Joanna Sharples of Aon explains why a ‘set and forget’ approach is not enough
When it comes to achieving the core goal of pension savings - helping members build up enough savings for retirement - the default investment strategy is the single most important aspect of any defined contribution (DC) plan. After contribution levels, investment returns have the biggest impact on the size of employees' pension pots. But too often, the link between what members need to save for retirement and the way the default investment strategy helps them to achieve that is not given enough focus.
Most pension scheme members don't have a personal goal for how much they need to save to retire. Our research has found that 71% of DC members have no goal in mind. This underscores the work that schemes - and their investment strategies - need to do to support savers who are uncertain about how much they need to save and who cannot manage their own investment strategy.
In the default investment approach Aon uses for both The Aon MasterTrust, and its Group Personal Pension scheme, we look at the level of growth that we believe members need to build a suitable pension pot by retirement. We then set a target level of returns for different stages in a member's life that will deliver the above-inflation growth they need.
Having a long-term focus is particularly important, because if our strategy performs well and exceeds its target returns (as it has done consistently over the last five years), we can start to reduce the amount of investment risk earlier for members approaching retirement (which we are currently doing), safe in the knowledge that they have grown their savings sufficiently. Similarly, if market performance means that members' investments have not achieved targets as anticipated, we can continue to invest in assets that produce higher returns for longer.
Monitoring pays dividends
Investment performance is likely to be incredibly volatile over the next few years, as markets reshape themselves following the Covid-19 pandemic. That means DC default investments will need to be carefully monitored and adjusted as needed - it is not enough to take a ‘set and forget' approach and still expect to meet members' needs.
Another important aspect of default strategy design is the role of diversification. Diversification is important at all stages of pensions investment, from young employees starting to build their pension pot, through to those approaching or even beyond retirement. However, diversification techniques can vary over time. In the early years of saving, diversification might mean a wide-ranging equities portfolio that invests in diverse companies and sectors globally, with different potential for growth. For members closer to retirement, it is more appropriate to invest in a wider range of asset classes to achieve diversification and provide a balance between risk and growth.
To achieve that balance, our investment strategy changes over time as members get closer to retirement, from an equities-based approach, to one that includes a mix of different assets.
The performance of our default funds over the last year, despite huge turbulence, has shown that our long-term strategy is paying off. We have been able to bring more certainty to members' savings by hitting our targets earlier and limiting the amount of risk taken by savers close to retirement.
Good quality default investment strategy is a vital component of any DC pension scheme and its significance to helping members retire with an adequate pot of money cannot be overstated. Whether you are exploring options for a new pension provider or reviewing an existing scheme, forging the link between what members need to save, and how the investment strategy will help them achieve that, is critical.
Joanna Sharples is chief investment officer at Aon DC Solutions