Inflation risk is arguably the biggest current challenge for DC pension investment strategy, but analysts say a long-term view is needed when it comes to asset allocation.
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That was one of the key points shared at the Corporate Adviser round table held last month at the House of Lords, where decision-makers from the DC sector discussed how workplace pension providers are performing for savers and how the retirement savings landscape could be improved.
Experts at the event said it was hard to draw any concrete conclusions from the experience of the great financial crisis of 2008 – when experts predicted that equities would perform poorly, only for quantitative easing to fuel a decade-long bull run for equities.
Ian McQuade, CEO at Muse Advisory said: “The DC investment environment does have a tendency to be quite cyclical. Over the last decade equity returns have been strong. Those that have had a high allocation in their default funds benefited from market conditions. But you go back to after the 2008 financial crisis, we saw then the proliferation of diversified growth funds and absolute return funds in response to that.
“In terms of where we are today, it’s a really tricky market. You’ve got inflation surging certainly in the UK, a low growth environment with that and a market that is hugely volatile. So in response to that, I think we’ll start to see some creative solutions perhaps to offer alternatives.”
James Monk, head of DC investment at Aon added: “Inflation risk is key because if you look at the way that most of the platform default strategies are close to retirement, there’s very little inflation risk management. Inflation has been fairly under control for a long period of time.
“We know that 90 per cent of people buying annuities buy a level annuity. People’s retirement benefits have badly eroded and inflation-linked annuities, which nobody’s been buying, have become a little bit more sensible.”
The Corporate Adviser Master Trust & GPP report revealed that the average default fund failed to keep pace with inflation in 2021 for savers reaching retirement.
Brian Henderson, partner and director of consulting at Mercer argued inflation is not a factor that should be reacted to alone, though it should be on the agenda. There are many other factors to be borne in mind, including ESG, biodiversity and social impact.
He said: “I bet you nobody is thinking about inflation from a strategic perspective, so that needs to come onto the agenda as well. I think it’s too simplistic to say that one thing will drive change. There are so many things being presented at the moment and navigating your way through some of that stuff goes beyond the wit of many.
“We’re going to see more emphasis on active management coming into the mix, we’re going to see more diversity across different forms of asset allocation, as in people will be looking at it from a different lens because they’re forced to do that and then thirdly, I think there’s this piece about how do you combine all that to deliver the better outcomes as a whole.”
He said: “We have strategic reviews every three years and we take views over the long term. We try not to get upset about what’s happening in the immediate term otherwise you start chasing your tail.”
According to the Corporate Adviser Master Trust and GPP Defaults report, the annualised returns for schemes over the last five years at retirement, one day from state pension age, differed by 9.17 percentage points, with National Pension Trust attaining 9.27 per cent in 2021, compared to 0.1 per cent from Hargreaves Lansdown’s 100 per cent cash default strategy while National Pension Trust returned 11.71 per cent. This demonstrates the significantly divergent outcomes for members at-retirement.
Baroness Ross Altmann raised a fundamental question – ‘what do we mean by member outcomes?’. Pointing to the huge divergences between entire workforces’ outcomes at retirement, she highlighted that default pension strategies do not account for individuals’ circumstances.
She said that while the CAPA report’s data points of 30 years, 5 years and 1 day from state pension age were all very useful, they may not reflect the reality of most people’s lives. A more personalised approach would lead to more suitable, and therefore more useful outcomes, she argued.
She concluded: “The overall pension approach hasn’t made room for individual difference in a market where people’s lives are very individually different now from what they might have expected it to be. You’ve got standard funds which are driven towards a particular date that may be totally useless.”
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