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What should employers and their advisers look for when choosing a pension scheme for their staff? From good governance to clear communications, there are a wealth of different components that combine to make a good quality scheme.
However, when it comes to achieving the core goal of pension savings – helping members build up enough savings for retirement – the default investment strategy is the single most important aspect of any DC plan. After contribution levels, investment returns have the biggest impact on the size of employees’ pension pots. But too often, the link between what members need to save for retirement, and the way the default investment strategy helps them to achieve that goal is not given enough focus.
The way in which pension schemes manage their default investment strategy needs continuous and close attention. Aon’s 2021 DC scheme member research, Keeping on Track in Challenging, found that, even during the market turmoil of early 2020, only 7 per cent of respondents said that they had checked the performance of their pension savings.
On the surface, that simply backs up the well-worn argument that members do not engage with pensions. But it also shows how much employees rely on and trust their pension scheme to invest effectively and grow their contributions appropriately over time.
We also know that most members do not have a personal goal for how much they need to save to retire. Our research found that 71 per cent of DC members have no goal in mind. Yet again, that points to the work that pension schemes – and their investment strategies – need to do to support savers who are uncertain about how much they need to save and do not want to manage their own investments.
In the default investment approach we use for both The Aon MasterTrust and our Group Personal Pension schemes, we focus on the level of investment growth that we believe members need to build a suitable pension pot by retirement. We then set target levels of
return for different stages in a member’s life that will deliver the above-inflation growth they need and use these to establish the investment strategy.
Having a long-term focus is particularly important. If our strategy performs well and exceeds its target returns – as it has done consistently over the last five years – we can start to reduce the amount of investment risk for members approaching retirement at an earlier stage than we are currently doing and safe in the knowledge that they have grown their savings sufficiently. Similarly, if market performance means that members’ investments haven’t achieved the return targets as anticipated, we can continue to invest in assets that produce higher expected returns for longer.
Investment performance is likely to be incredibly volatile over the next few years, as markets reshape themselves following the Covid-19 pandemic. That means DC default investments will need to be carefully monitored and adjusted as needed – it is not enough to take a ‘set and forget’ approach and still expect to meet members’ needs.
Another important aspect of default investment strategy design is the role of diversification: investing in assets that behave in different ways in different market conditions.
Diversification is important at all stages of pensions investment, from young employees starting to build their pension pot, through to those approaching or even beyond retirement. However, diversification techniques can – and should – vary over time. In the early years of saving, diversification might mean a wide- ranging equities portfolio that invests in diverse companies and sectors globally, offering different potential for growth. For members closer to retirement, it is more appropriate to invest in a wider range of asset classes to achieve diversification and to provide a balance of risk and growth.
To achieve that, our default investment strategy changes over time. As members get closer to retirement, they move from an equities-based approach to one that includes a mix of different asset classes.
The performance of our default funds over the last year, despite huge market turbulence, has shown that our long-term strategy is paying off. We have been able to bring more certainty to members’ savings by hitting our targets earlier and limiting the amount of risk taken by savers close to retirement.
A good quality default investment strategy is a vital component of any DC pension scheme and its significance in helping members retire with an adequate pot of money cannot be overstated. Whether you are exploring options for a new pension provider, or reviewing an existing scheme, it is vital to forge the link between what members need to save and how the investment strategy will help them achieve that goal.
The post Tony Pugh: Don’t overlook investment strategy – it’s the key to meeting retirement needs appeared first on Corporate Adviser.
