At a recent roundtable, accompanied by an esteemed panel of industry experts, we pondered the question of how Defined Contribution investment strategies have evolved over the past eighteen months. Aside from a heightened awareness of ESG risk factors and an accelerating drive to incorporate or understand associated metrics, it was generally acknowledged that their design is driven by a formulaic approach to asset class weightings. There would have been little in the way of dynamic management of members’ assets and a reliance on equity markets to rebound. As it happens, global stock markets recovered strongly and vindicated an approach that can rarely be accused of taking risk off too early or participating too late. This of course somewhat depends on a member’s proximity to retirement.
We are by no means at the end of this pandemic and the impact on businesses, the economy and global debt (amongst other measures) are still to be felt. However, this environment of heightened volatility and uncertainty has provided a means to assess the robustness of default funds and the journey to and including, decumulation. For those strategies heavily reliant on equities, often the case for savers early in their working lives, a high tolerance towards volatility would have been required from an engaged member. More worryingly, an engaged member may have chosen to reduce their holding in risk assets and crystalise a loss (highlighting the need for effective and timely communication).
The performance of pure equity and bond portfolios over the past decade has been strong, somewhat of an exception by historical standards. But we cannot buy past performance and past performance does not indicate future results. An impactful drawdown seems not unthinkable and prospective retirees may find their time-horizons incompatible with the sort of holding periods that have historically been associated with markets recouping losses. Given this, a diversified and dynamically managed strategy which taps into a range of return drivers to diversify equity and credit risk may be a good alternative for those expecting a relatively smooth returns journey without necessarily compromising long-run returns.
Failing to diversify across multiple lowly correlated risky assets leaves investors wide open to periods of exceptional price and returns volatility and periodically large capital drawdowns. DC pension schemes can take advantage of positive cash flows and a very long investment horizon to access a wider range of risk premia, embracing tangible asset classes that have the additional benefit of engaging members. However, DC decision makers are less inclined to cast the investment decision making net as far and wide as their DB counterparts.
Perhaps the drive towards consolidation and associated scale may overcome some of the well-known impediments to investing away from public markets. Although we are seeing advanced thinking and some regulatory intervention, short-term implementation is constrained by market dynamics which has led to competition based on price (which would need to be higher for those with an explicit allocation to illiquid assets). Risk-adjusted returns net of fees should surely sit at the heart of what determines a good member outcome.
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Past performance is not a guide to future performance.
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