The debate has been running for a while but now target dated funds are truly manifesting themselves in the UK market. This investment approach looks like it will be adopted by the Nest Corporation for the new National Employment Savings trust. From recent statements made by Mark Fawcett, chief investment officer for PADA the main features of the Nest investment offer will be:
- 1. Target dated funds invested in corporate bonds and cash in the first 10 years
- 2. A funds of funds model across up to 40 different target date funds
- 3. Possible use of capital guarantees close to retirement
This appears to be a sound decision, given who Nest will be targeted at and the need for a paternalistic approach. We have already seen this from government in terms of the mandatory lifestyling approach for Stakeholder. For many who take part in Nest there is likely to be very little other pension provision and the main objective is likely to be annuity purchase at retirement. Therefore the membership will be keen to mitigate risk for their main retirement planning vehicle. The proposed design of the investment offer will certainly be relatively simple to communicate.
Some are concerned about the lack of diversification in the first 10 years but the approach being discussed reflects this paternalistic attitude and ensuring early Nest investors are not put off by market volatility possibly resulting from equity investment. The main issue will be for older Nest members who may suffer in terms of the lack of diversification and muted returns. Combined with the total minimum contribution of 8% which we know is not adequate to provide other than a sustainable retirement income in retirement, the annuity outcomes for this segment could be very poor.
I mentioned before the target date fund approach will be easier to communicate and to all intents and purposes it starts to look a little like DB investment. However the lack of flexibility if members do change their minds about retirement may cause issue. Also, the recently announced charging structure also implies the provision of capital guarantees closer to retirement may be difficult to support.
As we have seen from government-backed pension initiatives before, the outcome can drive behaviour elsewhere in the UK pensions market. This can benefit other pension savers but I would suggest that the Nest approach to target dated funds should not be the model for the private employer-sponsored UK pensions market. Why? Lack of diversification is one reason and there are already target-dated lifestyle strategies available in the market. These provide risk-grading, rebalancing and governance to make sure they are fit for purpose as the member moves towards retirement.
These target dated strategies offer greater flexibility than target dated funds but given the increase in life expectancy and longer working lives, this could be further enhanced. Member communications could be introduced in the transition to retirement allowing members to consider their options say at 10 and 5 years to selected retirement age. This would allow a member considering drawdown to change their strategy to allow a ’through’ glide path to death rather than retirement.
Also, if the rumours of a change to annuitisation rules in the UK do come true then this strategic approach will become more and more important for the non-Nest segment of the UK pensions market.
Ann Flynn – Head of Marketing Communications, Corporate Pensions, Scottish Widows