The name alone can put investors off default options, but all is not lost. Jerry Gandhi outlines how the industry can turn a negative into a positive
The word 'default' starts with negative connotations. Any online search will throw up a number of meanings, but the two main definitions indicate a failure that usually results in a negative legal or financial consequence - something to be avoided.
With that as a starting point for communicating default investment options in defined contribution (DC) pensions, we should not be surprised that members set out with a feeling of mistrust or trepidation. Together with the general apathy and suspicion around pensions, this means communicating the value of saving in a pension scheme with even the best-quality default fund is a major uphill battle.
But what is a default fund in a pension context? In practical terms, from a member's perspective, it can be considered a 'buy and forget' strategy. This is certainly true for those in contract-based arrangements where investment changes are difficult for members to make; and even more true where the DC pension pot sits within a defined benefit (DB) scheme. In DB pensions, the trustees' attention is usually more focused on managing the DB deficit with little, if any, time spent managing the generally much smaller DC funds.
Reflecting on recent trends in DB pensions and the significant interest by DB scheme trustees in fiduciary management, I would contend that this represents an effective move by DB trustees to a form of default strategy. We all understand that managing assets is time-consuming and complicated, so passing assets to a third party that understands your objectives and is focused exclusively on managing the assets against your needs makes real sense.
The objectives in the DB arena are to minimise the risk of members not getting the benefits promised - the risk of loss - and to manage the future contributions that the sponsor needs to pay to ensure the scheme can deliver. DC objectives are not dissimilar: little or no loss of capital may be desirable, but the assets also need to grow so that the target pensions shown in the illustrations presented are capable of being delivered without the need for material increases in member contributions at a later date.
Statistics show that where members have a choice, the easy route is to delay the decision. Auto-enrolment will use inertia to enrol members, but if faced with significant choice or information it may become easier to decline and walk away. The complexity of pensions also makes it easy for members to persuade themselves that keeping the cash is better.
To overcome this, the standard offering - the default choice - needs to be seen as positive. It also needs to deliver its objectives. The need for members to make decisions must be limited and if they need to be involved the choices must be relevant, easy and understandable.
In practical terms, this means the assets need to be managed by trusted, experienced experts. These managers must be empowered to continually adjust the risk profile and return objectives in the light of evolving markets and not be overly restricted in carrying out this process. Transparency is also critical: the costs being incurred in all areas must be fully disclosed, so confidence in the industry can be restored.
Much work is being done by the industry to improve transparency and this is leading to cost efficiencies - however, the focus now needs to evolve away from simply lowering costs towards adding value from the way in which the assets are managed.
We can learn a lot from the DB evolution towards fiduciary management and draw a parallel between the selection of a fiduciary manager for DB pensions and selecting a good DC default fund. This means selection of an investment manager who has clarity over the members' objectives, the skill to deliver an open and honest dialogue on costs and the continual strive to add real value.
Easy, transparent and member-centric DC funds are the way forward. Then default investment funds will be seen as positive.
Jerry Gandhi is chief operating officer of NOW: Pensions