A measure of success

The introduction of benchmarks for defined contribution schemes now allows trustees to compare how the market is doing, regardless of scheme-specific objectives. Sebastian Cheek reports.

“Each scheme will have a specific investment objective, but trustees still need to know what the market as a whole is doing.”

Henry Cobbe

The use of benchmarks is prolific in the world of defined benefit (DB) investment, but until recently was a rarity among defined contribution (DC) schemes. The introduction of a DC index series by FTSE in October last year however finally gave the industry a barometer against which to judge default fund investment as a whole. The launch was particularly welcome given The Pensions Regulator’s requirement for DC trustees to carry out a strategic review of defaults every three years.

FTSE business development director Jennie Austin explains the index series was launched to offer trustees a performance benchmark that looks at the investment strategy holistically rather than simply the underlying funds in isolation.

“There was no way of evaluating the whole strategy or the combination of the options that have been put together,” she says. “It is a very standard reference benchmark which is something trustees can look at and actually reference their strategy to.”

The series comprises a number of different indices which represent the performance over time of a two-asset portfolio of equities and bonds that, like most glidepaths, moves progressively away from equity towards fixed income. It also has three index groups with different equity allocations at the outset – 100%, 80% and 60% – to reflect different default risk profiles, as well as different target dates – 2005, 2015, 2025 and 2035 – to reflect cohorts of people retiring at different times.

Investment research and advisory firm Elston Consulting designed the series in conjunction with FTSE. Managing director Henry Cobbe explains in DC pensions, each scheme will have a specific investment objective, but trustees still need to know what the market as a whole is doing.

“Comparing against the FTSE 100 is not appropriate because for different cohorts at different stages of the journey their risk exposure is going to be very different,” he says. “So all we are doing is trying to establish that neutral broad market benchmark but in a cohortised format.”

The indices have a two-asset approach to reflect the two polar opposite choices available to members investing in capital markets: the market portfolio which is, broadly speaking, the global equity market to target a benchmark for younger savers; and the risk-free portfolio or index-linked gilts to target a benchmark for income in retirement.

By comparing the default strategy to a neutral benchmark trustees can also see the value added by making changes to their portfolios such as adding alternatives or multi-asset funds. For this reason, as Cobbe says, the index series does not include asset classes outside of equities and bonds because that would deviate away from the indices’ neutral position.