Auto-enrolment, the most ambitious attempt to reform pensions in a century, will launch in the autumn, but we must not think we have cracked the problem of getting people to save for their retirement. We haven’t. Not by a long chalk.
After all, what does auto-enrolment actually achieve? For many, it will mean membership of a low-cost defined contribution (DC) pension scheme for the first time. Of course, the corollary of low cost is low return, and there are good and bad reasons for this.
To keep costs low, these funds will invest in passive investments. There are many who do not believe active managers can consistently call the market and so refuse to pay a premium for that type of management.
That was the good reason. The bad one is the selection of asset classes typically considered ‘low risk’. Not to protect the members’ investments, but to control volatility so there are no sharp swings in fund values that might frighten the horses and cause new members to opt out next time. It’s all about managing expectations.
Those who are enrolled into schemes with considerably higher contribution levels will be the lucky ones, but as we move towards a place where workplace retirement saving occurs only through DC schemes, there is growing consensus that we must do a better job of DC provision.
Line in the sand
Some of this consensus has been prompted by The Pensions Regulator drawing a line in the sand with its DC principles. The threat of the regulator wielding a big stick against those who fail to heed its thinly veiled warnings has focused minds.
The first thing for immediate review is the DC default fund. This holds more than 80% of DC members in a fund in which they bear all investment risk, yet are totally exposed to the vagaries of the stock market with allocations of up to 100% in shares. Those who adhere to the axiom of the equity risk premium will say you’ve got to be in it to win it and, over time, shares outperform bonds and other asset classes. Fair enough, but the trouble with defaults is they try to be all things to all people. A one-size-fits-all approach sounds attractive, but it means that it doesn’t really fit anyone at all.
This lack of tailoring becomes more of a concern as people approach retirement. Lifestyling has tried to move an individual’s retirement fund into less volatile, arguably safer, assets, but over the past decade will have done little more than crystallise losses made during the market falls into bonds and cash. Not in all cases, such as in 2011, but that was an example that proved the general rule.
Until recently, cutting-edge practice was to extend the lifestyling period to 10 or 15 years. This might help to avoid a market meltdown, but it is still a crude instrument that pays no attention to an individual’s circumstances.
What was needed was a new approach that weighed up the needs of members and sought to smooth out the worst of the peaks and troughs for investors. We used to have a solution that achieved this: with-profits. But that went the way of all flesh, when over-confidence, collusion and poor regulatory oversight came home to roost.
To be fair, there are a number of innovations that look promising. The last few years have seen diversified growth funds gain traction as employers seek a saving structure that satisfies the basic requirements of auto-enrolment and is one they would be happy to enrol themselves into. Target date funds offers some optimism, promising a better fit of investments to individual requirements.
However, we keep focusing on finding the Holy Grail instead of sticking to our knitting. Even the best of best-of-breed fund structures can achieve little if it is starved of funds. Good outcomes for employees at retirement rely far more on adequate levels of contribution than a single fund structure or lower fees.
The danger is, the vast majority will believe that now they are saving for a pension, they are sorted. This merely displaces the (misplaced) belief that the state will look after them. It won’t, nor will auto-enrolment. It is but a tiny step in the right direction. But if we don’t build on it, it will be for nothing and we won’t get a second chance on this scale this generation, possibly not this century.
Padraig Floyd is contributing editor of Workplace Savings Quarterly
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