What’s the current situation?

Although most of the concern expressed about auto-enrolment is focussed on administration, the success of workplace pensions will ultimately be based on their outcomes for people using them.

It is the performance of the investments that will make the biggest difference to your staff.

In this guide we look at how you can measure the investment propositions of the pension providers you are looking at. If your company already offers a workplace pension, this guide can be used to measure whether your existing provider’s invest­ment offering is fit for purpose or whether you are due an upgrade.

We’ll divide the guide into five areas

• Governance is the act of governing. It relates to decisions that define expectations, grant power, or verify performance . Governance controls strategy, execution, main­tenance, choice.
• Strategy is the plan to maximise the outcomes of all members in the workplace pension.
• Execution is the way the strategy is carried out.
• Lifecycle is the changing needs of a member as they pass from accumulating to spending their pension savings.
• Choice refers to the range of options available to those who want to select their own investments.

Strategy

The point of having a number of workplace pension providers is to allow for different strategies to compete over time. We are impressed by the publication of the strategy of the scheme (a statement of investment principles preferably including a scheme philosophy).

Clearly the strategy needs to be credible, but we do not want to prescribe what it should be. For instance, NEST have a view that those entering workplace pensions at a young age should not be exposed to their fund falling in value as this might put them off saving in the future. This strategy is clearly articulated and while it may not

Execution

While a wide diversity of strategies is a good thing, there should only be one kind of execution “good execution”. What this means is that the decisions taken by those making the strategy should be carried out with precision and in the interests of the growth of the fund. Often, sloppy execution is ignored, this is a governance failure.

The impact of poor execution is usually borne by the member not by those paid to carry out the work so it is vital that governance committees and trustee boards know what to look for.

Examples of such “shoddy workmanship” could include

• Out of market risk (when units are bought and sold)
• Uncompetitive spreads (when buying or selling stocks and shares)
• High commissions (on the sale of stocks and shares)
• High currency management costs (from hedging currency risk)

Lifecycle

Whether for you individually, or for the entire membership, the trustees or IGCs must do all they can to get people in the right investments for their right stages of their lifecycle. People with long time horizons- those starting their investment careers, can afford to take risks that those close to the end of their careers cannot. Typically these connect to the security of the capital value of their “pot”.

There are many variations in the way people spend their retirement savings which cannot be fully recognised in a default investment strategy. Some people choose to retire later than others ; some will choose to drawdown from their fund while others will use a guaranteed annuity.

Historically, the argument is that people need to take control of their own investments and make sure they are communicating with those managing their pots so that they follow an appropriate investment strategy.

Sadly, this has often not happened and people have found themselves in the wrong investments at the wrong time, often with disastrous results.

Recently, attempts have been made to make decision making easier by using target dated funds. With a target dated fund, all a member has to decide is the year they anticipate drawing their pension. This is seen by some as a better way of helping manage the lifecycle.

In other countries, the choices of when and how to retire are reduced and actions are taken collectively rather than individually. This is sometimes known as Collective DC. The Government are consulting on whether such a simplified system could be used in the UK.

Choice

We have mentioned how trustees and IGCs need to exercise care to ensure people take the correct decisions as their lifecycle changes.

A different problem associated with choice occurs for them with people who do not want to use a conventional or “default” investment strategy but want to go it alone. Some workplace pensions (notably NOW pensions) do not encourage any choice at all and wish to channel all investments through a single option. This is not only easier to administrate, it is also easier to govern.

Increasingly, as the requirements of DC governance become onerous, trustees and IGCs are looking to restrict the choice of investments offered to those who want to ski “off piste”. Theoretically the same standards of governance should apply to all funds offered to the scheme but necessarily those choosing funds other than the default option, should expect less scrutiny from those governing those funds.

For this reason, we are concerned when we see a wide choice of funds with no clear governance structure in place.

Who guards the guards?

In the past, investment consultants have been on hand to help employers and trustees to manage the investments within workplace pensions. More recently , we have seen investment experts embedded on the trustee boards or in the IGCs, these independent trustees (or governors) are in place to ensure there are no conflicts of interests between those who profit from the schemes (the providers) and the beneficiaries of the schemes (the members)

However, we are still concerned that there is insufficient oversight on some workplace schemes and both as www.pensionplaypen.com and as First Actuarial (who provide analytics to Pension PlayPen, the monitoring of not only of the strategy ,execution ,life­cycle and choice of the plans but also of their governance is critical.

Our investment ratings for each provider are based on our assessment of all aspects of a scheme’s investments – including investment governance.

Ten questions to be asking your provider about investments

1. Do you have a trust board- if not are plans in place to set up an Independent Governance Committee?
2. Do you have a statement of investment principles (or similar) that outlines the investment strategy and the investment philosophy in place?
3. How do you measure good execution in your fund- what measure are in place to measure the impact of costs to the funds that impact on performance?
4. What steps have been taken to recognise the changing lifecycle of the membership?
5. What is the rationale for the choice of lifecyle vehicle (TDF, Managed DC,Lifestyle)
6. What is the attitude to investment choice, what choices are there and how are they managed?
7. What sanctions are in place if an investment manager fails to follow a stated strategy or demonstrates poor execution?
8. Do you have a stated policy on Socially Responsible Investment and is this in evidence in your DC strategy?
9. What plans, if any, are in place to offer collective decumulation options?
10. What investment information do you publish for employers and their staff?