Pension reforms fuel passive curiosity

This has led to a surge of interest in products such as multi-asset and absolute return, but with many retirees looking to live off their income for a while, a low-cost passive solution could also play a part in both the accumulation and decumulation phases.

Sales of tracker funds have remained strong, with figures from the Investment Association (IA) recording net retail sales into the space of £5.4bn in 2015 compared with £4.9bn in 2014. Meanwhile, the first quarter of 2016, while difficult for some, saw tracker funds enjoy net retail sales of more than £1bn as investors sought to maximise Isa allowances before the end of the tax year.

Guy Sears, interim chief executive of the IA, notes: “With changing pension regulation and uncertainty in the global economic outlook, multi-asset and absolute return products have been popular with retail investors.

“Tracker funds also remained popular with retail investors and now make up nearly 13 per cent of industry funds under management. Active and passive investment strategies can both play a part in helping people meet their investment goals.”

Passive investing is likely to be ticking the box for many near- and post-retirement investors partly because of growing awareness, and also due to the low costs related to these products, be they index funds or exchange-traded products (ETPs).

Pension schemes are better off using their time to determine strategic asset allocation – which can then be implemented cost-effectively using index funds Veronica Humble, LGIM

“The most high-profile issue is the requirement for investment governance committees to provide a credible definition of ‘value for money’, incorporating a balanced assessment of quality versus cost.”

But she notes that investment issues have “taken a back seat, although heightened volatility at the start of 2016 has threatened to bring investment back into the spotlight”. She adds: “Active managers have been criticised for their purported lacklustre performance net of fees, while passive investing has increasingly been portrayed as the mass-market DC solution.”

Index funds have always been a part of the pensions landscape but how much of an impact will the pension reforms have in terms of the passive market?

Neil Cowell, head of UK retail sales at Vanguard, points out: “The DC market is set to triple to £1bn over the next 10 years, so a wall of money is going to emerge. Because of that, there is inevitably going to be an opportunity for investors with a simple, effective, low-cost investment solution – and passive fits that bill perfectly.”

Veronica Humble, senior investment strategist at Legal & General Investment Management, says that where pension members have little investment knowledge, index funds are an obvious starting point for schemes as they are low cost, easy to understand and provide a reasonable amount of diversification.

But she notes: “The way these are being used is changing. Ten years ago, most DC schemes used an index fund as the default fund; now, most want more diversification through a multi-asset fund. Index funds fit into this model. Risk and return differentials between asset classes are, generally, higher than differences between managers in an asset class.

“In other words, the mix between UK and overseas equities may have a greater impact on performance than manager choice. In our view, pension schemes are better off using their time to determine strategic asset allocation – which can then be implemented cost-effectively using index funds.”

Meanwhile Rima Haddad, head of UK institutional distribution at ETF Securities, notes the pension changes in the UK pose challenges for clients, with two key themes being cost and transparency.

“ETPs are generally cost-effective, particularly when compared to traditional mutual fund structures. The reforms will also require independent governance committees and trustees to consider costs and charges, and the FCA is looking at introducing regulations about disclosing transaction costs.

“Across Europe, we are seeing regulation that is placing end savers at the centre of the investment process. We expect this to continue, particularly in the pension industry.”

Many might appreciate the potentially higher returns of a fully active investment approach. But with market volatility expected to continue and pension regulation tweaks an almost annual occurrence, the issues of risk and cost mean passive options should not be ruled out when looking at pension portfolios.

Nyree Stewart is features editor at Investment Adviser