THE FUTURE OF PENSION DEFAULT INVESTMENT STRATEGIES

As we celebrate 15 years of success with our Pensiont Approaches, Maria Nazarovan Investme-Doyle, Head of Pension Investments, looks forward to what the future holds for multi-asset investing.

In 2020, it often seemed as if uncertainty was the only certainty for investment managers, workplace pension administrators, and the millions of people who are saving for retirement. With COVID-19 cases still rising, economic growth hampered by new lockdowns being imposed here and abroad, and the fallout from Brexit still unknown, investors will likely see market volatility stretching into the new year and beyond. Against an uncertain backdrop, we believe that for long-term pension savers, a multi-asset default investment option continues to offer one significant advantage: the protection offered by portfolio diversification.

But regardless of the direction taken by political, economic or public health factors, what changes might lie ahead for pension default investment options – workplace savings options for those scheme members who chose not to make their own investment decisions? There are multiple external forces at play that could inform how default investment options evolve, including institutional developments like the rise of Master Trusts, shifting demographics, regulatory requirements, and investors’ drive for responsible investing. These will all have an impact on scheme members in long-term pension strategies.

Investment innovation in Master Trusts

There’s little doubt that, given their current trajectory of exponential growth, Master Trusts will become an increasingly dominant form of pension provision within the next five years. Master Trusts are set up by companies – including Scottish Widows – that provide services to workplace pension schemes. In contrast to traditional DC trust schemes set up by specific employers, a Master Trust is a pension scheme intended to be suitable for multiple unrelated employers.

The Master Trust market is set to evolve significantly by 2025. Already, a vigorous review process by the Pensions Regulator saw the number of MTs on the market cut in half. As the process of consolidation continues, there will be even fewer Master Trusts on the market, but those who remain will become more sophisticated with respect to their investment approach and, thanks to the scale of their rapid growth, they will wield more impact and become more influential in this space.

Shifting Investment Objectives

One theme for creating multi-asset default investment options will be even greater diversification in determining the ideal asset mix. The traditional “balanced” portfolio of equities, bonds, and cash positions will remain a staple for many investors, but as market conditions change, the use of alternatives such as infrastructure debt, private equity, or other bespoke strategies will become increasingly important ways to unlock value for investors. A more flexible mix of emerging and global equities, corporate and government bonds, property and alternatives, and active and passive strategies can provide a better balance of market risks. Of course, the more sophisticated the asset mix, the higher the costs involved, which will be an important consideration when assessing the value for money of these strategies.

Moreover, an emphasis on flexible post-retirement solutions is likely to become more important as people work later into their lives – not fully in drawdown and perhaps even still saving into their pensions. Providers will need to adapt investment solutions that can keep up with the changing lifestyle and income needs of pension savers.

Regulatory Scrutiny

Another issue that will impact multi-asset investing will be heightened scrutiny from regulators. In recent years, for example, the issue of costs and fees has become more important – not only to advisers, employers and members, but to regulatory agencies. Charges have been put under the spotlight with the Markets in Financial Instruments Directive II, the charge cap for auto enrolment defaults has been introduced and the requirement to disclose transaction costs alongside ongoing charges has been embedded.

Cost disclosures are only a part of the “value for money” conversation taking place throughout the UK and Europe, as regulators seek to stem the economic impact of poor-value investment vehicles. Consequently, firms will need to be able to prove that their products offer value, fair pricing, and clear disclosures for consumers. Additionally, the Financial Conduct Authority has set its sights on funds holding illiquid assets such as property, and the proper use of benchmarks in targeting and measuring performance. For those approaching their selected retirement date, ‘retirement pathways’ (ready-made investment solutions) are starting to go live across a variety of platforms for unadvised customers.

These are all positive steps in ensuring better outcomes for people post retirement. However, a lot more work needs to be done to meaningfully support those who will not be able to benefit from the luxury of personal financial advice. We believe the industry should come together with the government and regulators to ensure these savers are offered a post-retirement strategy that works with minimal or even no intervention on their part.

Responsible Investing

This issue of stewardship dovetails with the ongoing trend in the market towards Environmental, Social and Governance (ESG) integration, which aims to take into account financially relevant factors relating to sustainability of investments, alongside more traditional metrics. While the definitions and metrics still vary quite a bit, the growing trend towards ESG integration is undeniable. Why is it so important to get on board with ESG? And particularly, why is it important that we make the effort to integrate these factors into existing default investment options rather than launching new standalone funds?

There are three main reasons: investment rationale, customer demand and societal need. Looking at the investment rationale, it’s very compelling. Whereas previously the industry was trying to justify ESG integration on a forward-looking basis, the benefits are starting to come through in past performance figures as the investment world moves on. This means that adopting responsible investment practices makes us a better investor for members. It makes it imperative, then, that we leave no one behind and integrate ESG factors into our default investment options where the majority of scheme members are invested.

There is also growing demand from pension savers. Poll after poll of consumers in this area highlight agreement that pension providers should be taking account of ESG and sustainability issues on their behalf. ESG can also be a fantastic way of engaging with members, particularly millennials who have traditionally been the most elusive group for pension communications efforts.

Last, but not least, is the societal need. The most pressing issue is the climate emergency and, with that, the need to transition to the low-carbon economy. But there are plenty of other environmental and social areas where societal preferences and consumer expectations are changing fast. By taking these factors into account, not only will it make pension investments more sustainable, but it can also enable positive – and vital - change.

Investing for the future

Whatever the market conditions in the next few years, pension providers will need some essential resources: a thorough governance process with independent oversight; a long-term investment horizon and patience amid volatile conditions; a clear focus on ESG issues; and creativity and flexibility in seeking out opportunity for pension scheme members to build wealth.

Find out about the launch of the PIAs, and how events from the last decade and a half have shaped them, from Investments Director, Iain McGowan, or read our 15 years of the Pension Investment Approaches Report (PDF, 265KB).