Time to banish boom and bust in pensions
The pensions industry is failing to control risk in pension schemes says Alan Phillips, managing director of Fidelius
Is it in our cultural upbringing to continually seek out risk? We are all aware that there is no reward without risk, but what are the parameters of this? How much risk do we have to take to achieve acceptable rewards? What is an acceptable reward?
I suspect that many clients are educated in the basic principles of risk versus reward, with risk determined by how and where their money is invested and reward being the resultant return or loss. But do risk and reward necessarily go as conveniently hand-in-hand as we think? I believe not.
The financial services industry has been disappointingly lacklustre in dealing with this problem when presenting solutions to the employees of the majority of DC and DB pension schemes in the UK. The lack of robust and sophisticated investment processes sitting behind the default funds on offer from product providers does not help an apathetic public, and subsequent mediocre performance often does them a great disservice. Everything pivots on the selection up front of a fixed retirement age, before which there are generally uncontrolled risk parameters and volatility levels but when these are combined with the changing retirement aspirations of the individual over time, the whole basis of the lifestyle ethos is destroyed.
The response from Nest in proposing target date funds is certainly a better, more controllable approach than lifestyling, but unless they are built around a high level of governance with regard to volatility controls, these solutions can leave clients completely unaware of the damage that volatile markets can have at inopportune times.
The recent document from the FSA on ’Assessing Suitability’ points to the need for much improved risk-profiling tools, which I agree is essential. Clients need to be educated to understand all aspects of risk from their physical and individual capacity for loss to the need to take risk to achieve specific goals over defined periods of time, but the fact is that if they then don’t take advice (whether out of choice or because advice isn’t available to them) then how do they achieve the right results? Because it certainly won’t happen in a lifestyle or default fund. Regardless of how sophisticated a risk profiling mechanism is, it will be completely wasted if not backed up by a full advice process.
So let’s stop this disservice to the workforce and target a complete end-to-end service-based solution that can adapt to investors’ changing life aims and goals. Employers need to be urged to provide access to real financial advice and build in the cost to their company’s budgets. Direct advice is the only proven solution than can deal with this problem.
Advice can be conducted on a face-to-face or on a sophisticated remote basis, and for those employers who can’t afford this, or where it’s not practical, a scheme-wide solution needs to be created that allows full and accurate risk profiling and then, vitally, facilitates access to a series of investment funds which control and target volatility as the main driver so that the investor gets no nasty surprises.
Volatility controlled investing is the only way forward for individuals to invest the bulk of their core savings. Employers need to seek out advisers that can demonstrate that they can not only provide the right group pension product, with suitable administration levels, but who can also manage all employees’ funds in line with each individual’s requirements, regardless of when they retire, and protect them from the periodic losses endured by portfolios that adopt a static asset allocation as their main driver.
Assume static asset allocation models are the untouched sail that catches the wind to power the yacht. What happens when the wind blows too hard or indeed drops away completely? The answer is obviously nothing, as you will either stall or go out or control, never knowing when or if you will reach your destination. But what if you can control the wind, maintaining consistent momentum and constantly adjusting the profile of the sail to keep some momentum in low winds and keep control in high winds? Then you can be confident of reaching your destination within the time goals you originally set.
Let’s empower employees to understand their goals and what is required to achieve them, give them the comfort and knowledge that risk is controllable through advice and active management and then, perhaps, we can change the boom and bust culture that afflicts UK pensions once and for all.