Report highlights wide variations in similar default strategies

Similarly labelled default strategies are delivering very different results, and actively managed schemes are being beaten by passive funds, according to a new report from PensionDCisions.

The research also shows that pension consultants have widely differing views on equity exposure and fund choice range.

The survey of 43 large employer-sponsored schemes shows wide variations in regional equity allocations. No plan uses a straight global equity index and 60 percent of plans benchmark themselves against a bespoke combination of a UK index and a World ex-UK index. The remaining 40 percent create individual benchmarks that reflect their own decisions on regional equity market allocations.

Home bias, in terms of allocation to UK equities, varies significantly, according to the survey. For example, clients advised by Mercer have an average UK allocation of 55.8 per cent compared with an average of 47.0 per cent for Watson Wyatt advised clients.

Passive funds achieved annualised returns of 7.3, 13.7 and 14.4 per cent over one, three and five years, compared to 6.4, 13 and 13.6 per cent for active funds, according to the PensionDCisions default investment strategy survey of large employer scheme. Figures relate to the period ending on December 31, 2007. The survey’s sample contains only a few active default funds with 5-year track records. Higher fees accounted for some of the under-performance of active managers. The average fee for active funds is 0.51 per cent compared to 0.20 per cent for passive funds.

On average, the survey finds some 80 per cent of members are in the default investment option which, in more than three quarters of the plans, allocates members’ assets entirely to equities in the initial stage. Approximately two thirds of respondents would like to reduce the number of members invested in the default strategy. Plans with an all cash or bonds default strategy have the lowest default rate at 22 per cent, followed by multi-asset strategies at 72 per cent and equity strategies at 84 per cent.

Compared to last year’s survey there was a net increase in the number of plans wanting to reduce dependence on the default option.

The survey comprised a majority of trust-based plans. Contract-based plans tended to have a much higher range of choices – an average of 50.2 versus 13.4 for trust-based, a lower employer contribution of 7.2 per cent compared to 7.8 per cent for trust-based, a higher incidence of active management and a higher investment management fee of 0.51 percent versus 0.23 per cent for trust-based.

There are a significant variations in how lifecycle mechanisms are implemented with de-risking typically starting at 5 or 10 years prior to retirement. Strategies vary significantly across investmentconsultants, with the average de-risking point for Hewitt advised clients at 6.8 years, 7.8 years for Mercer advised clients and 9.0 years for Watson Wyatt advised clients.

The median number of fund choices is 11. Breaking down by investment consultant the mean is near identical for Hewitt and Watson Wyatt advised clients at 10.7 and 10.8 respectively, which contrasts starkly with Mercer clients who are offered 19.5 choices on average.

Graham Mannion, managing director of PensionDCisions says: “The market for DC services is opaque. Neither employers nor individual members have access to the facts necessary to assess objectively whether their DC arrangements represent good value.

“Many defaulters do not appreciate the implications of how their money is invested and do not feel responsible for the outcome. Employers face long-term risk from this gap in expectations. Creating a baseline of employee awareness and responsibility is prudent and achievable”.