The issues and concerns associated with individuals making investment decisions in a defined contribution pension scheme have been well documented. Everything from ‘radical conservatism’ to market timing has been used to describe the investment behaviour of scheme members in such arrangements.
Pension scheme trustees, their advisers and providers have all been attempting to address this very important matter – but, it has to be said, with limited success. Why is this and what can be done to ensure that individuals invest appropriately to provide for a sufficient income in retirement?
As most people would acknowledge, the primary issue is not the scheme member who is investing too aggressively (ie is overweight in equities – and perhaps those of emerging markets) but the individual who has opted for an overly conservative investment approach, and thus is not assured of having enough to provide for even a modest retirement income.
The popular approach in the UK has been to introduce some form of ‘lifestyle’ product whereby the asset allocation of an individual’s investment portfolio changes from 100% in equities to balanced and, ultimately to fixed income as they position themselves for the purchase of an annuity at retirement. It is interesting to note that the UK is considered to be ahead of the US (in terms of take-up) when it comes to such products as it reflects the more ‘paternalistic’ nature of British trustees.
Is this a good thing? Are lifestyle funds the answer? The answer to the first question is obviously yes. It is a good thing to introduce products and services that help scheme members manage their retirement provision more effectively. The second question is, perhaps, not as easy to answer.
Generally speaking, there are two approaches to lifestyle funds. One, most common in the UK, provides a reallocation of a number of underlying investment funds in the latter years as an individual approaches retirement. In addition, their products often have an annual rebalancing process which ensures that the asset allocation of the overall portfolio reflects the appropriate exposure to equities, fixed interest and cash based upon a prescribed retirement date.
The other, less common, approach (but one that is prevalent in the US) is actually a fund that has a ‘maturity’ (ie retirement) date at which time the fund will be entirely invested in fixed income. In other words, unlike a ‘fund of funds’ approach more common in the first example, these arrangements are actually single funds.
Perhaps a better way of comparing the two approaches is to describe the first as a ‘fund allocation’ and the second, more accurately, as ‘asset allocation’. The distinction is not obvious at first. A few questions may provide some insights into the differences:
q Who is responsible for the geographic and sector exposure of the overall fund?
q Where does responsibility lie for the overall performance of the lifestyle fund?
q In the event of changes in markets, where does responsibility lie for changing the actual fund allocations (or funds themselves) in the first approach?
q Is the investor ever exposed to large reallocation (and the timing) which could materially affect the value of their fund?
To put it simply, the more common approach to lifestyle funds in the UK is not without some significant concerns. In other words, the ‘fund allocation’ approach does not adequately address the questions raised. By comparison, the characteristics of a more accurately described ‘asset allocation’ lifestyle fund, described as the second approach, are as follows:
q Managed as a single fund.
q Prescribed ‘maturity date’ means that investors planning to retire on or about that date all invest in the same fund.
q Responsibility for performance (ie stock selection and asset allocation) is handled as with any other fund.
q There is no need for any rebalancing or large (single day) reallocation which would expose the member to market timing issues.
This type of lifestyle approach is beginning to grow in popularity in the UK as some US providers are designing and introducing such arrangements to pension fund trustees. Given the penetration and receptiveness of trustees to the concept of lifestyle funds for their members, I don’t think that it will be very long before this approach becomes the dominant approach to ‘lifestyling’ in the UK and Europe.
Trustees and board members of pension funds are ultimately concerned with the provision of retirement income for members. To that end, whether it is a defined benefit or a defined contribution scheme, the responsibility to ensure that scheme members are able to build towards a sufficient income in retirement lies with the trustees. In fulfilling this responsibility, they have a requirement to consider both the fiduciary and administrative implications of the two approaches to providing a lifestyle investment option for members.
It must be said, however, that offering lifestyle-type products must not, and does not, remove the inherent responsibility of trustees or boards to educate members of defined contribution schemes; just because a member can effectively invest in a fund and ‘forget about it’ until retirement does not mean that trustees can abscond from their fiduciary obligations.
The fact is, that if trustees are asking scheme members to take responsibility for their own retirement, and to invest their contributions accordingly, they must educate them about ALL the means available to them in fulfilling this responsibility.
David Calfo is a founding director of London-based asset management consultants Provizion

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