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Inside the defaults: Nearly four years on, how are auto-enrol funds working?

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Pension providers’ defaults funds are coming under growing scrutiny as Money Marketing research reveals the investment performance of millions of first-time savers.

Despite an intense focus on charges, experts say these “pale into insignificance” compared to the impact of investment returns over the lifetime of a pension fund.

Nearly four years on from the start of the automatic enrolment programme, Money Marketing takes a deep dive into the default funds of some of the largest providers in the UK.

Since auto-enrolment began in 2012 over six million people have been auto-enrolled into workplace pensions. Of these the vast majority make no investment choice and are placed into providers’ default funds.

According to Pension Policy Institute research, 99 per cent of master trust members and 85 per cent of savers in other defined contribution schemes simply park their money into defaults.

The story so far

Money Marketing approached Nest, Now: Pensions, The People’s Pension, Standard Life and Aviva to build up a picture of what is really going on within auto-enrolment schemes.

We asked the providers to model the changing value of a typical auto-enrolment saver‘s pot. The scenario was a 22-year-old earning £25,000 a year – with no salary increases – from October 2012 to June 2016.

The assumption is they made no investment choice and are placed into the provider’s core default fund.

In our research Aviva’s default fund returned the most over the period, with the fund valued at £1,600 net of charges at June 2016.


However, it is difficult to draw straight comparisons between providers because of several variables. Firstly The People’s Pension did not have data for October 2012, the first month of auto-enrolment, meaning their modelling is slightly out of step.

Aviva and Standard Life members pay a variety of charges depending on the arrangement entered into by employers. In both cases it is assumed the member is charged at the 0.75 per cent auto-enrolment cap.

Government-backed scheme Nest declined to provide information.

A spokesman said comparisons were hampered by issues such as when unit prices are reported, and warned of looking too closely at short-term performance rather than the long-term.

Pension Playpen founder Henry Tapper says while it is early days, there will already be divergence between bond heavy and bond light strategies. He adds it is likely to be charges that will differentiate in the first years of auto-enrolment.

He says: “If our performance measure is the outcome and we measure it by the transfer value then you can expect to see the front-end loaded charging structure – used by Nest – showing the lowest TV, Handily you can’t transfer out of Nest, yet.

“You can expect to see the monthly-deductors, most master trusts, in the middle and the annual management charge-only funds on top.”

The People’s Pension has a 0.5 per cent annual management charge; Now: Pensions levies a 0.3 per cent AMC and £1.50 per member per month administration charge; while Nest has a 0.3 per cent AMC and a contribution charge of 1.8 per cent on each new member contribution. Standard Life and Aviva members pay a range of charges at or below the 0.75 per cent cap.

Investments trump charges

Last year consultancy JLT Employee Benefits performed its own study into the difference between the best and worst performing default funds over the lifetime of a typical saver.

It found those in the poorest funds could lose up to 6 per cent of annual returns, equivalent to around a loss of around £500,000 over 35 years.

JLT senior consultant David Will says: “Based on our research, investment returns are far more important than charges. It’s fair to say provided the charges are reasonable, that is within the 0.75 per cent cap, they pale into insignificance compared to other factors such as investment returns and contributions. They have much greater influence.

“There are very different approaches taken and they are evolving over time, particularly because of the pension freedoms. One-size-fits-all was never appropriate and it certainly isn’t now – people are now going into drawdown, or taking cash, as well as buying annuities.

“The general trend has been away from equity-only growth engines to more of a multi-asset approach and we’re seeing a move away from traditional lifestyling. And looking forward, employers and providers will need to start factoring in the role of Lifetime Isa.”

Standard Life head of pension strategy Jamie Jenkins says the range of different investment approaches used is a sign of the market’s health.

The trend has been away from equity-only growth engines to more of a multi-asset approach

He says: “Some defaults are more focused on cheaper fund options that give exposure to equities and hopefully growth over the long-term; some – like Nest – are focused on young people not experiencing extreme volatility; and some, like us, are trying to provide a real return and dampening volatility especially approaching retirement.

“So there is not convergence and that’s healthy. A good market will provide choice and employers and advisers may well choose different providers and their defaults based on the type of employees to be enrolled.

“For instance, a scheme where people are wealthier may well look at auto-enrolment as a top up to an existing defined benefit scheme and may be more concerned with looking at growth than with reducing risk.”

While Nest declined to share investment information, a quarterly investment report explains the decision behind prioritising low volatility in the early years of retirement.

It says: “Younger savers told us that they would react very negatively to falls in the value of their savings. For this reason, members who join in their 20s will typically spend up to five years in the foundation phase. In this phase we concentrate on steadily growing the balance rather than exposing our members to substantial investment risk. This lower volatility approach still aims to at least match inflation after taking charges into account.”

Adviser view

Default funds are an important part of the consideration we make when selecting a scheme however employers and the professionals they work with  also need to consider a number of additional factors including cost, payroll compatability, ease of use and much more when selecting an appropriate provider.

Chris Daems is director of Cervello Financial Planning

Expert view

Time to tackle investment performance

Workplace pension providers have not published member outcomes for those saving under auto-enrolment. But we are nearly at the point where four-year data is available so it is worth considering how to measure performance.

What people would like to know is what a transfer value would be and this is what Money Marketing have asked for. TVs are the best measure of performance as they measure outcomes and cannot be fiddled.

So what impacts a transfer value?

Three things – money in, money out and return on investment. In the very short term, return on investment should be a relatively small factor but with divergence between bond and equity returns, we should already be seeing some divergence between bond heavy strategies, such as Nest, and bond-lite, like the People’s Pension.

Assuming the money going in is equal, then the other factor impacting TVs is the charge on the fund and in the short-term this is the most important factor. There are three member-borne charging structures in the workplace pension market: the annual management, the contribution charge, applied by Nest, and the monthly deduction from the fund, used by Now: Pensions.

AMCs are tough on big funds but are great in the early years, contribution charges are the other way around – destructive on values initially but ineffectual on larger funds. Monthly deductions may not hurt TVs as much as contribution charges but they are corrosive to small funds that stay small, so especially for early leavers.

If our performance measure is the outcome and we measure it by the TV then you can expect to see Nest’s front end loaded charging structure showing the lowest TV (handily you can’t transfer out of Nest, yet.

You can expect to see the monthly-deductors (most master trusts) in the middle and the AMC-only funds on top.

So what about risk management?

Classic behavioural theory, as employed by Nest, is that negative returns impact fund behaviour. Default funds are often managed to de-risk volatility, either through a high bond allocation or a diversification over a number of asset classes. The apathy of the public and advisers to TVs suggests that dampening volatility is a waste of money.

The lesson of the last four years is that young people investing for the long-term, really do not pay attention to short-term outcomes. This is as it should be. Workplace pension providers know this insouciance will not last – nor should it.

Henry Tapper is the founder of the Pension PlayPen


Ros Altmann

Ros Altmann: My priorities for 2017 auto-enrol review

      Through automatic enrolment we are now helping millions of people, many for the first time, to save for their retirement. The programme has been a great success to date and we remain on track to complete the gradual roll-out of auto-enrolment by 2018.  By then, around 9 million people are expected to […]

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There are 7 comments at the moment, we would love to hear your opinion too.

  1. Great result!

    “A 22-year-old earning £25,000 a year – with no salary increases – from October 2012 to June 2016.
    In our research Aviva’s default fund returned the most over the period, with the fund valued at £1,600 net of charges at June 2016.”

    Assuming a minimum contribution of 1% each employer and employee this would equate to £500 per year X the 3.75 years on the example equates to £1,875 in total. I appreciate that not all the money is counted from year one, but a members view would be: “Me and my employer have put in £1,875 and have lost 14.6% of my money”. (One wonders what the worst fund produced?)

    So he has had a 1% reduction in his salary, which has lost him almost 15%. In addition we now have the Brexit situation with the pound at a 30 year low and chasing parity on the Euro and at rates against the US$ that look like the old € exchange rate. His costs are going to increase hugely. Petrol, heating, lighting, food, transport, clothing – you name it. No to mention how much more expensive his holidays (if he can afford them at all) will become.

    Add this to the fact that in a couple of years he will be losing even more of his salary. £750 (3%). What chances of (say) a 5% – or more – rise to make up? Slight to nil I would have thought.
    So will we see the rush to the exit manifested by rising opt out rates? I wouldn’t bet against it. As I said from the outset – it just shows what a crap scheme AE is. Sure the providers love it – they are the only ones to stand to make any money out of it. And in the early years they too will probably be losing out. Then Government wants it so that they can shirk their responsibility and ensure that they can continue to pay themselves and their employees the fat DB schemes. Then of course for those over 40 what exactly will they get for all this? Probably be able to afford an extra tea bag a week at the end of it all.

    What a waste of time and effort all round.

    Just as a comparison – before any charges – the FTSE ALL World Index made 21.2% over the same period and the FTSE All share made 12.1%. Even the FTSE 100 made 6.3%. How Aviva – the best!! – manage to lose money is really illustrative of the skill set of these providers.

    • The AE minimumum contribution is based on qualifying earnings. That’s earnings above £5824 (currently). So the contributions would be more like 2% of £19,200 or £384 p.a. and using the same 3.75 factor gives £1440 total contributions, so definitely hasn’t lost money.

      Also this wouldn’t all be invested on day 1 so comparing to the total return on an index from October 2012 until today isn’t a fair comparison. Would probably be fairer to compare to the return from mid-way through that period until today say August 2014 until June 2016 – but I don’t know what that would give as a comparator.

    • Darren Hedgley 7th July 2016 at 1:34 pm

      Harry, I think you might be labouring under a misapprehension. The statutory basis for AE contributions is on based upon Band earnings and not from the first £1 earned – which is referenced in the graph within the article. If so then your investment return figures will be out I’m afraid and hence why you believe a loss has been made. Far be it for me to “defend” providers but your comments would seem to be somewhat inaccurate and therefore harsh to say the least. A quick look at one of the default funds Aviva uses for AE shows me they made a c10% return over the last 3 years, which whilst not as good as the FTSE All share figure you quote is above the FTSE 100 6.3% and assumes a 1% AMC.

  2. Apologies all round. Yes I had overlooked band earnings in my unseemly haste. £1,440 in and £1,600 out equates to 11.2%. So I have been a bit (if not a big) idiot. Still it still doesn’t get away from the fact that employees are getting less to take home,, haven’t had and are unlikely to get a decent rise. (Real earnings have declined by 7% since 2008). Costs will rise as a result of Brexit. So the future for everyone – including AE – is far from rosy.

  3. PS I am grateful to those who have corrected me.

  4. It’s those in historic GPPs or MP company schemes I feel sorry for. Many have default funds with lifestyling based on what would have been considered reasonable at the time but now is slightly mad. i.e. A default fund from a major provider moving funds from a multi asset fund FE score 65 to a similarly volatile long gilt fund FE score 65. A client approaching retirement whose supposedly safe fund moves from £195k to £218 from February. Luckily he has seen me and locked that growth in but thousands don’t

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