The Burden of Choice

CEO of NOW: Pensions Morten Nilsson

CEO of NOW: Pensions Morten Nilsson

The current UK pensions system has led many to lose confidence and they are no longer saving for their retirement. With auto-enrolment being phased in from October 2012, employers need to be looking for schemes that operate efficiently and cost-effectively, whilst not overburdening them with extra responsibilities that affect employers’ ability to run their businesses.

Simplicity is at the heart of promoting confidence in the UK’s pension system, which has been characterised by complexity for too long. A lot of this complexity has come from pension schemes offering members an over-extensive range of funds, which paradoxically have not increased engagement with pensions.  Evidence from the DWP shows that over 80% of members in Defined Contribution (DC) schemes opt for the default fund and typically remain there. Experience shows that this is no bad thing: in the mid 00’s ATP (the Danish state pension provider) offered a DC plan to 3.5 million members, 10,000 of whom made the investment decisions themselves. However, these members were shown to be taking excessive risk that was out of sync with markets, and our research in both the UK, and other countries, certainly indicates similar results.

The majority of members have little investment knowledge to make the right decisions when picking funds. People want a scheme that manages itself – as opposed to having to make loads of choices themselves – and one that produces strong and stable returns in the long run.

The advent of automatic enrolment has brought several new schemes to the market, but some of the default funds that they offer are heavily weighted towards equities, similar to the typical UK default funds’ equity allocation of nearly 80%. Equity markets are highly volatile in the short and medium term and everyone has watched the equity markets in Europe and the US yo-yo over the past five years. Peoples’ savings are being hit hard with every dip, and it could take years for pension pots to recover from the losses they have incurred. There needs to be a change of thinking throughout the industry, because tracker funds have proved time and time again that they are failing members and are not the best savings vehicles.

With the introduction of auto-enrolment and the number of savers in default funds set to increase dramatically. Members need an actively managed fund that mitigates risk by diversifying investments across various asset classes. This diversification strategy, coupled with active management, can provide the risk framework to ensure the value of a portfolio is less drastically impacted when there is a shock to the system. This enables the fund to produce more stable returns than the simple traditional funds that are used in the UK.

Offering a scheme that puts the onus on members to make investment decisions unnecessarily increases the workload for everyone involved.  The introduction of auto-enrolment will bring a new group of savers into the UK pensions system, some of whom will be saving for the very first time. It could add overwhelming strain if companies are then required to support their employees in the decision making process. Companies operating simple pension schemes that require fewer decisions from members are likely to benefit in the long run.

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