We are by no means ‘out of the woods’ in respect to the COVID pandemic, as a lockdown in Ireland, high case numbers, and ongoing vaccine rollout issues continue to dominate the new headlines. However, whilst volatility does remain somewhat heightened, we have entered a new Bull Market, stocks closed out 2020 on a high, and positive returns have continued through to 2021. COVID has also affected the pensions landscape in Ireland, not only through the impact of investments, but also on upcoming legislative arrangements. For example, the long-awaited auto-enrolment framework is still to be launched and the transposition and implementation of the IORP II is still to materialise. We don’t know what the rest of 2021 may hold, but with 2020 fresh in our minds it’s an opportune time to take stock and consider how we should appraise DC pensions.
When looking at a Defined Contribution pension scheme there are three main areas to explore:
I’ll focus on the third, as much has already been written in respect to Master Trusts and IORP II. However, it is worth noting the Pensions Authority’s recent assessment of Master Trusts in Ireland, and in particularly that the structure may not be the panacea that some in the market claim. As often is the case, there may be lessons to be learned from the UK experience in this area.
Within the investment ‘arena’ we try to focus on three main areas:
- Default Framework
Lessons from 2020
Within the context of the COVID Bear Market, it is easy to explicitly see the outcomes that providers across the market delivered under these three areas. For example, having a clear and flexible communication strategy in 2020 was imperative, a point highlighted by the unique nature of the COVID crisis in respect to not being able to meet face to face.
Communications should be tailored for different audiences – members, employers, trustees. For example, how you communicate with scheme members can play a key role in how people will behave when it comes to their investments. A communication strategy that keeps people informed during market volatility – perhaps covering topics such as basic investment principles and unit cost averaging can lead to positive behavioural outcomes. When we consider the switching experience for individual investors vs those in a DC scheme, we found that those in a DC scheme were less likely to switch in times of stress that those in an individual product, and even within a group scheme environment – those in a default were less likely to switch again. A fact that highlights the imperative need for a robust default framework.
Performance of course also plays a role here behaviourally, being invested in the funds that recovered quickest has a huge psychological advantage. This is without even extolling the well-established virtues of compounding, and the long-lasting impact of relative outperformance in a bear market on long term pension adequacy. Markets evolve, and change, but a consistent investment process should stand the test of time. This applies whether you are a fund manager, product provider, or financial advisor. And it is equally true of a DC Default Investment Strategy.
Getting DC investment right
There is often a conversation about investment styles in respect to a default strategy, and in my view, you can add value in three overarching ways:
- Default Composition (Funds used, average equity weighting, glidepath timeline, transition mechanics, various options in retirement planning stage)
- Asset Allocation (active top down, quantitative modelling, static, auto rebalancing,)
- Single Asset Components (Passive, Active, factor tilts, bottom up, top down)
The Active v Passive debate always gets caught in point No.3. However, in my opinion the debate should encapsulate all the decisions that drive your investment performance. If you take that more holistic approach, points 1 & 2 are likely to have a larger influence on the outcomes for scheme members. Points 1 & 2 cannot be done passively. The need for a proactive approach is imperative.
Another subject that garners much attention in respect to all investment products, but particularly in the DC space, is that of costs. AMCs, OCFs, TERs, (amongst others!) are some of the acronyms that are discussed ad nauseum in the industry. However, a closer inspection of regulatory information (namely the Pensions Authority’s DC Codes of Governance) reveals a much greater emphasis on ‘value’ rather than ‘cost’. The two are often used interchangeably but there is a subtle, yet fundamental difference between them. For example, the right default composition and asset allocation can add 100bps per annum in performance versus other options in the marketplace (1,000bps in 2020 in some cases) whilst a focus on 10 or 20 bps at the scheme outset generates much more attention from scheme trustees and consultants. Being cost conscious is certainly prudent, but it is only one element of the decision.
The current Economic Environment
Investment performance has always been the key driver of pension adequacy, and in my opinion, it is only going to grow in importance. In the current economic environment, business margins are as tight as ever and the propensity from a business and member perspective to increase contributions is reduced. In terms of more structural trends, the state pension is simply not viable in the long term in its current form, a fact accentuated by increasing time spent in retirement and the continuing demise of DB pension offerings. This all leads to a growing need for scheme members to actively take an interest in their pension and make their investments work as hard as they can for them – in order to ensure that they have the retirement they want and deserve.
In conclusion, there were lessons to be learned from 2020, but the main principles of DC pension investing remain intact. Consistency matters in terms of the overarching framework in place, as all schemes will see further Bear Markets and times of wider economic strife in the future. Therefore, it is important to appraise your scheme provider across the full market cycle and by the metrics that are most important to your scheme members. Unfortunately, there is no such thing as ‘precedented times’ – the world constantly changing and evolving and picking the right partner is imperative. There is of course plenty to debate in this subject area, with plenty of subjectivity – with that in mind it is important to concentrate the debate in the topics that really matter in providing pensions adequacy and cutting through the rest of the noise evident across the marketplace.
Author: Ian Slattery is an Investment Consultant with Zurich Life. Information about investing with Zurich can be found at https://www.zurich.ie/savings-and-investments/
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