Lifestyle strategies adopted as default funds do not adequately protect members from potential market downturn, latest research suggests.
These funds generally invest heavily in equities right up until 10 years before retirement, at which point they begin phasing bonds and cash into the asset allocation.
Lifestyle funds are typically adopted as default strategies for master trusts and multi-employer defined contribution (DC) schemes, in which 99.7% of members stay in the default.
However, in the 2017 edition of The Future Book, analysis by the Pensions Policy Institute (PPI) and Columbia Threadneedle Investments found that lifestyle funds had a 20.7% chance of a loss of at least 5% within the first five years. This was narrowly behind high-risk funds, which had a 23.5% chance of losing at least 5% within five years and carried the most risk.
Even where a lifestyle fund has five years in low volatility, the risk of loss is 13.3%, just one step down from a normal lifestyle fund.
Conversely, diversified growth funds (DGFs) are least likely to incur a loss within the first five years, regardless of their performance, the analysis also suggested, due to their exposure to alternative asset classes such as real estate, commodities and infrastructure.
For a low performance DGF, the chance of a loss of 5% within five years was just 11.9%, while a high-performing DGF had a 5.8% chance. Additionally, DGFs are least likely to deliver very low returns. Assuming a woman earning median wages saves consistently at 8% from age 22 to state pension age, a high-performing DGF would give the second-highest median pot in retirement, of £92,000.
This is behind high-risk funds, which could give a median pot at retirement of £102,000 but also have significant exposure to 5% loss within the first five years. Lifestyle funds could generate a median pot of £85,000, the report added.
Columbia Threadneedle Investments head of multi-asset for Europe, the Middle East and Africa Toby Nangle said, for this reason, these funds may not be appropriate for risk-averse people saving for retirement.
"Equities have delivered phenomenally strong returns," he said. "These may be a fantastic savings vehicle for the long term. However, there are unpredictable downturn periods. These sorts of downturn can take a long time [to come about] but have been proven to be significant. What if you don't have a timescale to recover?"
He said exposure to more diversified asset classes, through DGFs, would enable savers to fare better in such downturns.
This was backed up by PPI head of policy research Daniela Silcock, who said that the high number of people in default funds means the industry needs to properly assess whether they are appropriately allocated.
"The vast majority of people who are in DC pension schemes are in the default funds," she said. "99.7% are in master trust members. Are default funds fit for purpose? Are they helping people to do what they need to do?"
She added it was important to ensure these funds have a suitable risk exposure, as "people in the AE target group tend to be on lower income and more risk averse, and are more likely to get scared and stop contributing."
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