To default or not to default, that is the question. Or perhaps it should be but unfortunately it does not appear to be that much of a dilemma for employees. The vast majority – around 90 per cent – simply tick the default box time after time.
Little wonder that the Pensions Institute at Cass Business School warns that defined-contribution pension schemes are putting their employees’ retirement prospects at risk unless they act to improve the quality of default funds.
In its report, Dealing With The Reluctant Investor, the institute found that most traditional default funds do not match members’ needs in terms of asset allocation and risk profile.
It is not the first time the institute has made a swipe at default schemes. Two years ago, the Pensions Institute reached a damning verdict on advisers in its study on the DC industry. It said the tendency for advisers to use the providers’ managed funds suggests that they regard these as a “safe bet”, whereas in practice the risk profile could be too aggressive for some employees and overly cautious for others.
One of the main problems with default funds is substandard performance. Once again, some of the biggest pension personal pension funds have been “outed” as perennial duds.
According to Hargeaves Lansdown, pension funds totalling 37bn from Barclays, Zurich, Prudential, Norwich Union, Royal London, Scottish Equitable, Canada Life, Axa, Halifax, Winterthur and Clerical Medical have underperformed the FTSE All-Share over one, three, five and 10 years.
It is not just some of the most popular equity-based pension funds, the big-selling balanced managed funds are just as bad. They give the impression of being a mixed portfolio of equities, bonds and property – most are anything but.
Take Abbey Life managed. This so-called balanced fund has zero exposure to commercial property and just 13 per cent in fixed interest – 79 per cent of this “balanced” fund is in shares. It is not alone. The average equity weighting among balanced managed funds managed by insurers is 79.9 per cent, with an average of just 1.1 per cent in property.
Surely, it must have dawned on these fund managers a few years ago that commercial property was an opportunity not to be missed. So why did they ignore this vital asset class? It is too late now, of course. The boss of Land Securities has already called the end of the UK’s commercial property bull market.
What’s more, only about half of the schemes automatically include a “lifestyle” feature that will switch the member’s pension assets from equities to bonds as the planned retirement date approaches. Yet some have even questioned the quality of lifestyle plans.
DC Link, for instance, wonders whether the average lifestyle option consisting of three funds – equity, gilts and cash – is appropriate or just playing safe. Only a handful of schemes with the lifestyle option offer more than one equity and one gilt within the default. The majority of schemes have a standard offering of one equity, one gilt and one cash fund. Just 2 per cent of lifestyle schemes offer a genuine choice of investments to account for differing attitudes to risk.
Trustees and advisers often talk about the need for education and extending fund choice but having numerous external fund links has problems of its own. For example, a look at Friends Provident’s pension liter-ature to employees is mind blowing – dozens of fund links which is likely to leave the man in the street bewildered. Similarly, Clerical Medical offers over 50 funds and offers a 35-page document to would-be clients.
I agree that people should take more responsibility for their future but with the best will in the world it is unlikely to happen. The quality of the default fund is the key. They have to be more flexible and far removed from the heavily benchmarked, turgid historical offerings from insurers.
Target return and absolute return funds have been mentioned as a way forward but, for starters, insurers should overhaul their much maligned existing personal pension funds. They owe investors that much.
Paul Farrow is money editor at the Sunday Telegraph.