How to advise on workplace pensions

Is it a criteria stated in the fund manager’s contract of engagement or is it simply a desire expressed by the schemes trustees/ investment governance committee?

One quantifiable factor you may find useful is whether the scheme has signed up to the United Nations Principles for Responsible Investment.

Performance

Below we report on the annualised returns to the 31 December 2018, using a slightly smaller number of providers (19).  

Default fund - Annualised returns 

The issue with annualised returns is that they take no account of the fund’s volatility, that is, the risk taken in achieving these figures.  

Therefore, we have also included Sharpe and Sortino ratios.

Default fund - Sharpe ratios using 0.75 per cent risk-free rate

The Sharpe Ratio is calculated by taking the fund return minus the risk-free rate divided by the volatility of these ‘excess’ returns.

This ratio has no units and a higher number indicates better risk-adjusted performance.

Default fund - Sortino ratios using 0.75% risk-free rate

Sortino ratios differentiate ‘bad’ volatility of returns from total volatility by penalising only downside deviations.

They are an expression of the fund’s return minus the risk-free rate divided by the downside volatility.

Again, this ratio has no units and a higher number indicates better risk-adjusted performance.

Return

More detail on this subject can be found in the guide entitled ‘How to analyse workplace pension default funds’, published in May 2019.  

It is CPD accredited and free to download from the advisers section of the Defaqto website.

Summary of findings

When recommending a workplace pension there are many factors to consider when looking to evidence ‘value for money’.  

Defaqto suggest there are three critical subjects that should be included in every assessment, namely:

Contributions

8 per cent contribution rates are unlikely to be sufficient for most employees.  

Where the employer wishes to keep to the minimum legal requirement of contributing 8 per cent be sure to educate them on the long term issues this could cause the business.  

Importantly, be careful to avoid recommending ‘indirect discrimination’.  

Costs

Costs reduce returns so need to be minimised. However, do not make your recommendations based on charges alone

Effective management of the default fund (including performance)

Be sure to understand how the fund is managed and the asset diversification strategy employed; it may not be as wide as you expect.  

Also look beyond the annualised returns and ascertain the real return after the risks have been removed (ithatis, risk adjusted).

Advisers and paraplanners can trial the research tool Engage for free, details are on the Defaqto website.

Richard Hulbert is insight consultant at Defaqto