategies are not as sophisticated as those found in DB, new research has shown.
The study, carried out by Hymans Robertson, found that half of trustees think it will take DC at least ten years to catch up with DB – while the other half say it will never happen at all.
Raj Shah, Head of DC Investment at Hymans Robertson said: “The results of our research make it clear that DC strategies fall behind DB in terms of sophistication.”
The scheme size dichotomy
The lack of access to more innovative solutions is particularly pronounced among smaller schemes.
However there is some evidence that larger schemes are starting to make some progress. Nigel Aston, global head of DC proposition and strategy at State Street Global Advisors points to default design as one area where DC schemes have improved their offering.
He said: “The lag in making DC investment solutions fit for purpose was a natural result of the need to cope with the administration challenges of auto-enrolment first. Scale is important and we now see the larger and more progressive plans looking to beef up their default offerings.
“We’re seeing great strides forward from our clients in terms of ESG, smart beta, alternatives, volatility management and diversification generally.”
However, despite these improvements, there are still areas where DC schemes are struggling to make progress. And even the largest schemes lack the purchasing power that DB schemes have. Part of this is a problem on the side of providers though. Until DC schemes get substantially larger, there’s not enough demand for more complex strategies.
Shah said: “The sheer scale of assets enjoyed by DB schemes provides them with greater scope for sophistication and innovation, so much so that even the largest DC trust schemes that exist today would struggle to enter into the same investments.”
Should trustees be seeking more sophisticated investment strategies?
It may sound like DC investments have a long way to go. But experts have stressed that it is important that trustees do not overly complicate things.
Richard Butcher, managing director at independent trustee firm PTL said: “DC trustees should not seek sophistication for the sake of it. A simple strategy can be appropriate. It’s a question of what’s better value for money: More expensive sophistication or lower cost simplicity? Each scheme should have its own view.”
Aston said: ”Whether DC defaults will (or even should) reach the same extreme levels of intricacy as DB is up for debate. Transparency is critical in a consumer centric-environment. If you make DC as complicated as DB there is a danger it will get more expensive, more complex and result in poorer value.”
Steve Delo managing director of Pan Trustees agreed that trustees should not be trying to ‘catch up’ with DB developments. He argues that much of the innovation in defined benefit investment strategy is driven by schemes’ need to manage liability risk.
He said: “I think trustees of DC schemes should be doing what is expected of them - to analyse their membership, try to pin down any specific needs or trends, think about the likely retirement journey members will go on and use all this to construct an investment pathway that delivers the elusive ‘value for members’.”
That is not to say that in some areas more sophistication (or diversification) would not be welcome. In particular, an emphasis on daily trading means many DC schemes feel locked out of illiquid assets, an asset class which seems to be a good fit – on paper at least – for the return profile required by long-term DC investors.
Delo added: “Whilst [the charge cap] may be restrictive when trying to access some of the potentially viable illiquid/contractual cash flow investments now on the market, it has choked off some of the worst historic practices in DC of expensive investing in doomed active funds.
”The need for daily pricing for admin purposes does suggest that larger schemes - and master trusts - will be better placed to access certain emerging investment opportunities. The question will, of course, be what that extra investment sophistication brings to the typical DC member compared with the simple, largely passive solutions readily available at decent cost to DC schemes.”
The importance of getting the strategy right
Whether you’re looking at complex instruments or simple passive funds, it’s critical not to lose sight of what the overall investment strategy is.
It’s all too easy to get caught up in exciting new innovations on the one hand or simplicity and low cost on the other and end up forgetting what you’re trying to achieve. Instead trustees should be using a blend of approaches that best match their specific scheme membership’s needs.
Butcher explained: “The process is the same whether simple or sophisticated. Do your research (understand the members – their demographics etc), determine your investment objectives (return, volatility, liquidity and cost) find the tools needed to achieve those objectives, buy them. Trustees will, of course, need advice as part of this process – but beware the advisor with an agenda. The FCA found consultants have a vested interest in complex solutions.”
Claire Felgate, head of UK DC at Blackrock added: “The first step is to be clear on what the schemes objectives are.
“For example, If the scheme decides that the objective for the early stages of the glidepath is all about maximising growth within a tight budget then perhaps moving to a multi-factor index solution will meet that objective. If there is a requirement to protect capital as members approach retirement then assessing current risks and spending a bit more on a diversified and outcome orientated portfolio may be the best solution.”
Dealing with regulatory constraints
Of course, in a charge-capped world cost will always be a constraint – both in terms of what trustees can afford to do, and in terms of how those strategies are deployed.
And its important that schemes look beyond investment when it comes to evaluating costs. Trustees and IGCs must look at administration, member communication, governance and investments in turn and assess the value members get from each of these cost allocations.
Felgate said: “We are moving in the right direction with value for money but I would caution clients to think about the outcome they want to achieve and how they can do this cost-effectively rather than simply the cost in isolation.
“Most DC products are in pooled fund format so even small DC schemes can benefit from the investment ideas, scale and cost efficiency of these funds and I think they would be surprised at what they can get for their budget.”
A checklist for determining investment strategy
- Decide first on what the priorities and desired outcomes are
- From this define the investment strategy
- Look across the market to see what solutions are available to meet these objectives
- Evaluate costs looking at investments, administration, governance and communications
- Establish whether new innovations can better meet objectives in a cost-effective manner
- Blend solutions as necessary, keeping value for money front of mind