Paul Budgen: The way to compare default funds

Paul Budgen, NestAdvisers need to sort the wheat from the chaff when comparing default investment propositions says Nest director of business development Paul Budgen

Before making a major purchase, whether it’s buying a laptop or sorting out the family holiday, I always comb through online reviews to help me make the right choice. The price plays a part in my decision, but so do the features on offer and how my choice stacks up against the best in the market. The type of site making the recommendations matters too – are they independent and what do they consider?

Making a decision about what pension scheme to use for your customers is obviously many times more complex than a consumer purchase. It takes in a much larger range of factors and comes with due diligence requirements for advisers.

I would argue one of the most important factors is the quality of the scheme’s default fund. It’s not an easy judgement to make however, particularly as accurate comparisons can be thin on the ground.

The accuracy of some reviews of Nest and other schemes have been highly questionable, to say the least. To help, Nest sponsored the financial research group Defaqto to produce an independent view with their report How to analyse auto-enrolment default funds. The report describes assessment criteria advisers could both consider and evidence in their assessments. Here are some of the key points.

‘Value for Money’ means focusing on the big picture. The report is clear that there’s an ‘overarching need’ for advisers to evidence value for money and assessments should not be limited to investment performance. As advisers are well aware, the TPR’s guidance places an emphasis on strong governance and protecting member’s interests – or default funds, costs and performance are obviously important considerations but they should be weighed against other differentiators, like how the scheme manages risk. To ‘ultimately create a good outcome for the consumer’ advisers need to compare a bundle of differentiators.

So where do you start? Defaqto’s report gives some detailed descriptions of the main differentiators between individual default investment propositions. These would include investment management procedures and responsibilities; the implications of in-house and outsourced management; the clarity, robustness and repeatability of investment decision-making; how well defaults are performing against benchmarks and peers and the suitability of the default and identifying value for money.

When considered together, the report suggests that these differentiators indicate some providers and funds are ‘clearly more competitive than others.’

Getting an accurate picture of the quality of an investment approach is difficult as it can be judged in many ways, particularly in a volatile market. However, there are some indicators that help sort the wheat from the chaff. Defaqto used Sortino ratios to differentiate between ‘good’ and ‘bad volatility – that is volatility caused by high returns vs. volatility due to low returns. In addition, looking at information ratios can lead to a more accurate picture of risk-adjusted performance. There are several other examples in the report.

Considered together these differentiators provide a more comprehensive picture of a scheme’s default fund and a potentially more accurate picture of their long-term outcomes. Some key findings for Nest were that illustrative pension values assuming 2 per cent, 5 per cent and 8 per cent contributions rate showed us providing the highest, or second highest, values at the 40 years range amongst our peer funds. You can see how the funds compare within the report itself, here.

Nest sponsored this independent report in part to ensure that there was an accurate picture of our default fund available to advisers looking for reliable, unbiased information.
It’s one contribution to a wider debate about how we build greater trust amongst workers in pensions, many of who are saving into a workplace pension for the first time. Given that around 9 out of 10 automatically enrolled savers are staying in their default, ensuring workers are placed in a high quality fund that will give them good outcomes isn’t just about due diligence. It supports a shift that’s cementing saving more for a pension as a reality for millions of people.