Feature | Professional Investor
Key questions for
pension plan sponsors
and trustees to ask
QUALITATIVE QUESTIONS TO ASK A MANAGER WHEN
CHOOSING A DEFAULT FUND
1.
What is the goal of the fund at maturity (annuity
purchase, drawdown, income stream)?
2.
What is the TER of the fund, and what is the Total Cost
of Ownership (all-in cost to investor including TER,
platform and advisory fees)?
3.
What is the theory underpinning the strategic and
tactical asset allocation policies?
4.
How does expected return and expected volatility of the
fund evolve over time?
5. the asset allocation glidepath managed or automated?
Is
6.
How is volatility managed?
7.
How will the fund overcome: a) inflation risk; b) market
downside risk; c) shortfall risk; and d) longevity risk?
8.
What are the underlying constituent funds, how are
these selected, and what is their impact on TER?
9.
What experience does the manager have of designing
and running TDFs?
10.
How does the default fund measure up to each of the
DWP eligibility criteria?
QUANTITATIVE QUESTIONS TO ASK A CONSULTANT
WHEN CHOOSING A TDF
1.
How do the risk and return graphs look for a TDF vs
individual asset classes: is it successful in delivering
returns on a risk-adjusted basis?
2.
How do different TDF glidepaths compare to get a
snapshot of the manager’s current investment strategy
across all maturities?
3.
How has the glidepath changed compared to the
previous 3 to 5 years?
4.
How does asset allocation compare for TDFs of the same
maturity?
5.
Will a Monte Carlo simulation illustrate how different
funds with different asset allocation glidepaths are likely
to perform?
equity allocation at maturity (for example, to fu nd an annuity
purchase), others argue for a moderate 0-20% equity allocation
(to fund annuity and/or drawdown). This is known as the “to
or through” debate. We believe that the increasing number of
choices at retirement aside from annuitisation, plus increasing
life-expectancy justify a moderately “flat and conservative”
allocation to equities as appropriate insurance against longevity
risk (Cohen, Gardner & Fan 2010).
WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF A
PACKAGED INVESTMENT STRATEGY?
The advantages of TDFs are fourfold:
First, they offer a life-long age-appropriate investment strategy
in a single fund. While investors should review their investments
regularly regarding suitability, behavioural research suggests
that the majority of savings plan participants (for example
Figure 2:
Four generations of default fund
1980s
Default v1.0
Equity fund
Equity return
Equity risk
1990s
Default v2.0
Balanced fund
Target return
Variable risk
2000s
Default v3.0
Lifestyle fund
Target risk
Static risk
2010s
Default v4.0
Lifecycle fund
Target date
Dynamic risk
Source: Elston Consulting
Figure 3:
Old and new approaches to derisking the default fund
OLD
Default v3.0
(Lifestyling)
NEW
Default v4.0
(Target Date Fund)
Derisking
Traditional
Enhanced
Oversight
None: automated
Constant: managed
Derisking
timeframe
Rapid (5-10 years)
Gradual (25 years)
Asset allocation
Heuristic: straightline
Researched:
strategic & tactical
Market conditions
No regard
With regard
Equity allocation at
target (retirement)
0%
0-25%
Longevity risk
Higher
Lower
Inflation risk
Higher
Lower
Shortfall risk
Higher
Lower
Drawdown risk
Substantially lower
Partially lower
Source: Elston Consulting
44 | The Journal of the CFA Society of the UK | www.cfauk.org