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Diversified growth to play key role in DC default

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  • Diversified growth to play key role in DC default

GLOBAL - Consulting firm Lane, Clark & Peacock is advising pensions clients to adopt a new lifestyling default strategy for defined contribution (DC) plans which for the bulk of the investment period is equally split between equities and diversified growth investments.

Kevin Frisby, senior consultant at LCP, told delegates at the firm's global pensions briefing he had been working with UK pension funds to create a new default fund for DC schemes which will eventually be rolled out in Ireland, continental Europe and the US.

More specifically, he noted traditional default pension options have tended to be made up on equities investments until a person reaches approximately 55, when some of the assets are then transferred to fixed income and cash at a later date again.

Under LCP's proposal, pension funds would instead split their official equity allocation in half from the beginning of investment - instead of placing all 100% in equities - and place 50% in diversified growth funds (DGF), which in some cases also contains equities.

As time progresses and the individual heads towards retirement, for example 65, the make-up of the individual's default investment would then change, according to a model presented by LCP, so:

the equity and DGF allocations reduce each from 50% to 25% between the ages of 55 and 60; the equity and DGF allocations drop to 0% by the age of 65; the remaining money is then invested in corporate bonds and index-linked gilts to 60, and they then reduce by age 65 to build additional holdings in government bonds and cash.

Diversified growth funds still receive mixed reviews from the pensions industry, but they are growing in popularity among consultants as they currently contain a mix of equities, bonds and alternative investments, with the alternatives making up in the region of 25% of the holding.

That said, taking the concept one step further, HSBC Actuaries & Consultants, are now talking to providers about the prospect of building DGFs which have a much lower equity weighting and a higher alternatives focus, in part because pension funds are likely to have reasonable equity and bonds focus already.

Frisby said pooled vehicles by UK life insurer Standard Life, along with those from BlackRock, Schroders and Barings have performed well even during the recent financial downturn "and stood up extremely well during the crisis", as well as delivering at a cost of 0.6%-0.8%.

"[This strategy] takes some of the volatility out of the growth phase as we have a revised lifestyling strategy with 50% DGF. It is one which is targeting a low level of volatility, because you can see +/-20% on equities in any given year, but perhaps see +/-5% on DGF," said Frisby.

It makes a meaningful difference to the members' investment performance as it has the same risk-return aspirations as hedge funds, without the well-publicised problems."

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