With the first master trusts now receiving authorisation, the flood gates are opening to the consolidation of workplace defined contribution (DC) pension schemes into them. Under the new regime, pension plans being transferred to authorised master trusts can do so without the need for individual member consent or actuarial scrutiny. But will the all-important default investment strategy of the master trusts selected for the transfer have been subject to sufficient rigour in this process?
When selecting a master trust pension arrangement for its employees, the key element the employer is really buying is the trustees of that arrangement - they are the equivalent of the financial advisers in a retail world. Most importantly, we believe the focus should be on the trustee governance of the three key aspects of a DC arrangement: administration, communication and investment. When looking at any of these areas, employers should assess the independence of those trustees to oversee these on each member's behalf, their performance in so doing and the future resources available to them to deliver on them effectively in the future.
The master trust industry needs to ... ensure that disclosures around the default strategy meet the same standards an individual would expect if purchasing a fund from a financial adviser
This report is focused on the default investment strategy. This is where most members, rightly so in our minds, end up invested in these arrangements. In the long term we believe the governance that oversees this strategy is critical to the success of not only master trusts, but the auto-enrolment pensions venture we embarked on in 2012. At AllianceBernstein (AB) we have been an independent asset manager of DC investment default strategies in the UK - delivered primarily by our flexible target date fund service - for over a decade.
Our approach has been developed to provide a best in class governance and investment approach within the standards set not only by the Pensions Regulator but also by the Financial Conduct Authority (FCA). We believe the master trust industry needs to go further and ensure that disclosures around the default strategy meet the same standards an individual would expect if purchasing a fund from a financial adviser. As such, we have taken the opportunity to address the questions asked of each master trust based on our views of best practice established over the last decade.
Who is primarily accountable for the following day-to-day decisions?
The trustees are responsible for managing the objectives, beliefs and constraints of the strategy. As the investment manager, we provide analysis and advice to assist our clients with setting these objectives. We recommend all our clients retain an independent adviser to oversee our appointment and performance as the manager of their default strategy. Our clients can choose to constrain us on whether to use passive only underlying strategies or to use active underlying strategies.
If clients wish us to utilise active managers, we seek advice from them and their advisers as to who we should use. The investment manager is responsible for day-to-day investment management decisions. As the delegated manager of the default investment strategy we make all investment management decisions on behalf of our clients, enabling them to independently assess the performance of the default strategy on behalf of their members.
How would you describe the objectives of the default strategy to your members?
Our aim is to maximise the members' retirement outcome while taking account of their decreasing capacity to afford losses as they approach and, possibly, go past their target year of retirement. This approach will gradually move members from riskier assets, that are expected to produce better long-term returns when they are young (such as stock market investments) to less risky investments as they approach and go beyond their expected retirement date (such as cash and bond investments).
On retirement, members are assumed to use their built-up pension savings to provide for their retirement from the options available to them at that time, currently: a cash lump sum, income drawdown over a fixed period, income for life or leaving the assets as a legacy. The focus of the strategy between these options changes over time as agreed with the trustees to reflect the changing nature and needs of the overall membership of the plan/your section of the plan.
Our clients trustees have set, and review regularly based on market outlook, a longterm (over five years) performance objective for the strategy. These targets, in excess of CPI (both historic and current) are set out in the table on the left. As well as monitoring the performance of the strategy (net of all costs) against these long-term return goals, our client trustees monitor performance of the strategy in two other ways:
• A target retirement outcome, in terms of both the fund at retirement and the income that it may generate, for typical plan members at various ages on joining the plan
• A short-term simplified market related benchmark with a similar risk profile to the investment strategy but based on simple low-cost market index strategies to assess out performance as manager of the default strategy
What specifically about your membership has led you to adopt these objectives?
The trustees of each of our clients regularly review the objectives of the strategy considering their changing membership, changing membership behaviours and changing pensions regulation.
AB provides analysis to the trustees utilising its AB CyRIL (Cash, Rapid Drawdown, Income for Life and Legacy) tool, which analyses each member of the plan to assess the appropriateness of the current default strategy objectives and also highlights those member characteristics for whom it may be less appropriate for. As an example, for one of our clients a review in 2018 highlighted based on this analysis that:
• Based on the relatively small accumulated balances amongst mid-life savers, that the strategy could take more risk than would otherwise be the case for this group
• Given the relatively small expected levels of members savings, for those retiring in the next five years, additional emphasis is placed on members taking the entire accumulated fund on retirement as a cash lump sum
What differentiates your investment beliefs?
• First and foremost, understanding the specific needs of a plan's membership should drive the investment objectives against which the strategy is managed
• That we should focus on risk rather than returns in managing the strategy - i.e. we should achieve the best possible retirement outcome for members without taking more risk than they can afford in the short-term.
• That asset allocation will be the principal driver of short term risk and long term returns and this should evolve prudently through time with changing markets outlooks to efficiently achieve this
• That the strategy should be responsibly invested, a combination integration of ESG into stock selection and active engagement with underlying investments, for the longterm financial benefit of the members
• Charge cap allowing, active management of the asset classes and individual assets invested in can enhance risk adjusted returns net of fees, although the use of systematic approaches can be cost effective where it doesn't
• That clear and measurable performance metrics should be put in place for assessing and hold accountable the managers (including us) of the strategy
• That the trustees should be able to independently review the performance of all aspects of the strategy on the members behalf - avowing any unnecessary conflicts of interests
Looking back over the last five years how would you describe your investment performance?
Against our long term, CPI-plus, benchmarks it's pleasing that in all cases the strategy is exceeding its goals by on average 3 percentage points per annum (net of all costs) - producing absolute returns of between 6.5% and 9.7% (net of all fees) for members depending on their current age. However, it should be noted that this is against a background where equity markets have grown by around 9% per annum over the same period.
In assessing our performance, we have therefore focused on the benefits of what has been achieved by us allowing for the impact of active decisions we have taken to deviate away from simple low-cost investments.
To the extent that most other asset classes have under-performed global equities we are pleased to report that, against what has been a challenging environment for us we have added value beyond doing the cheapest and simplest thing possible, out-performing the simple market related benchmark we have been set without taking undue additional market risk.
How do you expect the objectives of the default strategy to change in future years?
Based on our latest analysis of our clients' membership we expect two key changes over the coming years as members pot sizes grow:
• For the amount of risk we can take for mid-life savers to reduce
• For the target retirement outcome for savers to move from cash to the provision of income drawdown over a 10-15 year period and then gradually mature towards one a lifetime income objective thereafter It is also likely that as the membership characteristics become more dispersed that we will need to enhance our engagement with the membership focusing on those members for whom, the default strategy may be a bad fit and providing alternative defaultlike options for them.
What key challenges do you believe you will face in the next five years in delivering on your objectives?
Unfortunately, having lived through a period of such high returns, with relatively low market risk, it is likely that future returns will be lower as global GDP growth slows. These lower returns we expect to be delivered with higher market risk and hence we should be cautious of attempting to offset this reduction by taking more risk on members' behalves.
Our focus is to make the assets work harder to meet our long-term goals while not taking any more risk than members can afford
As such, we think the likelihood of continuing to provide comfortable out-performance against our CPI-plus benchmarks is low and we will need to work harder with the investments to try and even meet them. This has been made worse with the growing use of systematic strategies increasing correlations across the market.
Our focus is to make the assets work harder to meet our long-term goals while not taking any more risk than members can afford. Accessing new return sources and maintaining sufficient investment budget to do this will be critical in achieving success here. Seeing beyond marketing hype and understanding the true value of new return opportunities will be critical to our success.
How do you ensure that the default strategy represents value for money to your members in context of the overall charges they pay?
First and foremost, it is about focusing on net of fee expected performance and not just costs. Additionally, it is important to established suitable benchmarks for assessing the performance of the default strategy as a whole in terms of value for money - our simplified market benchmark enables us to do this. This approach rather than one which focuses either narrowly on price or the performance of the underlying strategies that make up the default strategy is we believe critical in delivering value for money.
Finally by establishing clear independence in the trustees monitoring the performance of the default strategy from those accountable for the performance - along with ensuring there are no inherent conflicts between the commercial interests of the master trust provider and the manager of the default strategy. The approach is a best in class investment governance approach to ensure we deliver value for money on behalf of DC plan members within a robust governance model.
David Hutchins is a senior vice-president and head of EMEA multi-asset solutions at AllianceBernstein