The defined contribution (DC) market has seen a huge surge in growth over the last decade, due to many thousands of employers having passed their auto-enrolment staging date, and others yet to do so.
Default strategies are the funds into which contributions to workplace DC pensions will automatically be invested, without employees making a decision. Typically, the vast majority of employees are invested in a default fund, which highlights their importance for employees’ retirement planning.
Staggeringly, based on the latest quarterly data from providers to Q3 2021, there is in excess of 6 per cent a year difference in returns over five years between the best-performing default and the worst-performing one. Over this period, recent research has shown that the average workplace DC default returned approximately 9 per cent a year.
On the whole, though workplace pension defaults have rebounded from the COVID-19 pandemic, in both master trusts and GPPs, there is a marked differential in performance returns. Therefore, work needs to be done to ensure that members are invested in a strategy that is right for them.
What does the future hold?
A key theme in improving member outcomes will be embracing the growth in responsible investing, to include Environmental, Social and Governance (ESG) themes. It is emerging that well-run companies with sound ESG practices have a better chance of long-term success and profitability, and therefore this can have a positive impact on investment returns.
There is also political pressure on DC default funds to invest in illiquid assets, such as start-up businesses and infrastructure. However, there has been a reluctance from pension investment managers to invest in these areas, given these are more expensive investments. These could breach the 0.75 per cent charge cap for savers in default funds within the workplace, which DC schemes use for auto-enrolment.
Why undertake a default investment review?
It’s been two years since The Pensions Regulator contacted hundreds of trustees to ask them to confirm that they have reviewed their default strategy and the performance of the default, in line with their legal obligations. Quite rightly, The Pensions Regulator wishes to protect pension savers and ensure that workplace pensions work!
So, for master trusts and contract-based schemes such as GPPs, we would strongly recommend that as best practice, employers review their investment default at least once every three years. This is to ensure that their provider continues to offer a suitable strategy for their members. For employers, this could coincide with when they have to automatically re-enrol eligible employees who have previously opted out.
What are the key areas to consider when reviewing an investment default?
Aside from evaluating whether your default investment has performed in line with expectations, and whether other providers’ investment strategies are outperforming your default, what else should you do? Consider the following:
- What the default fund is currently invested in and whether you are comfortable with this
- Whether your default investment has evolved to take advantage of changing market conditions, and whether it is invested in the latest asset classes
- To what extent is your default incorporating ESG, and is this approach aligned with your corporate values and any corporate social responsibility policies you may have in place?
- Monitor whether your default investment continues to meet your members’ current and future needs, and whether it aligns with how your members are taking their pots at retirement; this can be achieved by using data within the scheme to inform investment design
- Gain employees’ views and incorporate their considerations about how they want to see their scheme’s assets invested
- Finally, whether your provider charges reasonable fees for its default in line with the market, and whether members value the benefits and services they receive
We recommend that if you have not reviewed your investment default for some time, now is an opportune point to do so! Recent developments such as ESG integration have seen the biggest shakeup of default design for many years, making it important to assess whether your investment default is still fit for today’s purposes.