Auto-enrolment default funds

16 January 2017

Patrick Norwood, Insight Analyst (Funds and DFM)

Learning objective: to see pension default funds as examples of multi-asset funds and then look at the similarities and differences across various features of the biggest automatic enrolment pension default funds.

Default investments are the funds in which contributions to pensions will automatically be invested, unless employees are given and exercise their own investment choice. According to Moneywise, 84% of savers are relying on their pension provider’s default fund to save for their retirement.

Under the Pensions Act 2008, every employer in the UK must put certain staff into a pension scheme and contribute towards it, with the staff often contributing too. This is called automatic enrolment (AE).

Defaqto recently carried out a study comparing the 11 largest AE default funds by AE assets under management. These are all multi-asset, although to varying extents as the table below shows:

 

Table 1: Main AE default funds – high-level asset classes used

Source: provider websites and factsheets

As can be seen, all contain equities, fixed income and cash. Some also hold ‘alternative’ asset classes to varying degrees. The advantages of such asset classes are the greater potential for higher returns and diversification; however, they can also be more risky, expensive and less transparent.

There is also a mix of manager structure across the main default funds reviewed: some keep fund management in-house, either using fund managers from elsewhere within their organisation or investing directly in securities; a couple completely outsource to external managers while others use both in-house and third-party managers.

The main rationale for outsourcing to third-party managers is that no one manager can be the best across every single asset class, but instead one should source a specialist manager for each different area. The disadvantage of this method is that third-party managers are generally more expensive than managing the funds in-house, although this may well be dependent on the available economies of scale and negotiating position.

In terms of investment approach (active versus passive fund management) there is a mix too. Active managers have the chance to outperform the respective index, but also run the risk of underperforming it. Passive managers, meanwhile, simply track the index and generally cost less.

Table 2: Main AE default funds – fund manager structure and investment approach

Source: provider websites and factsheets

AE has been running for just over 3 years. In the 3 years to end-July 2016, annualised returns varied from 5.4% to 9.6% across the funds looked at. Disparity in performance remained after adjusting for the risk taken by each fund, both total risk and downside risk only.

Finally, there was also seen to be variation in charges, with some funds having a relatively high annual management charge (AMC) and others having a lower AMC but also an initial contribution charge (as a percentage of the contribution) or fixed monthly administration charges. The latter types tend to work out better in terms of overall charges over the longer term (20 plus years) as there is then sufficient time for these additional charges to become diluted. In addition, those with the fixed monthly administration charge fare better with a larger pension ‘pot’ as this charge will form a lower portion of the bigger pot.

For a full review of the most popular auto-enrolment default funds see our recent publication How to analyse auto-enrolment default funds.

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