Target date funds do what they say on the tin: they target the retirement date. They have a degree of active management, allowing the manager some asset allocation discretion and how the de-risking should be managed. Smith says: “The introduction of NEST has made more schemes aware of the concept of target date funds but the number of clients who have implemented these types of solutions is still very small.”
Not everyone is a fan of target date funds. Bucksey says: “If you are auto-enrolling into a DC scheme at the age of 30, is it a realistic assumption to know exactly when you are going retire? Even if you could predict when you would retire, it would be impossible to predict how you want to secure your retirement income.”
Coming up with an alternative
Up until now there have not been sufficiently large DC scheme assets pots to warrant taking a more innovative and expensive approach to managing these risks. Henderson says: “As the assets increase, the management of that conversion process will become more relevant. There will be more of an emphasis on getting the decumulation phase right.” One DB strategy that could be used to manage the interest risk is liability driven investment (LDI) and a number of asset managers are looking at how they can transfer these skills across to DC schemes. Bucksey says: “We’re not ready to give to divulge our plans for managing the de-risking phase but it will involve introducing a degree of capital protection and some LDI-type strategy.”
Zurich Financial head of corporate funds strategy Jonathan Parker says: “We haven’t yet seen much innovation in the de-risking phase. Most funds still use passively managed bonds and cash. But over the next five years, I expect we’ll see funds possibly using interest-rate swaps to provide a better match for the type of assets an individual will buy at retirement.”
Companies recognise they will have to take a more active role in the design of DC schemes. They can not simply ‘set and forget’ a scheme; they will have to constantly monitor and innovate as the market evolves. The emphasis that the regulator is placing on good member outcomes means good DC schemes will have to be halfway between the paternalistic DB model and the independent retail model.
Henderson says: “Our interpretation of ‘good member outcomes’ is delivering a reasonable level of pension against some objective. That objective could be a 50% salary replacement ratio. It’s too expensive to guarantee that objective but it’s possible to minimise the likelihood of a bad outcome.”
Innovation will not merely be confined to designing better versions of existing solutions. Both lifestyle and target date funds tend to deliver a cliff-edge outcome: at a point in time there is a pot of money that has been converted. The whole purpose of these funds’ design is to purchase an annuity. In the future, however, there is no guarantee that the annuity will be the vehicle of choice to provide a retirement income.
Bucksey says: “There will be more emphasis on alternatives to annuities. Asset managers could come up with alternative solutions. For example, the industry could develop diversified income funds for those who do not want to buy an annuity.”
Keeping cost in mind
There is, however, one major consideration that asset managers will have to keep at the front of their mind: cost.
DCisions business development director Nigel Aston says: “There has been heavy focus in the DC industry on the cost of the investment products in the past. Some schemes are now willing to pay more for diversified growth funds that provide smoother returns so there is an encouraging move away from cost being the primary consideration.”
JP Morgan Asset Management senior client adviser in the UK institutional team Simon Chinnery says: “The problem with many of the clever solutions that the asset management industry devises is that they are too expensive. We have to be much more creative about how we can provide some measure of certainty with some level of risk as well as protecting against interest and inflation risk.”
The DC scheme will undoubtedly evolve in the future into a very different beast than it is today. Tackling thorny issues like ensuring good member outcomes as well as developing alternatives to annuities and more efficient risk management strategies while ensuring solutions are simple and cost effective will certainly make the journey interesting.
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