Lessons Learned in DC from Around the World
In this paper we look at many aspects of a Defined Contribution (DC) plan design from an investment perspective in order to identify lessons that can be learnt and applied. We look at the growing trend towards DC plan provision in many markets around the world and highlight what we consider to be the critical choices in plan design. We examine the effectiveness of certain practices in markets around the world, and try to bring clarity to the order of importance of the many decisions facing plan sponsors and governments.
Our key findings and recommendations are:
- Compulsion Compulsion Compulsion: We believe contributions of at least 15% of salary and real investment returns of 3% p.a.1 are the minimum required to produce an adequate standard of living in retirement. Contributions, unlike returns, can be controlled and therefore compulsory contributions and automatic enrolment are critical for maximizing the likelihood of success.
- A Path for Apathy: Default funds are a necessary feature as members typically do not engage with their pension arrangements until they get close to retirement. However, there is significant room for improvement in default design and implementation.
- Timing is... Everything: Losses and gains sustained when the DC account becomes sizeable have a significant impact on the overall outcome. While members need growth assets for as long as possible, limiting losses near retirement is crucial. Investment funds used in the growth phase should therefore target real returns and incorporate downside risk tools to reduce significant losses when the DC account is large.
- Quick Wins in DC Investment: Restrictions often limit the ability to diversify DC assets either by asset class or geography. The reasons for doing this initially in new DC markets are understandable but a reasonably swift progression towards greater diversification, into global investments and alternatives, is needed to improve members’ fortunes over the longer term
- The Pension Puzzle: Increasing life expectancy, a low growth environment, extremely low bond yields in many markets and rising expectations about costly retirement lifestyles all contribute to the post-retirement investment problem. Annuities, partially/fully guaranteed incomes, drawdown portfolios and income funds are some of the many approaches being taken. Further innovation in this area is required but we advocate a solution that incorporates flexibility, provides real returns and incorporates an outcome-oriented approach.
The list of complications could be endless, but generally the solutions already exist – in a diverse world, identifying the right set of keys for each DC market will be fundamental to success. It is our intention that this paper provokes thought and provides a useful reference point for those sponsors setting out to initiate (or update) such retirement provision for their citizens or employees.
1 Source: Schroders. For illustration only. Starting age 20 years, retiring at 60. Salary assumed to grow at the rate of inflation. 50-66% replacement rate.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.