Most workplace pension accounts are invested in so-called “default” investment strategies. The Pension Provider Survey 2024/5, conducted by the Department for Work and Pensions, reported that around 86% of auto-enrolment pension scheme members are invested in the provider’s default investment approach.
Unless a decision is taken when joining a workplace pension scheme, individuals are automatically placed into a default investment strategy. This is a good idea, as many choose to take no interest in how their pension is invested, and accepting a default strategy ensures that the pension adopts a diversified approach, investing in a range of assets designed for growth over the longer term. This also avoids individuals choosing a very conservative investment approach in their early years, which could potentially lead to a poor outcome.
For those in the early stages of pension saving, with decades before retirement, a default strategy may well be broadly appropriate, as it will provide a high degree of exposure to global equity markets; however, as pension values grow and retirement planning becomes a more important consideration, relying on a default strategy can create unintended risks, missed opportunities and increase the likelihood of underperformance.
Limitations of lifestyling
Most workplace pensions follow a lifestyling or target-date approach. In simple terms, this means investing more heavily in equities during the early years, then gradually switching into bonds and cash as retirement approaches.
The premise of such a strategy is to avoid a “cliff edge” scenario, which could occur if markets fall heavily around the time an individual reaches their normal retirement date. Whilst this is, indeed, sensible, such strategies are often too rigid and fail to consider the need to remain flexible when approaching retirement. Historically, lifestyle strategies were designed around the purchase of an annuity at retirement. Today, many retirees plan to use income drawdown, keeping their pension invested beyond their normal retirement date. For these individuals, reducing growth assets too early can significantly lower long-term income potential. Worse still, automatic de-risking can coincide with market downturns, effectively locking in losses at precisely the wrong moment.
Another common concern raised is the target date set for the lifestyle strategy often coincides with the point at which an individual will begin to receive their State Pension. The default strategy is, therefore, misaligned if the individual chooses to draw their pension at an earlier date.
One size fits all
Default investment strategies are designed to appeal to the average pension saver; however, a single default strategy cannot cater to the diverse needs of pension scheme members, their individual preferences or wider financial circumstances. Some may hold other significant investments, property or business assets, which will provide an income in retirement. Others may have membership of defined benefit pensions, which provide guaranteed income. Holding assets external to the pension may allow a different risk profile to be adopted for the workplace pension.
Ethical preferences cannot easily be accommodated through a default investment approach. NEST, which has over 13 million members, allocates a proportion of their default strategies to climate aware funds. This may not, however, satisfy those who prefer to take a more socially responsible approach to investment. Conversely, given the underperformance of socially responsible investments – when compared to mainstream investment strategies over the last year – investors less concerned with ethical considerations may prefer greater allocations to sectors such as defence, oil and mining, which have outperformed.
Underwhelming performance
We undertake detailed analysis of many hundreds of pension arrangements each year that are held by clients when they approach us for advice. An increasing consensus is emerging, which shows performance from default funds generally falling behind sector averages over the longer term. In the drive to keep costs low, many default investment strategies are now exclusively invested in passive funds, which aim to track a particular index or benchmark. By their very nature, passive funds will only ever track the performance of an index, not beat it. Whilst they are a good way of gaining broad market exposure, focusing on passive investments alone misses out on the potential for outperformance that actively managed strategies can provide.
Further underperformance often becomes apparent as individuals begin to move towards their intended retirement date, where the lifestyle strategy begins to reduce equity exposure and introduce greater allocations to fixed interest securities. Due to the reliance on passive strategies, the fixed income element is often concentrated in longer dated government bonds, which have performed poorly when compared to corporate debt over recent years. Furthermore, the absence of a strategic approach can increase risk, as credit quality and duration are not necessarily adjusted to suit prevailing market conditions.
The importance of advice and review
Pension investments are held for the longer-term, and those entering the workplace today may well be saving for almost 50 years before accessing their pension savings to provide an income in retirement. Over this time, additional performance that could be achieved from a tailored investment approach could lead to a significant difference in pension fund value when reaching retirement.
It is important to seek advice before considering any changes to your pension investment strategy. Our experienced advisers can analyse your existing arrangements and your wider financial objectives, to provide you with tailored, independent advice on an appropriate strategy that meets your goals in retirement. Keeping any strategy under regular review is as important as the initial advice, and our comprehensive ongoing review service aims to ensure that the strategy remains appropriate in light of current and expected market conditions and changes to your circumstances. Speak to one of the team to arrange a review of your existing pensions.
