Default funds weather Covid-19 storm

Often criticised because of their lower risk exposure and 'one-size-fits-all' asset allocation strategy, data from FE has shown these are performing better than the market as a whole and most actively-managed pension funds.

Moreover, according to commentators, default funds should bounce back in five years' time, for those clients with enough time until they need to take their pension.

It also shows, as one adviser said, that active fund-pickers had "as much chance of picking a fund wisely as they do of finding a toilet roll on a supermarket shelf".

For example, data for the month ended March 17, showed the FTSE All-Share slumped 29.7 per cent while Standard Life’s default fund had dropped 16.1 per cent, L&G's default decreased 17.1 per cent, Aviva's default option lost 18.1 per cent and Scottish Widows's default pension fund fell 22.8 per cent.

Steven Cameron, pensions director at Aegon, said:  “Default funds are sometimes seen as not adventurous enough or not personalised enough to people’s risk tolerance, but given recent events, I expect many people will be feeling reassured that they’re invested in a default fund which typically contain a mix of assets and an average risk tolerance."

These figures are likely a demonstration of how diversification can help cushion falls during periods of extreme volatility. -- Tom Selby

Nathan Long, senior analyst at Hargreaves Lansdown, said: “‘Default pension investments have seen big falls in the last month, but despite this, the story over five years looks far rosier. Default funds are well diversified, so while they’ve fallen in value they’ve held up better than the stockmarket as a whole. 

“The risk is that only a quarter of people actually know their pension is invested, and with markets having risen steadily since automatic pension saving began in 2012, we could see this abrupt fall cause unnecessary panic.”

Tom Selby, senior analyst at AJ Bell, commented: “Default funds are designed to give decent investment outcomes over the long-term to automatic enrolment savers who are not particularly engaged with their pensions.

"These figures are likely a demonstration of how diversification can help cushion falls during periods of extreme volatility. While someone invested in the FTSE All Share would have experienced a drop in fund value of nearly a third in the past month or so, default funds will tend to only have a partial exposure to companies from the index.

"The Aviva default fund, for example, holds just 14 per cent in UK equities, with the rest in a equities from other regions, bonds and cash."

However, he added: "There is no guarantee someone who picked their own stocks or funds would do any better or worse than these defaults."

Ivor Harper, director of Park Financial, thinks those actively picking their pension funds may have been hit much harder. He said: "If people had been choosing their own funds, the outcomes would have undoubtably been worse.

"They'd have chosen expensive options, or been too cautious in the early stages/too reckless in the end stages. Not all but I would say that, comfortably, 95 per cent of AE members have as much chance of picking a fund wisely as they do of finding a toilet roll on a supermarket shelf."

Mr Long's comments now contrast starkly with his scathing remarks about pension default funds made in February 2018, when Hargreaves Lansdown produced a report warning these were, on average, underperforming their active fund peers by 5 per cent. 

People who are more conservative could have better protected themselves had they made their own choices, but it would come at the cost of long term returns. -- Nathan Long

This underperformance, according to Mr Long at the time, was because default funds are a multi-asset pension product, they typically have 65 per cent invested in equities, with the remainder in bonds and cash-like securities. 

As a result, Mr Long said back in 2018 this restricted use of risk assets will have prevented default funds from participating more fully in the equity bull market. 

However, their lower risk asset exposure has helped them to hold up, as the economic effect of coronavirus forcing many industries to almost shut down in many countries has caused the pension savings of many savers to drop sharply. Those more exposed to equities will have fallen further, in line with the stock market. 

Source: Lipper provided by Hargreaves Lansdown

Last week, Financial Adviser revealed that clients invested in a typical balanced portfolio have seen more than 10 per cent knocked from their pot over the past few weeks. 

The IA Mixed Investment 20-60% Shares sector, home to many multi-asset funds has dropped about 12 per cent since February 17.

One adviser even described the coronavirus situation as “catastrophic” for anyone who had invested “sensibly in accordance with their needs” up until a matter of weeks ago and was looking to retire.

However, despite default funds suffering during this time they have performed better against the FTSE as a whole.

Yet in the long term, Mr Long said default funds must strike a balance between being adventurous enough to deliver long term growth for pension savers, while at the save time trying to guard against the worst of any stockmarket falls. 

He added: “What we’ve seen in the last month are the funds working as intended. People who are more conservative could have better protected themselves had they made their own choices, but it would come at the cost of long term returns. 

“It’s important to remember that for most people retirement is such a long way off that they should focus more on the potential for growth than protecting against market falls.”

95 per cent of AE members have as much chance of picking a fund wisely as they do of finding a toilet roll on a supermarket shelf. Ivor Harper

His comments were echoed by Alan Chan, director of IFS Wealth & Pensions. He said: "A default fund is a one-size-fits-all. So while it will suit many people, there will be some where it is not suitable for and a more tailored approach would be best. At some point, individuals start to take a more active interest in their pensions and how it’s invested.

"This might be because they now have more money in the pot, or they reach certain lifestages. They can then start to look at tailoring their pension funds to meet their own goals and risk tolerance by mix and matching funds. 

"This may not be possible with certain workplace schemes like NEST, People’s Pension, and Smart Pensions where choice is severely restricted that it’s pretty much non-existent."

When auto-enrolment was introduced in the Pensions Act 2008 it came with a requirement for pension schemes to offer members a default option where they did not express a specific investment strategy. When they launched in 2012, many employees who were automatically enrolled stayed in their scheme's default fund.

A default fund is chosen to suit the needs of the majority of scheme members. These funds tend to be riskier in the early stages of pension saving and gradually de-risk as the saver approaches their retirement age.

amy.austin@ft.com

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