The right blend

Default funds need the flexibility to be able to continue to develop says Axa Wealth head of institutional distribution and marketing, corporate investment services Mike Webb

Default funds have evolved rapidly since being thrust into prominence with the introduction of stakeholder pensions in 2001. Back then many providers simply offered a single fund as a default that was then adopted by a myriad of employers, or as was often the case, shell schemes.

Twelve years on it now seems that for DC trust-based schemes, no two default options are alike as investment thinking and needs have changed dramatically. The Department for Work & Pensions has estimated that 11 million workers will be automatically enrolled into a workplace pension over the next five years, meaning that more and more people in the UK will be invested in a default fund.

Auto-enrolment will be one of the major catalysts in driving innovation in DC fund design. The implementation of auto-enrolment has been a challenge in itself for trustees, pensions managers and payroll departments around the country. With an increased focus on governance, both regular reviews of schemes’ investment and default options will become commonplace.

Inevitably, such reviews could lead to future changes in members’ default options. Therefore, one of the factors for corporate advisers to consider in the default design is the ability to make changes to the default option without disruption to members and administrators, at minimal cost.

Over the past four years, many corporate advisers have reviewed schemes’ default arrangements, frequently increasing the allocation to emerging market equities and/or diversified growth funds. Where default funds are provided via an investment platform through blended/white labelled funds, making changes is seamless for all parties.

Scheme members continue to invest in the same blended/white labelled fund and therefore see no change in unit holdings, scheme administrators see unit holdings remain unaltered, avoiding any need for reconciliation and trustees receive continuous performance reports for the blended/white labelled fund, reflecting changes in asset allocation and, inevitably, the benchmark as well.

As one delegate stated at a recent conference where I was presenting, a blended fund structure allows trustees and their adviser to “future proof the investment solution”.

A blended fund and/or white labelled fund structure can offer flexibility for transitioning future fund changes through a single stage or multi stage approach. With a single stage transition, an investment platform can ensure that out of market risk is mitigated by placing deals at the same market valuation point.

Increasingly, we are witnessing a multi stage approach to default fund changes, often utilising healthy cash flows to DC schemes. This can vary from using cashflow simply to gain an increased allocation to a particular asset class, such as emerging market equities, or have specific target allocations at pre-determined dates. For example, trustees and their adviser may specify that a particular asset class reaches a 5 per cent allocation by Q1, 10 per cent allocation by Q2 and so on.

Many of these changes have been driven by the desire to access a wider range of alternative assets. If this trend continues and further diversification is sought through asset classes such as infrastructure or timber, the use of exchange traded funds may become more prevalent within default fund designs.

As default fund options continue to evolve, we are witnessing an increasing amount of focus on outcomes at retirement. This presents a challenge in itself, with the blurring of the retirement landscape caused by many factors including; the extension to our working lives, differing income requirements during retirement and annuity rates.

All of this suggests that target dated funds utilising dynamic asset allocation and income drawn down may continue to play an increasing part in the population’s retirement planning.

The world of DC default solutions has come a long way in the last 12 years, and the only thing that can be predicted with any certainty is that the evolution of default design is not going to stop in 2013. Irrespective of how solutions develop, the primary aim is to deliver better outcomes for members. If, along the way, we can make matters easier for members, trustees, advisers and administrators alike, through flexible rather than formulaic solutions, then so much the better.