The ultimate testing year

Millions of employees in DC default funds have seen their pensions slashed in recent months. Paul Farrow finds out how well the Corporate Adviser Ultimate Default Fund shortlist has fared

The importance of picking the right default fund cannot be underestimated. Until the British public shows the same appetite for choosing their investment funds as Americans, advisers, employee benefit consultants and trustees are going to have to make the right choice on their behalf. Because despite attempts to educate the workforce, the vast majority of employees simply tick the default box without a clue about the fund they are investing in or the manager they are entrusting with their life savings.

In the past a bog standard balanced managed fund, on paper, would have ticked all the boxes. After all, they claim to invest in a spread of assets. But the extent of that diversification has been called into question in recent years. Besides, the diabolical performance of many of the biggest funds is an embarrassment to the pensions industry, doing little to instil confidence in employees that their pension will deliver a decent result by the time they pick up their gold watch at 65.

This time last year, eight funds were nominated for the Corporate Adviser 2008 Ultimate Default Fund award. They were chosen on the basis they would be overlaid with a lifestyling process.

Twelve months may not be a suitable timescale for investing in equities, but short term performance figures are important to sponsoring employers. We catch up on how they did and whether the advisers that were bold enough to nominate them last year are happy with their choices, or whether they are hanging their heads in shame that they ever let the name slip from their lips.

corporate adviser november 2008corporate adviser november 2008 Performance -40%

This fund is the original ethical fund – it was the first fund that shunned stocks if they were associated with industries such as tobacco, brewing, armaments, oil or pornography. Where it started others soon followed.

To be nominated is no mean achievement. Ethical funds have been disregarded by many in the DC and GPP arena. Slow take up is demonstrated by the fact that Fidelity only decided to put its first ethical fund on its pension platform in 2005. The fund? F&C Stewardship. It is the lone green card on the platform to this day.

Up until 18 months ago the Stewardship fund was drawing attention – it had climbed to the top of the performance tables, which was a kick in the teeth for the green cynics. But in the past year or so it has struggled – many of the sectors it avoids on moral grounds, such as tobacco, have fared better than others.

Michael Whitfield from Thomson Online Benefits says the timing of his choice was unfortunate. “I picked a fund for the long-term and not for the credit crunch. Not only have equities bombed but also Friends Provident’s disastrous abortive deal with Resolution has conspired to make this look like a dead duck. Performance last year was poor and I was obviously unhappy as a result.

“But I think the principles of the fund were and still are fundamentally sound. But until the uncertainty surrounding Friends has been resolved I would find it very difficult to recommend it at the moment. If I were nominating a fund this year I would probably be a little more conservative and look at something like AXA’s Retirement Distribution Fund.”

That said its long-term track record suggests that if you are going green, this is a fund that should at least be on your radar.

Performance -27%

This is a mix ’n match active passive fund with the bias toward tracking (75 per cent is passively managed). The so-called Universal Lifestyle Collection lifestyle fund uses a two-stage investment process. In the first stage it aims to build the pension fund over the long term.

Then in the second stage, as the employees chosen retirement date approaches, it looks to help protect the fund’s annuity buying power, as well as taking into account the tax-free cash entitlement.

As retirement approaches, in this case six years from the chosen retirement date, the fund will be switched, systematically and progressively, into long gilts and, in the final two years, cash (to provide the maximum tax-free cash entitlement of 25 per cent). These switches happen automatically every month.

Douglas Chrystie who nominated the fund admitted that by definition this fund is unlikely to offer stellar out- or under-performance. True to his word the fund has performed adequately, which, given the state of the market is about all you can ask.

Performance -33.6%

Vocal adviser Hargreaves Lansdown has been championing this fund for some time – not surprising given its fee, which is just 0.8 per cent a year.

This fund is an old fashioned fettered fund of funds – in other words it only invests in in-house funds (around 14 of them) – hence a cheap total expense ration. It also has the benefit of having some highly regarded managers at the firm such as Richard Buxton and Andy Brough. Andrew Yeadon, manager of the Schroder Balanced Managed fund, says that “we have this depth, particularly in the UK and Europe”.

That said the fund has struggled this year. But Tom McPhail, the fund’s tipster, remains defiant and is happy with the choice he made last year highlighting that even corporate bond funds have taken ’a hammering’.

“Any default fund can only be a ’least-worst’ option for DC pension investors. We firmly believe that the very best answer for DC investors is for the members to receive sufficient information and guidance to be able to engage with their retirement investments and to make active decisions,” says McPhail.

“The fund has marginally underperformed the sector average over the past 12 months, but the longer term figures are still overwhelmingly positive, so I’m still happy with both the type of fund selected and the fund group and manager. The fund’s investment mix should benefit from the relatively cheap equity valuations, looking through the recession to the hoped for recovery in investment markets.”

Performance -17.3%

Standard Life’s Balanced Profile offers a combination of their Managed and Cautious Managed funds. The investment strategy lowers the equity exposure as retirement approaches, and it is good value – there is no additional charge to the scheme based-annual management charge.

A fall of 17.3 per cent for the year to the end of September seems credible, but that underperformed the sector average of minus 16.5 per cent – although, to be fair, it is the first time it has underperformed the average in five years.

PIFC Consulting who nominated the fund says it recommended the fund as a default because a default’s primary purpose is to provide those members of a group pension scheme who do not wish to actively make their own investment decisions with a spread of assets for growth over a period of long-term regular saving.

“The Standard Life Pension Managed One fund, as part of its Balanced Profile strategy, successfully met all our primary requirements,” says Robin Hames, at PIFC. “Over the short term, the fund has fallen in value, which is to be expected in current market conditions. Due to its spread of assets, it has not suffered as greatly as a pure equity fund and has, overall, performed in line with our expectations given its overall risk profile.”

Hames says the financial crisis would not make a jot of difference for his choice in the future and that he would be happy to nominate Matt Savage and his team at Standard Life again.

Performance -21%

BGI is a name synonymous with pensions and, along with L&G has cornered the passive fund market. The DC and GPP market just can’t get enough of the passive brigade, their low charges and benchmarked performance. That made it the Corporate Adviser readers’ choice for the Ultimate Default Fund a year ago.

The BGI Global Equity (50:50) Index fund invests primarily in equities, both in the UK and overseas markets, with approximately 50 per cent in the UK and 50 per cent overseas, split between the US, Europe (ex UK), Japan and the Pacific Rim.

Given its passive stance, the fund has mirrored the performance of global indices and has suffered a hefty loss.

Martin West, from Gissings who nominated last year’s winner is happy with his lot so far, reckoning that its exposure to different economic regions which has helped performance relative to their active counterparts. Being a passive fund has also helped compared to the active funds, many of which appear to have been impacted by the performance of financial and Energy stocks, he says.

“The down turn has been particularly marked over the past six weeks. The fund’s three and five-year returns are firmly in the second quartile. It must be remembered that the default has a five-year lifestyle attached to it. I am happy that this fund remains an appropriate default.”

Performance -15%

Target return funds have had their fair share of bad press – and in many cases it has been deserved. Several funds in this new breed have disappointed to say the least, but one or two (BlackRock UK Alpha, for example) have begun to show the industry what they can achieve.

This fund aims to match long-term stock market returns, which on average have beaten cash by 4 per cent a year – all with lower volatility of course. The objective of trying to deliver positive returns irrespective of market conditions has won over many pension providers – James Hay, has put them on its Sipp platform for instance. But it has been caught out by the credit crunch in the short-term – hence the ’aims to match long-term stock market returns’ caveat in its literature. The fund has fallen 15 per cent over the past 12 months. It has been undone by its 20 per cent weighting in financial related corporate bonds, which were sold off heavily.

“One of the Fund’s objectives was to produce positive absolute returns over any calendar year period and clearly the manager is disappointed not to have maintained his record of doing this, given that most asset classes have fallen over the last year as the global credit crunch has impacted on all areas of business,” says Scott Wylie, investment manager, Kudos Independent Financial Services. “While I continue to like the concept of a diversified portfolio of shares, bonds, property, cash and other instruments I believe that over the longer term the fund will outperform cash. With a slowing economy which is arguably in recession at present, I would be inclined to remain invested in a combination of cash and gilt type funds were I to be selecting a new default fund today.”

Performance +1.5%

This fund has to be on the odds on favourite to clinch the Ultimate Default Fund award for 2009. In a year when most funds have come down to earth with a mighty bump, CF Ruffer Total Return has delivered a positive return.

The fund has benefited from its avoidance of banks and consumer-related sectors. It also had exposure to Japan, which has performed in recent months. Other stocks that have performed well for the fund include Unilever and Canadian Oil Sands.

Adrian Coveney at Barnett Waddingham, who nominated the fund, had been familiar with Ruffer LLP for many years and with this fund, in particular. It has been attracted by its use of high quality, liquid assets such as UK and overseas government bonds. Funds are managed actively with a view to preserving capital and generating a return. Not surprisingly Mark French at Barnett Waddingham is happy with the year’s work. “Bearing in mind the market turbulence over the last 12 months, we have been pleased with the fund’s overall performance,” he says in an understated manner. “We are therefore confident that the fund remains an attractive option; particularly since volatility has been low since it was established eight years ago. Time will tell if the current crisis results in an inflationary or deflationary environment in future. In our view, much depends on the confidence banks will have when lending to one another which is a major determinant of the availability of credit to individuals and companies generally,” adds French. “But in our view, the Fund’s managers are aware of these and related issues. This bodes well for future prospects.”

Performance -23.6%

Diversification has become the buzzword in financial circles over the past three years. It hasn’t all been about the traditional asset classes of equities, fixed interest and property. To have a decent diversified portfolio you need to be able to get exposure to commodities, hedge funds and private equity. For example, Schroder Diversified Growth Fund uses ETFs to provide access to emerging markets.

It has won many investors over with its performance. The fund took over £1bn within 19 months having found favour among small and medium-sized pension schemes that don’t have the governance to invest in a wide range of assets directly.

But the diversified strategy has not been able to hide from the crunch and it is notable that the fund has made some changes, moving away from the hard hit emerging market and commodity sectors.

Chris McWilliam, senior consultant, Aon Consulting says the fund has been producing strong returns when compared with share indices but admits that it does not even come close to fulfilling its stated objective.

“Clearly, active fund performance is a moveable feast and we have taken a short term snapshot of its performance. We believe that this fund continues to be appropriate for a particular profile of investor. The most important aspect is to educate the scheme member sufficiently well so that they understand fully what they are buying when they invest their pension contributions in this fund,” says McWilliam.

“Given the falls in returns over the very recent period, we shall be monitoring its performance closely during the recession period. If the fund continues to be heavily weighted in global equities there may be further impacts on its performance and its ability to deliver its objective.”