Analysis of over half a million DC scheme members on its Guided Outcomes (GO™) framework has shown that post Brexit, the number of DC investors who will fail to achieve an adequate income in retirement has increased from two thirds to three quarters. From Hymans Robertson.

As a result, some savers will now need to contribute up to 20% of earnings to achieve an adequate income in retirement. Lee Hollingworth, Head of DC Consulting at Hymans Robertson, said: “Post-Brexit the reality is we’re going to see lower interest rates for longer. This will likely result in a negative impact on investment returns when pots are accumulating and on income conversion in retirement. As a result, the number of DC investors who will fail to achieve an adequate income in retirement has increased from two thirds to three quarters since the Referendum. Some savers will now need to contribute more than 20% of earnings to their pension to be able to retire on an adequate income. This will be a challenge for many. Fortunately there is scope for the pensions and investment industry to make investment strategies work harder to close the gap.”

Anthony Ellis, Head of DC Investment Proposition at Hymans Robertson commented: “We’ve evolved our investment approach to focus on delivering the highest possible returns for members, our expectation is an improvement in outcomes for members of at least 15% – wiping out the implications of the Brexit vote for DC pension saving.  Key to this is accessing long term risk premiums and reducing the focus on managing short term volatility in the early years of investing. It’s a contra-view to that of the broader market, but we feel that the member outcomes are being negatively affected by the focus on controlling volatility rather than focussing on delivering increased returns. In the early part of a member’s savings journey, short term volatility is almost immaterial compared to a member’s future value of contributions and investment returns. Long term investors need to harness the long term risk premiums that are available to them in order to maximise their eventual outcome.

“We’ve always looked at DC investment in three distinct phases – growth, consolidation and pre-retirement. The industry norm in the growth phase – when you’re more than 25 years out from retirement – is to utilise Diversified Growth Funds (DGFs). While DGFs have a role to play in DC investment, it’s not in the growth phase. DGFs have delivered lower volatility but with correspondingly less return than traditional long term investments. A smooth journey to a small pension pot is not a good outcome for members. What’s the point of paying for low short term volatility when you’re 40 years out from retirement and contribute regularly (i.e. regular purchase more assets at the prevailing price)? It’s an expensive way of getting less return in the early years of DC investing.”

Discussing what DC schemes should invest in during the growth phase, Ellis added: “Previously we’ve advocated a 100% equity allocation in the early stages of investment. But the market is changing and more sophisticated investment strategies that have until now been the preserve of Defined Benefit (DB) schemes are becoming increasingly accessible to the DC market at a compelling price. This is partly driven by increasing scale in DC.  “As broader options are now available to DC schemes, in the growth phase we recommend a significant allocation to factor based, or smart beta, investments. Complemented with high return diversifying alternatives, such as private equity and infrastructure, for example.”

Explaining how the investment strategy should change as members reach the point when they are 15 years from retirement, Ellis said: “When members reach the consolidation phase, capital preservation and risk reduction become important. DGFs can have a role to play here, but picking the right fund is key. It’s also possible to deconstruct DGFs and achieve the diversification and capital preservation at less cost.

“In the pre-retirement phase, which we would define as 5 years before retirement, it’s important to move away from ‘one size fits all’ defaults and understand what members are going to do with their savings pots. Using our GO™ framework we can easily segment scheme membership and create appropriate default strategies for those targeting cash, those that are likely to move to a drawdown product and those likely to buy an annuity. This is an approach we quickly adopted post pension freedoms which the vast majority of our clients are using to great effect.”

Concluding, Lee Hollingworth said: “Worsening economic conditions necessitate a change in approach for DC investment. It’s fortunate that we’re in a position where the market is evolving to make that a possibility. For too long DC investment strategies have been the poor relation of DB. We think that’s about to change. The industry needs to help make that happen.”