Too much choice can be a bad thing for workplace pensions, says Stephanie Spicer
We live in times of great personal choice – what we wear, what we eat and how we spend our time. It stands to reason when providing and advising on pensions, clients and scheme members should also be offered choice as to where and how they save for their retirement.
No more nanny culture for the pension saver. But is that reasonable, and has choice served the pension saver well?
Pension providers and corporate advisers spend huge amounts of time engaging with clients and scheme members to get them to understand their options – but when it comes to the number of investment options on offer, can you have too much of a good thing?
Scheme members are offered an array of different choices when it comes to company pension schemes. Whether to join at all, how to join, what to pay, what to invest in. All of these issues must be addressed, but delegates at the Corporate Adviser/Axa round table, DC pension investments: a time for change, asked the question how much choice does the average pension scheme member need when it comes to the range of investments put before them.
Only a few years ago greater choice was the watchword, and that trend has seen pension investment options stretching into three figures for some personal pension products. Default funds have been criticised for years in the national press, and group Sipps have taken the idea that choice is good to its logical conclusion.
Now some argue that default options are maturing and evolving to the point where they should be the obvious selection for the great majority of employees.
Mark Rowlands, head of consultant relations at Axa Corporate Benefits, argued that if pension scheme members are confronted with too many funds they get confused.
“We have seen academic evidence that says the more funds you offer the greater the member participation falls because too much choice creates fear of making the wrong decision. This in turn leads people to make no decision at all,” he said.
“So the answer is to create an appropriate number of choices and one of the areas that is evolving is instead of providing individual funds from individual managers there will be an emergence of investment solutions which consumers and members of pension schemes will invest in and someone will be responsible for managing and maximising the investment return. So one trend we should see is a move away from lots of individual funds to solution-based funds which will be a combination of funds blended together to create a solution for members.”
Rowlands argued that there are different ways this blending could be achieved. “It could be done by us as the provider, by a third party with the right investment regulatory permissions which could be the investment consultant, it could be done by a boutique fund manager or any fund manager. Trustees could put them together but they would need advice from the right people. So there would a combination of people doing it provided they have the right skills, knowledge and ability to execute it.”
Andy Cheseldine, consultant at Hewitt Associates, made the point that it makes little difference, in terms of take up, how many funds are offered, but agreed that too much choice gets in the way.
“It is an extra cost in terms of governance and communication and it doesn’t particularly help the members. The trend I think will be polarisation which will move more towards 90 per cent going into the default and a slightly separate communications solution with 10 per cent seeking something different.”
The matter of choice does not just concern how many funds are on offer however, according to Katharine Photiou, principal at Mercer. She said the industry also has to think about how to make it easier for members to choose funds.
“Some of our research on how to make it easier for members showed that they found it easier if there was one fund, so an obviously limited choice. But they also found it easier if the names of the funds were simplified and if the names of the managers were removed, that also made it easier to select. Another factor was if a short, concise summary about the fund was provided. So it is not just about restricting the choice but making it easer for members who are amongst that 10 per cent who want to choose.”
Rowlands said: “Vanguard looked at a million customers for their 401 k and analysed their investment decision making. Those who self chose reduced their fund value by 20 per cent. They made naive investment decisions, they chased performance, they screwed up the asset allocation. At the end of the day if you give members choice they will do worse than professionally balanced portfolios performed.”
How any choices are implemented once they are actually made is also important according to Jon Pearce, managing director of marketing and communications company Ferrier Pearce. “When scheme members come to make their fund choice we should aim to make it simple, providing straight through processing, so they can make a choice, make a click and it is done. They should not have to fill out forms to make it happen,” he said.
“Generally most scheme members don’t need to worry about what is going on in the background. There are 10 per cent of people who perhaps work for financial institutions who may understand how it all works and they may want to try and beat the market but most people just want an easy choice and for it to happen quickly. It is all about education and making them more comfortable.”
Professor David Blake, director of the Pensions Institute, argued the industry is doing more than it needs to in offering any choice over funds at all because most people don’t want to understand what a fund is – rather they want to know what it is going to do for them.
“They want to know the outcome at the end of the investment stage,” he said. “They want to know the potential income they are going to get in retirement and they want some certainty over that. Whatever the pension vehicle is it has to try and deliver that. The worst thing about defined contribution is people with the same salary are putting in roughly the same amount of money into the pension funds but experience big variations in incomes when they retire within only two or three months of each other.”
Blake said what people really want is a final salary, defined benefit type pension plan, of the sort that can no longer be delivered in the way it has been by private sector employers in the past, he added. While defined benefit is unaffordable, the industry has to try to get the defined contribution model to replicate it as closely as possible.
“People don’t like big cuts in income or going from being in control with a high salary just prior to retirement and then experiencing a big cut after they retire because they haven’t been informed about the contributions going in,” he said. “So we as an industry should focus on the outcome and what the funds can deliver.”
Delegates felt the industry is increasingly going down the route of making it unnecessary for scheme members to have to make too many choices, if not limiting choice altogether. Gary Smith, senior investment consultant at Watson Wyatt, says the industry is definitely seeing the emergence of more pre-packaged investment solutions rather than guiding individuals towards putting their own investment portfolios together themselves.
“Certainly scheme fiduciaries are actually creating those pre-packaged solutions now and delivering those to schemes and managing those much more effectively with the assistance of corporate advisers,” he said. “And providers are also starting to push those solutions. I think by far this is the right evolution and the right way to go.”
However, the risk of doing too much of the thinking for people is that they will not only happily absolve themselves of any responsibility but also look to blame someone else should something go wrong.
Will Allport, director, product strategy, UK & Ireland for AllianceBernstein, thinks the popularity of default funds and the implicit advice embedded within the default fund is particularly important, especially for those who might want to opt out of using the default fund to make their own choices.
“The journey for them going from using the default funds to making their own choices has to be very clearly recorded, in the sense that if the default fund has been well constructed by provider, investment consultant, trustees and/or employer, then that is likely to be the best option for the majority of members,” Allport said.
“If a member then says they want to make their own choices it is critical you record the fact that they have declined the default fund. When you consider the way people who do make their own choices behave and the performance they get within their investment portfolio, it is fairly worrying. Individual investors chase performance. No matter how many disclaimers we stick on investment products they just do. You only have to look at the mutual fund flows versus the FTSE over the past decade. It is staggeringly clear that people buy high and sell low.”
Choice may be a valuable commodity but without care it can prove much too expensive.