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.”
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
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