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FTSE firms shift DC defaults toward diversified growth funds

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A growing number of FTSE companies are shifting the design in their defined contribution (DC) default investment funds towards more active management, a study has shown.

Research from Towers Watson, into the DC offerings of some of the UK’s largest firms, found more schemes including diversified growth funds (DGF) while reducing passive investments.

Over the last five years, the proportion of FTSE 100 schemes using a DGF in their default fund rose from around 10% to 70%.

Of the 54% of trust-based schemes, the average allocation to purely passive investments fell by 22 percentage points to 40% over the last year.

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Over the same period, purely active allocations rose 5 percentage points to 17% with mixed allocations jumping to account for 43%, up from 26%.

In DC contract schemes, a similar shift occurred with passive investments falling from an average allocation of 88% to 64% over the year, however, still accounting for the majority.

Towers Watson said the mixed portfolios typically included an actively managed DGF.

“Increased use of active management need not reflect increased ‘stock picking’,” the report said, “instead, an active manager may be overseeing how funds are distributed between asset classes and active management may be used in alternative asset classes.”

Nico Aspinall, head of DC investment at Towers Watson, added: “The way you combine the assets makes the funds active, even if the underlying assets are passive.”

“Some DGFs may have building blocks which are very cheap, but they add this small layer of additional fees, which is asset allocation.”

Aspinall also said there was growing interest from DC schemes over smart beta investment strategies, but this has since been put on hold after the Budget, which may require and overhaul of investment strategies.

The government recently announced a change in policy regarding the purchase of annuities, which means investment strategies linked to annuity matching may require a re-design.

The research said almost all default funds currently shifted investment strategy away from growth assets to less-risky assets on the retirement approach, allowing for a better match with annuities.

Of the two variations to achieve this, lifestyle strategies and target-date funds (TDF), the former is the most popular, with only 3% of FTSE 100 firms using a TDF.

The average switching period for lifestyle strategies, as in the length of time pre-retirement investments begin to de-risk, has also increased over time.

Towers Watson said in 2004, majority of FTSE 100 schemes did this in five years or fewer before retirement.

However, the 2014 survey showed that three-quarters of companies now do this over ten years or more.

There had also been a recent increase in DC funds designing investment objectives according to providing a target level of income in retirement, based upon annuity rates.

However, 90% of FTSE 350 firms did not follow this and had investment objectives based on returns, with majority of both trust and contract schemes looking to track, or outperform, a benchmark.

Some 13% of trust schemes and 15% of contract had objectives linked to meeting an absolute return target, an objective closely related to the use of DGFs.

Only 10% of trust schemes and 6% of contract schemes had objectives based on providing a target level of income.

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