When the National Employment Savings Trust (NEST) announced it would use target date funds (TDFs) for its default option back in 2010, you would have been forgiven for thinking a wave of other defined contribution (DC) schemes would adopt a similar approach, especially following the introduction of auto-enrolment. However, while TDFs are used extensively and for the most part successfully in the US market for 401k plans, those who thought they would translate seamlessly into the UK market as a simpler, more efficient model than traditional lifestyle, have so far been disappointed.
“Given the UK has always had a glidepath mechanism through lifestyle, I don’t think people have felt TDFs bring a lot more to the party.”
Emma Douglas
As employers look to revamp or introduce new DC schemes for staff, there are a number of compelling reasons why TDFs are a more efficient investment vehicle than traditional lifestyle. For starters, advocates say managing assets within a single fund is cheaper, less risky and more streamlined than the traditional lifestyle approach of managing a group of different funds. Yet despite the benefit of streamlining, the lifestyle approach remains the favoured option for most DC schemes.
A major stumbling block is the fact that UK pension schemes have always relied on the counsel of their investment consultants who, it seems, are yet to see the merits. But why is this so? Where consultants have added value historically has been being able to pick best of breed and packaging that together for clients. With TDFs however, this process is removed, so there is nothing in it for them and as a result they have not been pushing them to clients. But consultants are quick to dismiss TDFs as a threat.
“I don’t see it as a threat because we provide different investment strategies to different clients on a different basis,” says Aon Hewitt senior DC investment consultant Ryan Taylor. That said however, Taylor admits he does not suggest their use to clients: “I have never recommended them to a client, but we have clients who have them and have used them. “The concern would be that you are handing over the asset management process to just one manager. How can one manager be good at every asset class in every region?”
Similarly, Mercer Investment Consulting partner Emma Douglas says: “I don’t think they are more a threat than any other fund because any client in the contract-based world can go to a provider and take their off-the-shelf default option. The market is developing to allow consultants the flexibility to influence asset allocation with open architecture TDFs.”
If you can’t beat ’em, join ’em
Consultants might claim not to view TDFs as a threat, but industry whispers suggests that some of the biggest players are looking to launch their own strategies to compete with the asset management houses.
Mercer already runs a form of TDFs – ‘target retirement date funds’ – for clients on its Workplace Savings platform. However, rather than put members into a TDF from the start, the TDF part kicks in around five years before retirement when the member can more accurately predict the date they are likely to retire. Prior to this, the member is in a growth fund.
Douglas explains: “We can intervene with some tactical asset allocation rather than mechanistic lifestyle. You can add value through active asset allocation in the de-risking period so we have built these TDFs. “ Mercer is never going to be picking stocks, but we think we can pick managers and make asset allocation calls.”
Meanwhile, Aon Hewitt’s Taylor says to his knowledge his firm is not working on a TDF solution, but adds: “I guess there will be some consultants looking at that. I still think if TDFs are to take off then I don’t see why consultants and asset managers could not work together to ensure clients get the best results.”
So are consultants actively pushing TDFs as a strategy to investors? NEST runs 45 TDFs, or what it terms ‘retirement date funds’, as part of its default strategy. Chief investment officer Mark Fawcett says it uses a consultant to help with manager selection for the underlying funds and for particular work such as modelling, but he and his team do the asset allocation in-house and act as investment advisers to the investment committee.
“Broadly speaking, we have relatively little consultant input,” he says. “Traditional schemes have a consultant come to every committee meeting and advise on asset allocation, we don’t have that.”
The Pensions Trust (TPT) has some £200m of £250m DC assets in its TDF strategy. Chief investment officer David Adkins describes the role the scheme’s consultant played as “significant”, not least for the major asset transition the trust undertook in February to move assets into the TDF strategy.
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