PensionsSep 27 2018

A possible alternative to lifestyling?

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
A possible alternative to lifestyling?

Target Date Funds (TDFs) are a relative newcomer on the pensions block and have been promoted as a possible alternative to lifestyling, which is the prevalent way of managing defined contribution (DC) pension assets.

But they have taken a while to take off, partly because lifestyling is so prevalent - dominating around 94 per cent of all DC assets - and has been relatively successful.

But TDFs' adherents sing its praises and claim many advantages over lifestyling so that new players on the pension scene, especially master trusts, that have a clean slate, are resorting to TDFs as a relatively easy and less complex way to manage the pension assets.

TDFs are single funds, usually based on a fund-of-fund or multi-asset structure, and with a fund manager running it with an end point in mind. So each fund will have the 'target' retirement date in mind, usually in batches of five years, depending on when the individual is planning to retire.

I think the problem is life isn't that simple - people's needs change and fund management companies change.Laith Khalaf

Conventionally there used to be a fund for each retirement date, but with the advent of pension freedoms, and the flexibility demanded by pensioners, this is more often now done every five years.

Laith Khalaf, senior analyst at Hargreaves Lansdown, says: "The idea is that you start off when you're younger, and you will start off with a higher risk portfolio and as you get older you will get less risk to when it reaches a point where it's the same all the way.

"I think the problem is life isn't that simple - people's needs change and fund management companies change and if you're taking a 30-year time horizon, there's going to be an awful lot of change."

Selling point

TDFs' proponents say that their big selling point is that the pension assets sit under one umbrella, so that as the policyholders in each cohort near retirement, it is easy for the fund manager to switch the allocation into a more suitable fund.

With lifestyling, which is the process used by the vast majority of DC schemes, the policyholder is in several different funds and the administrator has to seek permission if the saver wants to change allocation.

Will Allport, senior retirement strategist at Vanguard, explains: "The administration in any defined contribution scheme is very complex and very costly. The administrator moves their allocation around on the individual's behalf."

Say, for example, at the age of 50, an individual is 60 per cent invested in a global equity fund, 20 per cent in UK equity and 20 per cent in a bond fund. He says: "In lifestyling the administrator sees them having three lines in their account. 

"In lifestyling the administrator will see when you are 51, I'm going to transfer your allocation, with 58 per in global equities and 18 per cent in UK equities, and 24 per cent in bonds. It's a complex transaction for the individual - the administrator is moving the account around.

"A Target Date Fund embraces all of that moving of the allocation within the fund."

When the saver moves closer to retirement, the fund manager can simply move into a different asset class, by changing the allocation within the fund.

Constructive criticism?

One of the criticisms of Target Date Funds is that they seem to lump a huge number of people into one cohort - for example, people retiring between 2020 and 2025, or 2025 and 2030.

But Mr Allport notes this actually suits current retirement planning needs. He says: "If you're running a 2025 fund it means that [it is] broadly appropriate for an individual who expects to retire between 2023 and 2027. 

"Retirement has fundamentally changed. The number of men who retired at 65 last year was about 12 per cent - post-pension freedoms that trend continues to bear out. 

People buy into them seven or eight years before retirement and they do all the heavy lifting. They're very simple and then they end up with the retirement outcome you want.Brian Henderson

"30 per cent of people retire within a five-year window of their expected retirement date - we don't know when an individual is going to retire, and they don't know when they're [aged] 25 or 60."

Target Date Funds are very big in the US, with about $650bn invested, making them by far the most popular default strategy there.

But they are less popular here.

Brian Henderson, director of consulting at Mercer, acknowledges: "A lot of schemes, their current arrangements aren't broken, they don't need to be replaced with something else. If you're going to come out of your current arrangement and go to a TDF, you need to be convinced of the benefit of doing it.

"We have a rich history of people using administrators to do this - 94 per cent use lifestyling. TDFs can be quite compelling but trying to convince trustee boards to say, 'this arrangement is not fit for purpose, let's do TDF' is a big upheaval.

"I don't think TDF providers have won over hearts and minds and I don't think they've convinced a number of trustees to move."

He continues: "If you had a clean sheet of paper, it's a little bit easier to deal with.

"Many of the master trusts, whose aim is to manage a large scale of pension assets from auto-enrolment have signed up, and they offer a number of different outcomes that people are intending, mainly: cash, annuities, drawdown."

Confidence

Mr Henderson, whose company Mercer uses TDF in its master trust, says: "People buy into them seven or eight years before retirement and they do all the heavy lifting. They're very simple and then they end up with the retirement outcome you want.

"If you want to have an annuity or drawdown or cash, what's nice about them is they tend to focus on the outcome and dates and tend to be very simple."

The risks, however, is that one is relying heavily on the one fund manager to get it right. Mr Henderson notes: "You have to have a lot of confidence in the manager - you have to ensure that they have the ability to deliver going forward."

Because of the proliferation of cohorts, they tend not to be available on adviser platforms, simply because there would be too many of them and not enough volumes to warrant each fund being on each platform.

The next feature goes into more detail about how Target Date Funds work.

melanie.tringham@ft.com