Back to basics on balanced managed pension funds

For more than a year, the UK’s largest employers have been obliged to provide a workplace pension scheme for their employees and, so far, this radical piece of retirement reform has been hailed a success.

If you read nothing else, read this…

  • Balanced managed funds invest across a small range of asset classes.
  • Transparency in financial services has led to many providers closing or rebranding their balanced managed funds.
  • Balanced managed funds are gradually being replaced by the likes of diversified growth funds.

Employers have, by and large, complied with auto-enrolment legislation and the number of employees choosing to opt out has been lower than expected.

Yet the destination of millions of pounds’ worth of workers’ contributions remains contentious, with some industry commentators alarmed at the types of investment fund being used.

In the vast majority of cases, workplace pension schemes will be set up on a defined contribution (DC) basis. Most members do not take active investment decisions, so they end up in a default fund which is chosen either by trustees if the scheme is run by a trust, or by the pension provider and employer.

This makes the default fund extremely important in its construction, design and overall suitability for members, yet finding an adequate option that meets members’ varied needs can be challenging.

Range of asset classes

The most common type of DC default fund run on a contract basis is the balanced managed fund. As its name implies, the fund is typically invested across a small range of asset classes, comprising bonds, equities, property and cash.

A balanced managed fund is low maintenance, usually low cost. Annual management charges (AMC) can be as low as 0.5%, and it is relatively straightforward for employers and members to understand.

Laith Khalaf, head of corporate research at Hargreaves Lansdown, says: “Balanced managed funds are the predominant form of default strategy in contract-based DC plans and there are tens of billions of pounds invested in them. They are well diversified and, historically, they have been cheap, making them largely appropriate as a default fund strategy.”

But these funds are not without their critics. Heavy exposure to equities, irrespective of market conditions, saw balanced managed funds suffer during periods of volatility and led to questions over how much they could justify the ‘managed’ label. 

Nigel Aston, head of UK DC at State Street Global Advisors, says: “The problem with balanced managed funds is they are not really managed. They are active, but only in terms of the stock picking, where managers believe there is value to be derived by picking Shell over BP or IBM over Microsoft. However, the true value lies in picking equities over bonds, or in deciding whether to be in risky or safe assets.”

Khalaf says the trick to successful balanced management is to find a manager which applies genuine skill by ignoring what its peers are doing and applying its best ideas. He cites Schroders’ and Axa Framlington’s balanced managed funds as two such examples.

But quality usually comes at a price, and properly managed funds may cost a little more because they offer active management, says Khalaf. “The AMC on Schroders’ is 0.8% but that actually compares well with insurance company balanced managed funds,” he adds.

Closing of balanced funds

The advent of the retail distribution review, which brings transparency to the financial services industry, has caused some providers to close or rebrand their balanced funds.

In many cases, fund managers and insurance firms are distancing themselves from traditional balanced funds, favouring diversified growth funds (DGFs) instead.

DGFs promise true diversification across a broad range of assets, in which investments are rebalanced according to market conditions. The aim is to give investors a smoother ride while providing outperformance. Aston says: “More than anything else, members hate to to look at their [DC pension] statement and have less money than they had before.”

Balanced managed funds retain their place as a viable default strategy, but they are gradually being replaced by more sophisticated vehicles, such as DGFs.

The government and The Pensions Regulator have made clear their expectations for robust, default funds as part of ‘good’ DC governance, which could see weaker balanced managed funds pushed out.

Investors wanting to retain the balanced managed fund as part of their DC scheme will need to pick carefully and look beyond low prices to find the best value.