The imminent arrival of stakeholder pensions next April is forcing many providers to rethink their product ranges.
Charles Darwin, the celebrated Victorian naturalist, once said it was not the strongest or smartest animals that survived but the ones that adapted to their changed circumstances the quickest.
How right he was, particularly for those animals operating in the fast-moving world of financial services.
Next April, we will be able to put Darwin's theory to the test when the Government introduces its long-awaited stakeholder pension scheme.
While most providers agree that this is one of the most important events to occur in the investment industry in years, to date relatively little thought has gone into the products they will offer.
In some respects, stakeholder pensions resemble many of the defined contribution arrangements already available and we can look to the latter for some clues as to what stakeholder products might eventually look like. There are currently three different approaches to DC.
First, there are those arrangements rooted in final salary, or defined benefit, pension funds.
These are often managed on a balanced basis – split between equities, bonds, prop- erty and cash.
Second, there are funds that stem from a desire to avoid nasty shocks, for example, with-profits funds, which are very popular with life insurance companies.
Third, there are “lifestyle” funds, which recognise the differences between the accumulation phase and the problems of converting to annuity at retirement.
These are currently the most popular DC arrangements. However, each of these three approaches has its weaknesses.
Those funds that are based on DB arrangements often miss out on the potential for growth, particularly in the early years when they should be more heavily weighted towards equities, because they are so broadly diversified.
Furthermore, they are often measured against an index or a peer group, which can lead to uninspiring performance.
With-profits funds, meanwhile, do not tend to flour-ish in a low inflationary environment.
Lifestyle, while addressing many of the above issues, is only as good as its constituent parts. Moreover, investors in lifestyle products only get the full benefits if they retire at the stipulated age.
It is helpful here to take a step back and look at what motivates investors.
Under a DC arrangement investment risk is transferred to the member.
This cannot be half done. Once investment risk is transferred, it is transferred wholly to the member.
It is therefore vitally important that we do two things – one, make the member aware of this fact, and two, offer some choice to give the member some element of control.
Defined contribution members tend to view investments very differently from a trustee of a traditional DB scheme. The latter usually measures the performance of their fund against an index or a group consensus.
If the index goes down by, say, 10 per cent and their fund manager goes down by nine per cent, the trustees are usually happy.
A DC member may, on the other hand, have a very diff-erent attitude. His idea of risk is not underperformance relative to a benchmark but the risk of not having enough money in the pot when he retires.
Consequently, providers need to think about offer-ing the best opportunity for long-term growth when considering members of a stakeholder scheme.
The other point to note here is that perhaps the most important factor for members of DC schemes, over and above any choice of investment fund, is the length of time to retirement and the amount of contributions that are being made.
Underlying this is the mantra that holds good for all DC schemes: “Pay more and pay now.”
In the long run, this will have a more significant imp-act on members' final pot of money than any choice of fund.
We believe that investment managers need to take more responsibility for the inv-estment decision-making process.
For instance, members should not be expected to have to make timing decisions between, say, US and Japanese equities, or whether or not to invest in new asset classes.
Investment managers should take responsibility for the things they are good at, namely, understanding markets, asset allocation and stock selection.
In future, we believe that providers need to start from a different place when des-igning investment products. And the introduction of stakeholder pensions provides a wonderful opportunity to do this.
First, they need to ask some fairly basic questions of the scheme members, such as when they want to retire, how much do they want to contribute and how much they are prepared to endure if their investments fall in value.
Having done this, providers can move on to more specific questions such as whether members want to be aggressive or cautious, short-term or long-term, in their investment approach.
In response, investment managers can pull together various asset classes and funds from among their range of investment products and group them together under broad banner headings.
So, for instance, you might have an aggressive global equity fund, which moves in and out of different regions of the world and different sectors as and when the fund managers see fit.
Alternatively, for those investors more concerned with downside risk or their pot shrinking absolute, total return techniques may be more appropriate.
For more conservative investors or those closer to retirement age, more traditional products may still be appropriate.
The key here is for the fund manager to express fund objectives in terms of time horizons, long-term return targets and risk tolerances.
The final point about stakeholder is that we need to exercise restraint when it comes to choice.
At this stage it would be not be helpful if we went down the US route, which, in extreme cases, offers literally hundreds of choices. In our view, too much choice leads to decision paralysis.
In the coming evolutionary struggle, the animals that survive will be those that offer a broad, yet simple, range of investment products.
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