Thw Question - Are today’s lifestyling solutions suitable for derisking the DC pensions of employees not gettingindividual advice?
Dr Ros Altmann, independent pensions consultant
Lifestyling solutions suffer from the disadvantages of any ’one-size-fits-all’ approach. It may work for some people, but it will not be right for all.
The problem stems from a misunderstanding of investment risk. Most investors do not understand how markets work or ’investment risk’. For them, the only risk they really care about is ’will I lose money’, rather than ’will I outperform bonds, or the stock market’.
There is no guarantee that investing in equities, even over the long-term, will definitely produce good returns. Theory only says that investors can ’expect’ to be rewarded for taking equity risk, but this does not mean all investors will benefit individually, only that on average this will happen.
For many people, their DC pension is not the icing on the cake for their retirement, it is actually part of the cake itself, because state pensions are so low. For those who want to be able to plan their later life income, guaranteed funds of some kind may offer them what they want, rather than just investing in the markets without any downside protection. It is really important that individuals are given the choice to diversify much more widely beyond just equities and bonds and also that they have some help in recognising whether they can afford to take losses at all.
Craig Rodger, consulting director, JLT Benefit Solutions
As a concept a default fund with a lifestyle programme moving to cash and long gilts is sensible. Scheme assets move during the lifestyle programme to a basis that matches the way most pension scheme will pay both cash and income to members. But having a one size fits all approach can be dangerous and we are starting to see more and more employers looking to provide a small selection of fund options catering for different risk profiles and age groups.
Although default funds have developed since stakeholder introduced them, my opinion is that more must be done to protect scheme members as retirement approaches. Most investment consultants would agree that asset allocation is the biggest factor in successful investing therefore default funds need to have greater flexibility over where they invest (e.g. can corporate bonds be used to provide increase returns) and when the lifestyle programme commences. Default funds need to keep progressing their derisking facilities and move into concepts such as liability driven investment for DC will eventually replace some existing fund options. More employers need to consider making independent financial advice available to employees in the work place prior to the point where lifestyling commences.
Clive Grimley, partner, Barnett Waddingham
Basically, you are damned if you do, damned if you don’t. There is no guarantee that the lifestyling structure will produce superior returns to other investment structures. At present this means that members in the lifestyling time period will automatically be selling equities at what we hope is a low in order to purchase cash and bonds, although this is probably a poor investment choice. But the absence of lifestyling will, in many cases, result in the member leaving their range of funds unchanged from the time they join the plan to the day before they retire.
In the US ’safe harbour’ legislation has been introduced which gives low risk takers the chance to invest in a simple non-equity plan. Many members may prefer the security of the promise of their contributions being returned with a low rate of investment growth and the term “reckless conservatism” has been coined to describe this.
But long-term dependence on low risk funds will lead inevitably to lower than anticipated outcomes.
The real solution is to relax the regulatory framework, allowing DC members to obtain limited investment advice and to choose from a limited number of investment funds within a DC plan. In advance of this, lifestyling may have to be maintained.