Why pension lifestyle funds are from a bygone era

The non-workplace pension market consists of myriad different pensions and customer types. With such variety it is difficult to come up with solutions that will meet all needs.

One part of the FCA recognises this. In its plans to introduce a new customer duty for FCA-regulated firms, it’s moving to a principles-based style of regulation, asking firms to meet the needs of their target customer groups. But its plans for all providers to offer new non-advised savers in a non-workplace pension a default fund seem to go against this direction.

This proposal seems – at first sight – fairly benign. After all, it makes sense to offer to help customers make investment choices.

But I do not think this is a benign proposal.

Introducing a default fund into their existing customer journey will require some work but won’t be an issue for most providers. However, the FCA also wants the default fund to include lifestyling or de-risking, moving into ‘safer’ funds as the client nears retirement age. In our opinion, lifestyle funds are a pension feature from a bygone era and should not be mandated. They were designed in a world where the majority of people bought an annuity and needed to de-risk as they approached that purchase. Today the majority who choose to stay with a pension use drawdown.

Designing a de-risking fund will take time and money, and of course, that represents an opportunity cost. But more worrying, it could lead to poor outcomes for some customers. It may automatically move non-advised customers into ‘safer’ funds as they approach taking tax-free cash and designate the remainder into drawdown. This could be the point when, actually, they need to keep invested in the market, designing a long-term investment strategy for their drawdown funds. Or it could move them early when they don’t intend taking benefits for some time. Customers could end up heavily invested in cash or cash-like investments when they intend to remain invested in drawdown for another 20 or 30 years – exactly what the FCA does not want people to be doing.

More generally, in choosing a default fund for a range of customers, firms will need to adopt a low-to-medium risk profile to span the breath of different customer needs and objectives. Inevitably, this means ‘erring on the side of caution’ for many people, and will mean a lower risk profile than is suitable for many long-term pension investors’ objectives. This leads to poorer outcomes for many investors, with a loss in annualised return.

A non-advised customer may choose a default fund thinking that’s the safe option, but if they had been helped to choose more appropriate funds to match their personal objectives and risk appetite then that might have meant a better outcome.

There is no doubt providers need to think wider about how to help their non-advised customers make good investment decisions. But this should be led by firms devising solutions that fit the needs and wants of their customer base.

This article was previously published by Professional Adviser