Thought Leadership (Professional Only)

The Budget, the default and the unengaged member

For engaged members, particularly those approaching the end of their working life, pension freedoms are prompting a radical rethink of their investment strategy for retirement. For these members trustees must react and ensure that appropriate investment options are made available.

9 October 2015

Xziena Charles

Xziena Charles

UK Defined Contribution Specialist

The budget, the default and the unengaged member

For engaged members, particularly those approaching the end of their working life, pension freedoms are prompting a radical rethink of their investment strategy for retirement. For these members trustees must react and ensure that appropriate investment options are made available.

In our view though trustees have a far more challenging task, they need to ensure that they design their default to cater for the new options available for the majority of members who remain unengaged.

Prior to the budget most DC members were encouraged to purchase an annuity, which required little effort on their part and was relatively straightforward. We believe that many savers should now reject this pattern and take advantage of the new legislation. However, many default funds remain heavily invested in government bonds (Gilts), particularly in the years immediately before retirement, the effectiveness of which relies upon the assumption that an annuity will be purchased.

Although this may remain a suitable short-term strategy, if members are adequately warned of the underlying assumptions, in the longer-term it could have devastating effects for investors. Since the budget announcement, annuity rates have become increasingly volatile and this should set alarm bells ringing for trustees and members alike. Currently in the UK, gilt yields have been at their lowest, and if interest rates suddenly rise unexpectedly, savings pots are likely to contract – dramatically. If those members affected are no longer looking to purchase an annuity, then the fact that annuity rates will be correspondingly better value will be scant comfort.

Other options available to members are to take all of their hard earned pension savings as a cash lump sum or move into an income drawdown arrangement. As a result much has been made of the role for investing in cash. While it is true that a holding in cash may protect capital in the short-term, we feel this is another inadequate option over the longer-term, as inflation will eradicate any modest gains. There are also behavioural issues to consider, as access to large sums of cash, may make some savers behave irrationally, whilst leaving them with an unexpected tax liability.

It is clear to us that the current solutions available to DC members inadequately deal with their pension freedoms and the likelihood than many investors simply won’t decide what to do until very late in their journey. So what might a more appropriate solution look like?

All the indications are that investors will continue to rely on the default and there is little evidence that efforts to segment members into different defaults, based on an estimation of how they might take their pension savings, will be successful. Therefore a single default solution will be required and that solution will need to provide security and choice, but without giving up on growth.

Schroders have designed and developed an investment solution that we feel tackles these issues – the Schroder Life Flexible Retirement Fund.

At the heart of the Schroder Life Flexible Retirement Fund is an actively managed, conservative multi-asset portfolio, which targets inflation beating growth of 2% +CPI which would allow members who remain invested to grow their retirement savings. This is combined with systematic downside risk management, which enables the fund to aim to limit any potential loss to a maximum of 8% per annum, over any holding period.

Therefore, amidst all of the uncertainty around what members will do with their new found freedoms, the Schroder Life Flexible Retirement Fund could provide a single default fund solution that allows members to take full advantage of their new found freedoms, while at the same time, seeking to protect their savings, particularly in times of uncertainty within financial markets.

 

For professional investors and advisors only. This document is not suitable for retail clients.

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