In our previous article, ‘Default investment strategies – part one: lifestyle’, we consider the most prevalent type of strategy for members who are either not engaging, or those who rely on the pension provider to make the investment decisions on their behalf. This next article considers an alternative mainstream strategy: Target date funds.
Target date funds
While lifestyle strategies remain the preferred option for the majority of pension providers, there are a number who have adopted target date funds as their default. Target date funds (TDF) aggregate members by retirement age, i.e. their target date for retirement results in their investments being placed by the provider into a single fund that is managed by an investment team. For example, if a 40-year-old in 2024 has age 60 as their default or chosen retirement age, their investments are grouped together with all the other members who are likely to take their benefits the same year, i.e. in 2044. In practice, depending on which product provider is being used, the likelihood is that funds are grouped in five-year tranches.
One of the key benefits cited by the pension providers using TDFs over the traditional lifestyle strategy is that the TDF allows for active management of the asset allocation during the years approaching and through retirement. This avoids issues cited with lifestyle strategies, as the management team can avoid disinvesting during adverse investment climates and also take advantage of potential investment opportunities should they arise.
However, this active management oversight requires a significant amount of resource and governance to ensure that active decisions do not create unnecessary risks for the pension scheme members, which is possibly the reason why some of the smaller pension providers have not adopted this approach. There are also potentially greater costs, which ultimately may be passed back to the members should this approach become more broadly adopted by providers.
Risks
There are also risks where a member takes benefits earlier or later than the age stated on their policy, the investment strategy that is in place, be it a lifestyle strategy or a target date fund, will not be matched as it should be from an asset allocation perspective, which could mean being exposed to an increased level of volatility if taken earlier or an insufficient chance of growth where taken later.
Encouraging employees to actively monitor their plans and notify the pension provider where they wish to take benefits at a different time is a crucial part of engagement. However, it is also important to keep the default strategy under review to ensure you are providing employees with not only a well-communicated plan, but one that can deliver good outcomes in terms of performance and income in retirement.
What can employers do?
While the responsibilities for structuring the default strategy usually sit with the provider in the case of contract-based schemes, or trustees for master trusts, employers can undertake the following actions:
- ensure the default strategy complies with current legislation
- monitor who is involved and responsible for reviewing and making changes to the strategy
- consider a pension provider review where there is consistent underperformance
- help employees engage with their pension through financial education programmes
- nudge employees to ensure at the very least they keep their retirement age on their policy under regular review
If you would like help in reviewing your default investment strategy, or discussing how members could ultimately be encouraged to take control of their own plans, please contact us.
