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PPI: DC schemes have been resilient, but must now reflect on the lessons of the pandemic

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18 Feb 2022

We are now beginning to see the long-term effects of the pandemic and DC schemes must reflect on their experiences of the last two years, says Lauren Wilkinson.

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We are now beginning to see the long-term effects of the pandemic and DC schemes must reflect on their experiences of the last two years, says Lauren Wilkinson.

The last two years have been a challenging and uncertain time as governments, businesses and investors have responded to the Covid-19 pandemic and its economic effects. Defined contribution (DC) schemes have been relatively resilient, but their experience of, and reaction to, the pandemic may offer lessons for weathering future crises.

Long-term investment horizons and diversified portfolios helped DC schemes to cope with the extreme short-term volatility seen in the early months of the pandemic. The most obvious investment impact of Covid-19 in 2020 was an exceptionally high dispersion of returns between different asset classes, as the pandemic proved helpful to some businesses and harmful to others.

While experiencing significant asset price declines and volatility early in the pandemic, pension funds appeared to fare better than stock markets in general because most pension funds are fairly diversified, holding lower-risk assets alongside more volatile equities.

However, as the volatility was caused by external factors rather than economic shifts, the subsequent recovery has been particularly rapid compared to previous market downturns of this magnitude.

The immediate impact of volatility on those near to, at or in retirement suggests that lifestyle strategies still have an important role to play post-pension flexibilities. The prevailing view was that savers could benefit from delaying access to their pension pot for as long as possible to give them time to recoup losses, as well as making additional contributions to help restore pension pot values more quickly.

This caution was reflected in the number of DC pots accessed during 2020, a significant decline on previous years; around 277,500 DC pots were accessed for the first time in 2020, compared to 433,000 in 2019, a 36% decrease.

While the data suggests that many savers were able to postpone accessing their DC pot, for others this is more challenging in practice. Those on lower incomes, as well as those experiencing disability or long-term illness, are likely to find it more difficult to postpone retirement as they may not be able to supplement income with earnings.

Lifestyling strategies are particularly important for these individuals who are unable to implement other strategies to give their pension savings time to recover from market shocks, although bonds were not immune to the volatility experienced in the early months of the pandemic.

The uncertainty and volatility associated with the pandemic encouraged many schemes to review their investment strategy to ensure that risks and opportunities presented by the pandemic were appropriately accounted for.

However, economic uncertainty led to many choosing not to take immediate action in relation to asset allocations. This pragmatic approach protected schemes from crystallising losses. But now that the landscape has stabilised, many are likely to carry out a further review in light of their experience.

While the pandemic has introduced uncertainty and risk, it has also presented opportunities for investment. Uncertainty and shifts in economic activity resulting from the pandemic, and especially consecutive lockdown measures, meant that returns from some sectors were compromised.

By contrast, other sectors, for example, technology, provided growth and diversification opportunities for those investors with a good under- standing of where longer-term opportunities may be found. For example, technology and digital stocks bene ted as consumer behaviour shifted from physical shopping to online.

Meanwhile, other sectors, particularly hospitality, experienced substantial losses as a result of lockdowns and uncertainty surrounding the pandemic.

As the UK emerges from lockdown, it remains to be seen what the enduring impact will be of these changes in consumer behaviour and the subsequent impact on investment in these sectors.

For the most part, DC schemes have been relatively resilient during the pandemic, taking a pragmatic approach to investment and volatility. While the landscape has now stabilised, we are now beginning to see the long-term effects of the crisis and schemes must reflect on their experiences of the last two years in order to build greater resilience for future crises.

Lauren Wilkinson is senior policy researcher at the Pensions Policy Institute (PPI)

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