Focusing on the 'squeezed middle'

How do you believe defined contribution (DC) schemes should balance risk and return in default funds?

Lower-volatility investment default approaches can help improve retirement outcomes in several ways. They can materially reduce the scale of contributions while still giving the same degree of confidence in reaching a particular retirement outcome. In doing so, they can more than justify the higher fees generally associated with this active approach versus cheaper passive alternatives. Additionally, their reduced risk is consistent with behavioural drivers that are shown to improve member engagement and contribution rates.

To what extent is a 'one-default-fits-all' approach still appropriate for DC schemes? Should all DC members be treated equally?

We do not believe a 'one-default-fits-all' approach is appropriate for DC given the breadth of members that can be in the scheme. The wealthiest individuals tend to be most engaged and more commonly recognise the value of seeking investment advice. Insofar as they do, these members will only remain in the default fund if it happens to be relevant and suited to their individual needs. If not, then their wealth is likely to cushion against any adverse long-term consequences. Therefore, orienting default fund design around the needs of this group is arguably less critical to their retirement outcome despite the scale of their savings (which is normally a large part of scheme assets).

At the other end of the wealth scale, despite the prominence of pension issues today, there are many for whom paying into a pension plan remains an unaffordable luxury or otherwise low on a long list of priorities. Minimal contribution rates and low salaries mean that many members will rely primarily on state benefits to provide their retirement income. Any savings they do accumulate in DC pensions will likely make little overall difference to their long-term retirement lifestyle. 

This group is typically not engaged, is unable or unwilling to contribute much above that offered by the employer, and accumulates too few assets to reasonably expect to rely solely on the DC scheme in retirement. Many in this group are likely to take their entire pension pot at retirement, to spend or reduce debt, not to invest. Arguably a lifestyle glide-path that de-risks completely would suit these members, but what of the consequences for others? While there may be many members in this group, their collective assets will represent only a small proportion of the scheme.

Between the other two groups are those who do contribute personally, foregoing consumption today to secure a retirement not solely reliant on the state. For this group, the expense of bespoke advice is unappealing and the ability to make informed personal investment decisions rare. Critically reliant on the quality of the default fund and personally invested to the tune of a large part of scheme assets, it is these members who form the majority of engaged default fund investors. We suggest it is they, the 'squeezed middle', who should be foremost in the minds of those devising the default fund solution.

Should DC plans be responsive to different risk requirements?

While it may be desirable to offer a more personalised approach, it raises the issue of the level of engagement you have with members. If you only have the person's name, age and location it is difficult to establish their requirements. However, if you begin trying to gather more information there is the risk that you begin moving into the area of 'offering advice'.

Can a DC member's investment needs be determined from their behaviour?

This is a question open to numerous interpretations. You may be referring to the research into 'big data' in terms of establishing individual credit ratings. Recently some social media analysts were challenged in using artificial intelligence (AI) to deliver individual credit scores based on people's social media profiles. They found the AI was as good if not better at determining creditworthiness of individuals versus traditional techniques!

To what extent can DC defaults be extended into retirement?

For the growing numbers opting for drawdown, it is vital their assets can generate sufficient growth to provide a sustainable income throughout retirement. This is incompatible with an asset pot consisting largely of cash and bonds at retirement. It is clear the landing site for lifestyle glide-paths needs to be redesigned towards a portfolio more appropriate for drawdown investors. We also need to consider the needs of our 'squeezed middle'. Is their priority a new car, a holiday or sufficient assets to sustain a comfortable standard of living through retirement?

Malcom Jones is an investment director at Standard Life Investments and a senior member of the firm's global investment specialist team, specialising in absolute return and multi-asset investing. He has over 25 years' experience and has led both global fixed income and equity teams as an investment manager.

The value of an investment is not guaranteed and can go down as well as up. An investor may get back less than they invested. Tax rules may change.

To find out more, visit www.standardlifeinvestments.com/dc