Why SMEs should review their auto-enrolment default funds on a regular basis
Two separate research surveys indicate that millions of people in workplace pensions may not be getting the best deal from their default funds. One survey suggests pension savers could be more than £300,000 worse off.
Research carried out by JLT Employee Benefits (JLT) shows that the difference in investment performance between the UK's top ten defined contribution (DC) default funds is so big that investors in the worst fund could be missing out on over £300,000 of additional savings by the time they are 55. As 92% of pension savers invest using the default strategy, this emphasises how important it is for the employer to select a good quality default fund.
The research also found that the default funds with better returns two years ago were no longer necessarily the best in the market today. So employers need to monitor their default fund on a regular basis to keep an eye on any drop in investment performance.
Whilst statutory contributions are set to increase from 2% to 8% over the next two years, this could be negated without sound investment decisions on the choice of fund.
A second research study into the state of UK workplace pensions takes this a stage further. It points out that millions may not be saving in funds that appropriately protect them from possible market downturns. It also puts forward the case for pension savers to invest in diversified funds.
The study is called The Future Book: unravelling workplace pensions, an annual publication that is now in its third year. It was commissioned by Columbia Threadneedle Investments and produced by the Pensions Policy Institute (PPI). The study takes a look at how UK workplace pensions are doing as well as the issues and challenges faced by those saving for retirement. It also shows what the Defined Contribution (DC) pension landscape may look like in the future if savers ignore the need for diversified investment.
Whilst the number of UK pension savers and employers going through auto-enrolment has increased significantly, the vast majority of savers invest in their pension scheme's default fund. The majority of default funds employ a lifestyle strategy, which usually means investing heavily in equities before phasing the asset mix into bonds and cash around 10 years before retirement.
As part of this year's report, the PPI looked at how the fund design and strategy can impact upon returns for scheme members. It compared lifestyle strategies against other default investment options (low volatility, high risk and diversified growth funds) and assessed their likely returns as well as the possibility for losses should there be market downturns.
The research showed that high risk funds would deliver the highest returns, but are also the most likely to incur a loss of up to 5% cent within the first five years. It also showed that Diversified Growth Funds (DGFs) were the least likely to incur losses or low returns in the first few years and would deliver the next highest returns. Lifestyle funds produced slightly less than DGFs but are the second most likely to make a loss within the first five years.
This demonstrates that despite the aversion of many with low incomes and low risk tolerance, lifestyle funds may often not be the best option. It emphasises that many people are not investing their pension in a way that makes the most of their money or protects them adequately against market downturns.
In many cases, the research suggests that diversified growth funds, combined with investment in alternatives, such as real estate, infrastructure and commodities, could be a good option, providing reasonable returns with reduced volatility and better long-term protection from investment losses. Diversification should be across asset classes and also globally, across regions.
Both sets of research provide food for thought for SMEs and their pension schemes. For more information or to discuss your pension options, contact Kellands Corporate.