A new report by Cass Business School for the DC Investment Forum (DCIF) analyses the investment strategy of the UK’s trust-based Defined Contribution schemes in 2017.
The report, Investment Strategy: A bird’s eye view, focuses on the investment strategy available to members of trust-based DC schemes and is based on discussions and interviews with over 20 experienced pension scheme representatives and their advisors.
It comes at a significant time as DC schemes have faced a large amount of regulatory change in recent years including auto-enrolment, the introduction of the charge cap and Pensions Freedoms.
Investment Strategy: A bird’s eye view has the following key findings:
The ‘growth’ phase design
The predominant asset class in the early stage of pension accumulation remains developed economy equities, with the preference tending to be for these to be managed on a passive, market capitalisation-weighted basis. Although equities managed on this basis usually make up a significant proportion of the risky exposure in a default fund and often 100% in the ‘growth’ phase, the main reason given for the use of passive rather than active funds was cost, rather than any entrenched views about the merits of active versus passive investing. The lower cost of indexed funds allows schemes to integrate other strategies such as DGFs, without violating the charge cap.
Many of the schemes interviewed for this report have developed a more structured approach to asset allocation in the late accumulation stage of pension saving. Here passive equities may be combined with DGFs, and corporate and government bond funds at the outset.
Given the still very nascent nature of the drawdown market, it is perhaps not surprising that the investment strategy in the drawdown phase of a member’s life has received relatively little attention so far. The interviews revealed a number of questions that will need to be addressed in the future, if schemes decide to offer in-scheme drawdown to members.
While some relatively large DC schemes have responded to the new pension freedoms by designing default investment strategies that accommodate a drawdown investment option, smaller schemes are more likely to still offer members only the cash and annuitisation options at retirement.
Illiquid asset classes
During discussions about the post-retirement period of members’ lives the possible need for asset managers to develop “risky annuities” arose. A risky annuity would be a pooled fund of cash-generative illiquid credit assets of the kind currently favoured by larger DB schemes. More generally, most interviewees felt there should be a role for illiquid asset classes in DC investment options for members. A significant number of interviewees felt that the mechanics of DC platforms were one of the key barriers to integrating illiquid asset classes into DC portfolios.
Andrew Clare, Professor of Asset Management at Cass Business School, the lead researcher on this project, said:
“This report has identified some of the innovative approaches that some schemes have implemented since the introduction of Freedom and Choice. It also highlights some of the challenges that trustees and their advisers have to face as they strive to offer scheme members the sort of investment opportunities that are routinely available to DB members.”
Rob Barrett, Chair of the DC Investment Forum, said:
“In the wake of pensions Freedom and Choice, we asked Professor Clare to take the temperature of trust-based pension scheme decision-makers on their current investment challenges. This report sheds light on their direction of travel, and some of their current considerations.
“It is clear that the next few years will be pivotal, as more and more data become available on the decisions people are making, allowing schemes to continue to tailor their investment options, with the help of their advisers and investment managers. We welcome this interesting snapshot and the interviewees’ clear dedication to finding better solutions for DC savers, a commitment that we echo.”
Download the report here.
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