There is no denying that auto-enrolment is paving the way for the British population to have a half-decent savings pot in retirement.
According to recent figures from the Office for National Statistics, 76 per cent of UK employees were members of a workplace pension scheme in 2018, up slightly from the 73 per cent enrolled in 2017.
Minimum contributions also increased at the start of this month.
But how many of the 10m auto-enrolled employees know where their money is being invested?
Unless you made an active choice at the start, the vast majority of savers will be invested in their pension provider’s “default” fund – essentially a diversified basket of investments, using a preselected one-size-fits-all approach.
Auto-enrolment has been phased in since 2012, and it’s now a statutory requirement for all companies to enroll their staff in a pension scheme. Unsurprisingly, this means that the use of default funds has been rising.
Most default funds will invest heavily in equities when the policyholder is younger, gradually reducing the risk over time (often by increasing the bond and cash weighting) as the saver gets closer to their chosen retirement age.
There’s certainly a lot to be said for the simplicity of default options, which – much like auto-enrolment as an initiative – remove the need for people to make complex decisions about their savings.
Keith Churchouse, director of Chapters Financial, says that making investment decisions is a step too far for many individuals once they have been auto-enrolled.
The concept is to provide an ‘off the peg’ solution, which makes a decision more straightforward, or removes the need to make a decision at all
But is the default fund always the best option?
One of the risks is that the default process might not match the member’s lifestyle plans. As Churchouse says: “If the saver wants their pension pot to match their personal objectives, they need to be active with their decisions and the investment options within the scheme.”
For example, if you are a young, adventurous investor who wants to target a high level of investment growth, some default funds may be too low-risk to suit to your goals.
Research house Defaqto has provided City A.M. with figures looking at some of the most popular default funds (all in their growth stage), rating them on various factors, including the return, the level of risk in relation to the return, volatility, and any ongoing and one-off fees.
Of nine popular providers, the Scottish Widows Pension Portfolio Two fund was given the lowest Defaqto rating. Though the returns aren’t bad at 6.6 per cent over the past five years, the £213m fund has been marked down based on other metrics.
The government’s £4.5bn National Employment Savings Trust (Nest), which was set up to help facilitate auto-enrolment and has around 7.5m members, is ranked highly. Nest's default Retirement Date fund has scooped up an admirable 7.9 per cent over the past five years.
It’s also positive to see that five of the nine popular funds have been granted a top Defaqto rating, returning more than eight per cent over the past three years.
|Default fund*||Defaqto diamond rating||3-year return (%)||5-year return (%)|
|SuperTrust – LGIM World Equity Index||5||11.9||10|
|Willis Towers Watson - Drawdown Focused Medium Risk||5||11.1||n/a|
|B&CE Global Investments||5||8.5||7.2|
|LGIM PMC Multi-Asset 3||5||8.4||7.2|
|Nest 2040 Retirement Date||4||8.1||7.9|
|Aviva Diversified Assets Fund II||3||7.2||6.6|
|Now Diversified Growth||3||5.6||5.7|
|Scottish Widows Pension Portfolio Two||2||8.5||6.6|
*All funds in growth stage
Of course, past performance doesn’t determine future success, and Scott Gallacher, chartered financial planner at Rowley Turton, warns against comparing these funds on their returns alone.
He points out that the best performing fund on the list, SuperTrust’s LGIM World Equity Index, is entirely invested in equities, and has an FE risk score of 116. This means that it is a riskier investment than if you’d invested entirely in the FTSE 100.
By comparison, the worst performing fund, Now Pensions Diversified Growth, has a much lower FE risk score of 58, largely because it aims to avoid being overly exposed to the performance of any particular asset class.
This just goes to show how varied the default funds are, demonstrating that while providers have a one-size-fits-all approach, the industry doesn’t.
And it’s not just the underlying investments that are wide-ranging either, because Richard Harwood, financial planning manager at Brewin Dolphin, points out that the speed of change (that is, when and how the fund starts phasing out investment risk) will differ depending on the provider.
While the Defaqto figures can give guidance, the data doesn’t assess whether a default fund is suitable for each individual invested.
“As there is no account taken of the underlying members’ circumstances, there is no way of knowing whether a default fund is correct for them,” Harwood explains.
“The concept is to provide an ‘off the peg’ solution, which makes a decision more straightforward for a member, or removes the need to make a decision at all. It is unlikely to provide the best outcome for an individual, as it does not take account of that individual’s needs or situation. But that is not the point.”
It can be tempting to pick your own funds based on economic forecasts or your own hunch, but in reality, most people aren’t investment experts
And indeed for the majority of pension scheme members, the default is probably a reasonable option.
“It can be tempting to pick your own funds based on economic forecasts or your own hunch, but in reality, most people aren’t investment experts,” warns Claire Walsh, personal finance director at Schroders.
“The danger is that you reduce the diversification of your investments, increase the risk, and potentially underperform.”
She also points out that, unless you regularly review your investment, the funds you choose at one point in time may not be appropriate later down the line.
That’s not to say you shouldn’t switch funds, and – given that most workers will be invested for decades – it’s certainly worth finding out if the fund you’ve been automatically allocated to is well-suited to your individual needs.
The truth is that, despite being enrolled for years, many members of workplace pension schemes haven’t logged in online to find out what savings they’ve got, or what their money is invested in.
“If you haven’t already, take a trip round your new pension, making sure what your employer and you are paying all adds up, especially with this month’s minimum contribution increases, which are likely to show up on your account in May,” says Churchouse.
The independent financial adviser suggests that you should also take a look at the investment fund that you’ve been added into, and see what other funds are on offer.
“Many savers do not know that there is usually a choice and range of funds for their pension – from ethical, low-risk, high-risk, Shariah-compliant, and others.” You can also mix and match to suit your individual plans.
“Defaults can be a blessing for those who have limited interest in how their money is invested,” says Churchouse. “But they could also be a curse for those who have specific plans for when they want to retire, and how they want to access their pot when they get there.”