DC can’t go on like this

With DC assets set to triple in the next 10 years, fund managers understand they are going to have to up their game. Simon Chinnery, incoming chairman of the DC Investment Forum and managing director, head of UK DC at JP Morgan Asset Management believes the time is ripe for creative thinking.

Simon Chinnery, JP Morgan Asset Management
Simon Chinnery, JP Morgan Asset Management

With its clunky lifestyling, lack of diversification, missed investment opportunities and crudely set targets, most observers agree there is room for improvement in the way the nation’s retirement pots are managed.

Fund managers and investment consultants have until recently devoted considerably more time to the world of defined benefit pensions. But with DC assets set to overtake those in DB in the next three or four years, and auto-enrolment set to supercharge that transition, asset managers are wising up to the need to offer something better to the DC market. 

It is against this backdrop that seven fund managers – Axa Investment Managers, Baring Asset Management, Invesco Perpetual, JP Morgan Asset Management, Schroders, Standard Life Investments and Threadneedle Investments – have come together in the Defined Contribution Investment Forum (DCIF) to share thinking and develop strategies for offering better solutions to the eternal retirement funding conundrum.

Taking over chairmanship of DCIF this month from Andy Dickson of SLI, JP Morgan’s Simon Chinnery wants to see the investment management community fully come to terms with the change that the switch to DC brings. For Chinnery, a former ballet dancer and a painter, that will require a more thoughtful approach.

“The DCIF came about because we didn’t think DC investors were getting the best deal,” says Chinnery. “And this is why our Mind the Gap report came about.”

This report, published by DCIF last month, argues that daily dealing is limiting investment options in DC pension schemes, which is in turn ensuring investment options are inferior to those available to DB funds.

“What is it about DC that says you have got to have daily liquidity? Several people said, ‘its what you have to do’. But when you start digging in you find out there is no regulatory requirement. It has actually grown out of an administrative function. The life companies have said ‘we have all this money coming in but we don’t want to be left holding it, so we will invest it on a daily basis’. This was fine when it was being allocated to a balanced fund or something similar. But if you look at what DB are doing investing across a wide area of asset classes, why wouldn’t you apply the same thinking for DC. We can’t take our money out for a long time, so why shouldn’t it be invested in long-term assets?” he says. “When you look at DB the conclusion you come to is there is a benefit in doing things this way. Then you look at DC and it feels like it is coming out of the Dark Ages.” 

While few would argue that change is needed, how are pension consultants and employer pension managers supposed to understand which of the new breed of defaults are any better? Chinnery says before defining better, we need to define what success looks like.

“We have a growing attention to how you measure the success of DC. It is not as straightforward as DB where you have to grow the assets and hopefully have a surplus. DC is all the risk on the individual. 

“In the US we have done studies looking at the different types of asset class returns you can get from different DC decisions. So you have got target date funds, managed accounts and the DIYers. And the dispersion of outcomes of DIYers over a 3 year period is massive. Some people are brilliant and through luck or judgement get great returns, but there are an awful lot of people who do a whole lot worse, certainly when compared to a managed account or a target date fund. 

“So the key is getting them to a position where they can retire. Its not just about getting a big pot, and the luck of the draw depending on when in the cycle you joined, or the skill of one DGF manager versus another DGF manager. If you define how you can get most people over the finishing line by getting them over a minimum replacement income then at least that gives them the opportunity to retire,” he says.

So does Chinnery therefore think it unlikely we will see more alpha managers coming into the default space arguing they have a pretty good diversified growth fund that will do the job for the accumulation phase of the saver’s life?

“I think that is the wrong place to start. You may get more money at the end but you may not. If risk is all with the individual, they just want to retire. 

“Just bunging in random funds on the basis that they are there for growth and you can diversify from that, feels too much like playing roulette. Yes it might give you some diversification, but what is the point of that diversification, and how is that dynamically managed over a 15, 20, 25 year process? Because unless you manage that money over the period to which they are intending to retire, you are just in a fund that goes up and down with markets. It’s a different approach. 

“The consultants have started to think about the benefits of diversification with an outcome in mind. And it isn’t just maximising the pot. Its actually how do I get more people over the retirement line. 

“And for HR that is really important because otherwise you get a whole load of people who can’t afford to retire,” says Chinnery.

Chinnery says the pressure on so many employers to select a decent default fund may lead to some getting it wrong, particularly if, once traditional players’ capacity is reached, new pop-up providers appear with familiar-sounding brand name default funds that may turn out to be inappropriate.

“If people have got to buy something, there is a real risk they will end up in something sub-optimal and place themselves open to the risk of litigation years down the line. Especially for companies that have got to comply but haven’t got the time, the investment proposition has to come off the shelf. To some extent some DGF funds can say that they have been through hellfire and brimstone in the last few years and delivered in an  asymmetric way, which is basically jargon for saying they haven’t lost large amounts of money. But how do you put that in a sustainable mix for people who are going to be saving for the next 20 or 30 years?” he says.

“The key here is at the moment very few people are saving in DC. In 10 years time there are going to be a lot more people. From an adviser point of view, in the lack of tangible track records, advisers have got to see there is a way of putting someone into a fund that is managing a glidepath in a way that is dynamically managing that journey all the way along and not just a bunch of funds that are put together to meet a bunch of volatility measures that nobody really understands anyway.” 

And how can advisers and employer’s HR and pension departments tell the different DC default investment models from one another given the dearth of tools to help? 

“There are about 80 different TDF managers in the US. They don’t all have a glide path but you can put them in a compass and compare the more aggressive and less aggressive. And you also have the ‘to retirement’ and ‘through retirement’. 

“Right now we in the UK can’t compare because there is not enough history. But as we get towards the 16m new savers, as the weight of money in DC moves to be greater than in DB in 2017 or 2018, the focus not just from a scheme point of view but from a regulatory one will be how do we measure whether these funds are doing a good job for their members.The problem for the comparators is that with lifecycle funds you get a value each year and it may be more or less. 

“And then there are the questions such as what is a correct benchmark? Is it 100 per cent equities? Which indices do you use?” he says.

Simon Chinnery, JP Morgan Asset Management
Simon Chinnery, JP Morgan Asset Management

Given the eternal tussle between life offices and fund managers over control of assets, does Chinnery see consumers getting easy access to the best DC fund management solutions and if not should the regulator intervene to make access to pension platforms more straightforward?

“From an adviser point of view it is absolutely essential there is access. Otherwise you are going to find yourself being corralled into the first choice which will unsurprisingly be a platforms own products. That may be appropriate but it may not. From the DCIF’s point of view, we just want the best designed, best thought through offerings available to the widest number of people. And with the more advanced platforms that have the technology that can be more flexible about things like daily pricing, are genuinely open-architecture, they are the ones we will see the flows increasingly go towards.”

There are still issues to be resolved around charges, such as soft commissions, which do not look good for the reputation of the fund management industry when people understand what they entail. Investment Management Association chairman Daniel Godfrey is launching a drive to increase transparency around charges and Chinnery supports his goals.

“We can’t hide behind jargon. People are trusting us with their money. Pricing has to be as clean as possible. The more smoke and mirrors there are, the less trust there will be. That doesn’t mean everything has to be simplistic. 

As well as actually improving the way products, particularly default funds, operate, that also means understanding the psychology of the end users. To this end the DCIF has researched new ways of engaging with consumers, its paper Identifying new ways to engage with savers in Defined Contribution Pensions floating the idea of investment funds with a social objective. 

Chinnery says: “This piece of work was all around saying we have auto-enrolment, with the PPI predicting 16m DC savers by 2017, and yet we have also just been through a whole load of anti-capitalist protests, with the Occupy movement amounts others. So we asked what would incentivise  people to save and commissioned a report from Movement which found a reasonable proportion said they would be prepared to sacrifice some returns to invest in something they believed in.” 

Engaging with end DC investors is a potential growth market for advisers too, if the US is anything to go by says Chinnery.

“I am seeing a trend upstream from the adviser community going into  group Sipp, and then deciding the diversification being offered to management should be offered to everyone. 

“We have seen in the US the retirement planning market has mushroomed over the last 10 years. Because DC was never really institutional – which
was because DB was in the minds of the big managers – DC was retail, and it was the large retail distributors, the Fidelitys, the Vanguards, the T Rowe Prices, that went in and thought this is all about individual savings. 

“And because there is a whole weight of money coming off the 401ks now, that advice market is growing. In the next 10 years we will see a very strong growth in the retirement market towards retirement specialisation. RDR has been a catalyst for redesigning their business model and we have got a great opportunity to work in partnership in that space with the larger corporate advisers.”