Time to review your default investment strategy?
Jenny Holt | February 8, 2016
It’s already three years since the first employers passed their auto-enrolment staging date and many thousands more have staged since. And while the initial focus of most employers was getting their scheme set up on time, many are now thinking about reviewing their scheme’s default investment strategy – either because pension freedoms have triggered changes in how employees want to take their retirement benefits or they’re approaching their three-year review date.
Are you one of them? If so – we’re here to help.
As an employer, what do you need from a default investment strategy?
So people are reviewing their default. Which of course means providers will start reeling off a depressingly-long list of features and technical details that you need to think about.
But before we get into that, let’s first think about what’s important from your perspective as an employer.
When we ask employers like you what they would like to get out of their workplace pension scheme, most will mention at least one of the following:
- Cost and risk reduction – most employers want to minimise their scheme’s running costs and don’t want to be exposed to the risk of complaints from employees over their choice of provider and/or default
- Workforce management – having employees who are able to retire when they want to and when you need them to
- Staff retention/recruitment – being able to attract and keep employees who value the investment you’re making in the pension scheme
Here’s how a default investment solution can help
We believe there are five key factors that must be in place for a default investment solution to meet both employee and employer objectives.
Taking the first two together, if there’s one thing that the last few years have taught us, it’s that change is the only constant. Ongoing changes in legislation, economic conditions and employees’ behaviour can all result in changes being needed to default investment solutions.
So as an employer, you need a solution with a flexible structure that supports change. This results in less work and cost for you, particularly if the provider is willing to take responsibility for making and communicating these changes as and when they’re made.
Diversification – mixing it up.
Nobel Prize winner Harry Markowitz has been attributed with saying that diversification is the only free lunch in investment. And everybody likes a free lunch. But if you use an approach that combines different types of investments – diversification! – in a way that targets the best possible returns for a given level of risk, then you also get the potential for more consistent returns over time.
This can help …
- reduce your employer risk by producing more consistent outcomes for employees, not just for their current workforce, but also for future generations.
- make it easier for you to plan, as employees are more likely to know how much they’ll have by a particular date, and so have more certainty over when they can afford to retire.
- very importantly, make it less likely that employees will experience large falls in the value of their pensions just before they want to retire – which could result in them having to work longer.
Consistency alone isn’t enough though.
Focusing on returns
A default investment solution has to deliver high-enough returns to get your employees to where they need to be by the time they retire. So defaults need to be regularly reviewed to make sure they continue to be invested in the best possible investment mix for their given level of risk.
A recent report from JLT1 highlighted the difference in the performance of providers’ default solutions over the last three years and the impact that investment returns can have on employee outcomes. With Independent Governance Committees publishing annual reports and a greater focus on defined contribution schemes more generally, comparisons of default solutions are more likely to be widely available. That means employees will be able to compare their employer’s default with other solutions and make judgements about the value of their current pension.
Underpinning all default investment solutions should be a strong governance framework. Department for Work and Pensions’ guidelines on defaults set out certain roles and responsibilities that need to be carried out, including ongoing reviews and governance. Providers who are willing to take on a lot of this responsibility can save you a lot of time and money. And the introduction of Independent Governance Committees gives additional comfort that someone’s overseeing providers’ governance processes.
So how does your default measure up?
If you haven’t already thought about how you’ll review your default investment strategy, then the five factors in our infographic above might be a good place to start.
Our auto-enrolment default investment solutions – including the Standard Life Active Plus III Universal Strategic Lifestyle Profile (SLP) that’s the default for our Good to Go pension schemes – have been designed with employer and employee needs in mind, with Standard Life taking on much of the responsibility for making sure they remain up to date and suitable as a default. Their flexible structure meant that we could easily update them last year to reflect the different ways employees can now take their retirement benefits as a result of the new pension freedoms. This left employers like you free to focus on actually running their businesses.
And, as you can see below, the growth phrase of our default solutions have consistently delivered impressive returns for the amount of risk taken.
Please note the above graph doesn’t take fund charges into account
So if your scheme default isn’t measuring up, why not have a think about how making changes to it could benefit your business? And don’t miss out on that free lunch!