There are drawbacks to target date funds

The Budget has sounded the death knell for the investment world as we know it. Industry commentators have recognised that lifestyle strategies, which are predicated on people buying annuities, have been rendered irrelevant by this year’s Budget.

Hargreaves Lansdown estimates that £165bn is invested in lifestyle strategies. That comprises three-quarters of the entire pension default fund universe.

Unsurprisingly, Tim Banks is ready to dance on its grave.

Banks is managing director of sales and client relations at Alliance Bernstein and a long-time proponent of lifestyle’s arch rival, target date funds.

Every single lifestyle in the UK will need to be reviewed and in all probability, most of them changed

“In our view, every single lifestyle in the UK will need to be reviewed and in all probability, most of them changed,” he said.

Lifestyle strategies are predicated on people buying annuities, and its rather abrupt demise was triggered by the Treasury’s decision to liberalise at-retirement options, giving people the freedom not to buy an annuity with their pension pot at retirement.

What will replace it?

Target date funds, which allow savers to choose a ‘retirement window’ instead of a particular date, are a hot contender. Alliance Bernstein has been shouting about them for years. Nest uses them, and anything the soon-to-be DC monolith does is likely to be followed. J.P. Morgan Asset Management recently launched its own offering.

Few would dispute that target date funds are less well-developed in the UK than in their US birthplace.

“Most [US target date fund] models have a through-retirement option which effectively is all about retaining the real value of your capital beyond retirement,” explains Robert Higginbotham, head of global investment services at T. Rowe Price, an investment management firm with a large US presence.

Tim-Banks__WEB_READY

Tim Banks, Alliance Bernstein

In the US, target date funds typically leave pensioners 20-40% invested in equities through retirement. “We are at the 40% level typically in our default retirement date fund,” says Higginbotham.

“If you go much below that, you may be able to draw 5 or 5.5%, but you’re effectively less likely to be able to retain the value of your capital for 20-30 years and therefore you run the risk of running out of money.”

My 90-year-old mum just gets a pension each month – she doesn’t have to worry about the ups and downs of the stock market

However, with its market dominance, lifestyle may yet adapt and fight back. Target date funds are not as well supported by UK law. In the US, the 2006 Pension Protection Act, which gave protection to employers who choose an auto-enrolment investment fund on their employees’ behalf, gave impetus and legitimacy to target date funds.

Ian Price, head of pensions at St James’s Place, offers a good argument against relying on a pension that remains up to 40% invested in equities. “My 90-year-old mum just gets a pension each month – she doesn’t have to worry about the ups and downs of the stock market.”

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