An employer holds a heavy responsibility when it chooses its default investment fund.
Among most employers, it is conventional to use lifestyle or target date funds. For younger workers, the money is held in equities, then over time it is switched into bonds and cash. Often the member can nominate a planned retirement date and the lifestyling switches are geared towards that date; a recognition that one size does not fit all.
The question remains whether to spend time and money on employee engagement. Traditionally the answer would have been yes. But there is a growing sense that, for most employers, it is just unrealistic to expect employees to engage fully with investment choices.
So the design of the default fund takes on a new importance. We are seeing a gradual shift towards structures that do more of the work behind the scenes, using the sophisticated variations on lifestyle funds that are now becoming available.
All the same, few employers can step away from engagement entirely. The bottom line is that there is one big decision that all employees need to engage with: how much to pay in.
Tangled relationship
There is a tangled relationship between this decision and the default fund design. Longer term, we will see an increased focus on default funds that protect employees from risk using some of the more sophisticated structures.
But the immediate challenge is drawn out by the National Employment Savings Trust’s (Nest) decision to use a low risk, low return investment approach in the early years of membership. Danger certainly lies in an investment strategy that is overly cautious. Nest’s decision, though, recognises that many of its members will simply stop paying contributions if they see their money falling in value.
Arguably some employers’ own schemes aren’t that different. Employers need to weigh this up carefully. Whatever else they decide, they need to respect the fundamental link between communication of risk and members’ confidence.
Mark Baker is legal director at Pinsent Masons
I can’t disagree, but I’d like to see a more confident exposition of the need for engagement at multiple levels. Risk (in the sense of investment or inflation risk) is not something most people understand; and, even with a well-designed default (which seems to be a bit like El Dorado – sought after but never found), employees still need to appreciate and act on the balance of risk, return, contributions and choices their scheme offers. If that doesn’t need true engagement, I don’t know what does! Alternatively, the NEST concept likes the paternalism of the past “we’ll take care of it for you”) but without the more generous returns of those past days! Another recipe for disaster IMO…