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DC schemes should abandon 'lifestyling' approach, says Cass Business School

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  • DC schemes should abandon 'lifestyling' approach, says Cass Business School

GLOBAL - The 'lifestyling' approach adopted by many defined contribution (DC) pension schemes could be replaced by more innovative alternatives, as the approach is producing smaller pension pot sizes for savers than ever before, a new report has found.

According to research conducted by Cass Business School and sponsored by BNY Mellon, the 'lifestyling' approach - where investors' pension pots are automatically switched out of equities into government bonds in the 10 years preceding retirement - is now inadequate given the fall in equity markets and annuity rates.

Cass Business School professor of asset management Andrew Clare said: "Our research has shown that the equity bear market and the decline in annuity rates over the last 10-15 years has had a devastating effect on the final pensions of DC savers who have relied upon the mechanical lifestyling approach. 

"A more enlightened and more flexible approach to the DC accumulation phase is definitely needed."

The 'Outcome orientated investing for retirement' report argues that DC pension schemes should adopt a "dynamic" investment strategy that enables investors to receive a tailored investment solution and therefore a greater chance of achieving pension targets.

The strategy should be outcome-driven, recognise investors' attitudes to risk and take a flexible approach to the decumulation phase, the report said.

In the research, Cass Business School and BNY Mellon focus on a 'momentum' strategy and a 'contrarian' strategy.

In the 'momentum' case, the report found that DC schemes should increase their allocation to equities for the coming year if the asset class performs well.

If the equity return in the previous year is more than 16%, the allocation to the asset class should be increased by 5%; if the equity return is less than 4%, the allocation should be reduced by 5%.

The 'contrarian' strategy stipulates that, when equities perform well the previous year, a decreased allocation is appropriate.

According to the research, both strategies work well, as they lead to an improvement of the replacement ratio.

Clare said: "To some extent, you could deal with the pension problem just by putting more money in.

"But it's not sensible to put more money into a structure that's not working. Fix the structure first - then put more money in if that's what you want."

He finally concluded: "We need to think about every DC member as if they were a mini-DB scheme."

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