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As more and more individuals join pension schemes for the first time under Auto-Enrolment, almost all of which are defined contribution schemes, one particular issue jumps out at us.

And that one thing is that more than 90% of members will push the default fund investment button. They do with good reason, all this is very new, ‘’someone else must know better than me’’ and ‘‘it wouldn’t be there if it wasn’t any good for me’’. At CBC we don’t blame the members in any way for this, in many cases it may be the correct decision for them. It’s just that we believe that this is a decision better made with eyes wide open rather than sleepwalking into.

What is a default fund? It’s required to be provided by every Auto-Enrolment pension scheme and its purpose is to avoid the individual not joining the scheme because they can’t figure out what investments to choose themselves. Before Auto-Enrolment there was enough anecdotal and statistical evidence to show that employees did not join defined contribution schemes because of the wide choice, and conversely, the lack of easily available guidance as to which funds to invest in. I could get on my soapbox and start on about the lack of financial education within schools and further education and the impact this has on our society, but there is a movement building to improve this sorry state of affairs so I won’t.
The default fund usually has a lifestyling component, which means pension assets are moved out of equities and into hopefully safer investments such as government bonds and cash as the investor approaches retirement. The intention of this is to bank the investment gains and not leave the member exposed to equity market falls on their retirement. There is a growing trend for a mark II version of a default fund to be offered to members with differing risk profiles to avoid the criticism that one size does not fit all.
Further developments are being made to default funds being made up of Target Dated Funds. These funds are investment funds whose assets change to suit the risk and return needs of the member. Research by investment managers indicates that the member’s attitude to risk and the rate at which they can save are closely linked to the member’s age. Each target date fund is designed to gradually adjust its mix of assets as the member gets older and closer to when they are likely to retire. The interest in Target Dated Funds has increased since the National Employment Savings Trust (NEST) opted to use such funds for their default fund.

How do members make their choices?
People are different and decisions are made for many reasons. In choosing whether or not to invest in a default fund, members should be concerned with considering their probable retirement date, their lifestyle in retirement and how much they can afford to regularly contribute to the scheme. The problem is that many schemes offer a wide range of investment choices which confuses rather than enhances the logic of the member’s investment decision. For many, the default fund box is ticked because it is the line of least resistance for the member, not because it the best investment choice for their future retirement.

Investment performance
The member’s pension at retirement is driven by four factors:
 The amount of contributions paid in
 The investment returns achieved
 The scheme charges
 The cost of buying a pension
Investment returns are therefore an important consideration for members in monitoring their pension investments. Yet to even monitor their investments is something which many members are not equipped to do – how do you compare one set of performance figures to another investment managers?
The simple answer is that it is possible but the process is opaque and far from simple even with professional investment advice. But, and it’s a big but, trustees and governance committees have a responsibility to do just this in order to look after their member’s interests and in the words of the Pensions Regulator Code of Practice 13 ‘provide good member outcomes’. The increasing interest being taken by the Pensions Regulator to defined contribution pension schemes clearly shows that poorly performing default funds have to be addressed.

Where do we go from here? CBC believes that members have a right to feel secure in the knowledge that the scheme they are contributing to (or contributed to in the past) is being well managed. Trustees and their advisers therefore have a duty to choose one or more default funds which reflect the potential membership and to monitor the funds’ performance proactively. This does not mean taking a short term approach but does mean understanding the reasons for disappointing investment performance and taking action if required.
This is very much a work in progress and the story will not end here, watch this space

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