Default performance ratings – huge range of member outcomes revealed

Millions of pension savers are being exposed to massive differences in risk, equity exposure, asset allocation strategy and performance because of huge variations in the structure of providers’ defaults, a new report from Punter Southall Aspire reveals.

The report says some providers are taking too much risk for the level of return they are seeking, while others are excessively cautious for the growth phase of a default fund.

While Scottish Widows’ Pension Portfolio 2 Pension Series 2 achieved some of the highest three-year returns of the nine private sector defaults covered in the report, it was singled out as taking an excessive level of risk to achieve that return. The fund had a three-year annualised absolute risk of 10.2 per cent, higher than the MSCI World’s sub-10 per cent risk rating, yet had achieved lower returns, of 10.2 per cent, compared to the MSCI’s 15 per cent return, despite taking that higher risk, says Punter Southall Aspire.

The Zurich Passive Multi-Asset (V and IV) fund was the best performer over the three years to June 2017, with an 11.8 per cent annualised return, but it too had a relatively high level of risk of 9.3 per cent.

Fund Annualised 3-yr performance (%) Annualised 3-yr risk (%) Sharpe ratio
Aegon Default Equity & Bond Lifestyle Pn 11.40 8.75 1.26
Aviva Diversified Assets II Pn S6 10.37 8.25 1.21
Fidelity Diversified Markets Pn 9 N/A N/A N/A
Friends Life – FL My Future Growth Pn 11.56 7.99 1.40
L&G Multi Asset PMC Pn 3 10.36 7.34 1.36
Royal London Governed Portfolio 4 Pn 9.30 7.01 1.27
Scottish Widows Pension Portfolio Two Pension Series 2 10.73 10.24 1.01
Standard Life Stan Life Active Plus III Pn S4 6.51 5.22 1.17
Zurich Passive Multi Asset IV Pn CS1 11.87 9.32 1.23

Standard Life’s Stan Life Active Plus III Pn S4 default meanwhile sat at the opposite end of Punter Southall Aspire’s three-year risk/return matrix with the lowest absolute risk, 5.2, but also the lowest three-year absolute annualised return of 6.5 per cent. Standard Life responded by saying that over five years its fund had achieved annualised returns of 9 per cent.

Friends Life’s My Future Growth fund had the highest Sharpe ratio, at 1.4, with Scottish Widows having the lowest at 1.01.

Differences in funds’ exposure to equities was found to be huge, with Scottish Widows’ default having the highest exposure at 85 per cent, while Legal & General’s Multi Asset fund had the lowest at 45 per cent of its total asset allocation. The average allocation to equities amongst the defaults was around 62 per cent.

Default options were found to hold an average of 26 per cent on average to fixed income, with Legal & General and Fidelity’s Diversified Markets fund having the highest allocation, both with 47 per cent, while Royal London have the lowest exposure with 0 per cent.

Providers with their own asset management arm – Royal London, Standard Life, Fidelity, Aviva, Legal & General – have developed the more diversified and sophisticated default offerings says Punter Southall Aspire, because having their own in-house asset manager means these organisations tend to be better resourced in terms of economists, strategists, portfolio managers and specialised analysts.

Most of the defaults do not use alternative investments such as commodities, property and absolute return strategies due mainly to cost constraints. The average percentage of the overall allocation to alternative investments within the default funds is almost 6 per cent, with Standard Life and Royal London’s Governed Portfolio placing the highest weights at 21 per cent and 19 per cent respectively.

Average allocation between UK and non-UK assets was 27 per cent and 73 per cent respectively at the time of the survey, with Aegon’s Default Equity & Bond fund and Zurich’s default having the highest concentration in the UK region with approximately 50 per cent of their total assets.

Friends Life, Scottish Widows, Aegon and Zurich were all found to employ a limited range of asset classes, with Zurich using the least, at four. L&G, Fidelity, Royal London and Standard Life took a more diversified approach incorporating commodities, high yield, property and other alternative investments alongside the traditional asset classes.

The report differentiated Royal London, Standard Life and Fidelity for their use of active underlying funds, with the majority only using passive components. Being more expensive than the passive funds, actively managed funds are targeted to deliver higher returns than their corresponding benchmarks, along with greater downside protection due to their tactical management.

Punter Southall Aspire says that providers such as Zurich, Friends Life, Aegon and Scottish Widows should involve a tactical active asset allocation approach to benefit further from market inefficiencies.

Punter Southall Aspire managing director Steve Butler says: “This research identifies a group of defaults that are getting the right level of return for taking the right level of risk, but also highlights that there are some funds taking too much risk for the return they are getting, while others are being too cautious.

“Scottish Widows is taking more risk than the MSCI, but without getting more return. It has done well though, so that makes having a conversation with the client about it a difficult one. Standard Life’s 45 per cent equity holding on the other hand is not taking enough risk for a growth phase fund, although we like its diversification and its tactical approach.

“Some funds that say they are being actively managed are not being that active. We found one fund that had only made active allocations twice in three years – there is a certain amount of window-dressing here.

“What this report shows is that employers or trustees need to do a proper review of their defaults every three years to make sure they are doing what they are supposed to.”

A Standard Life spokesperson says: “Performance by itself will not really tell our story very well as Active Plus III is much more diversified and takes less risk than competitors. So over the last year or so, when equity markets have performed very strongly, more concentrated strategies with relatively high levels of equity exposure will have done better. However, in other environments when equities – which are currently at historic highs – do badly, Active Plus III is more likely to outperform. Our approach is supported by research around customers’ attitude to risk and a desire to reduce the likelihood of customers opting out or stopping paying into their pension after experiencing a large loss.”

Scottish Widows head of fund proposition Iain McGowan says: “This research focuses only on the portfolio offered by Scottish Widows up to 15 years before retirement. From this point, we gradually reduce the equity proportion and the level of risk as the member approaches retirement. Our Pension Portfolios offers access to equities and bonds in various proportions. In normal market conditions, we would expect this to result in less risk than a global equity index, such as MSCI World. However the comparison is made over a period where global equities have generated high returns in unusually stable markets.”