After a difficult 2022, 2023 brought some "much-needed good news" for UK employees, according to analysis from Barnett Waddingham, which found that all governed defined contribution (DC) default solutions posted a positive return in 2023.

The research showed that, when observing the one-year growth portfolio performance for 2023, the average growth across all 22 schemes was 12.8 per cent, up from -9.5 per cent in 2022.

According to the group, this was largely due to rising equity markets and reducing bond yields.

However, when looking more closely at performance, the analysis showed that there was a "significant gap" between the best and worst performers, with a gap of almost 10 per cent in the growth phase and around 8 per cent at-retirement.

Strategies that had equity portfolios that were predominantly global did better than those with more evenly weighted portfolios, with the comparatively poor performance of the UK market detracting returns for those with a UK bias in particular.

Diversification was also a performance detractor, as all other asset classes, such as bonds and commodities, failed to keep pace with equity markets, with strategies with investments in property suffering in particular as a result of difficult conditions.

Despite this, the firm argued that scheme performance over the five years to 31 December 2023 helps to provide a more "balanced picture" than the short-term view, capturing the impact of Covid-19 and the turbulent market conditions of 2022.

Indeed, when looking at the growth portfolios for all governed DC default strategies across this period, there were positive annualised returns as schemes achieved average growth of 9 per cent.

This, according to Barnett Waddingham partner and head of DC, Mark Futcher, could give DC trustees time "to pause for breath and look to the future".

“The next few years will be some of the most critical in the life of governed DC default solutions as they look to introduce allocations to private markets and meet the needs of members as they enter retirement – all amidst an ever-changing market and regulatory environment," he stated.

"Mansion House and Long-Term Asset Funds (LTAFs) have invigorated interest in illiquid asset classes, but allocations remain very limited across governed DC default solutions - achieving a meaningful allocation to illiquid asset classes throughout the glidepath is essential to truly improve member outcomes."

He also argued that the cost/value balance will be critical within this, however, noting that commercial constraints are driving many providers to launch new more expensive governed DC default solutions in order to access illiquid asset classes.

'Different shades of green' revealed as providers share net-zero targets

Alongside this the latest asset allocation analysis, Barnett Waddingham shared its latest research on current sustainability ambitions within DC schemes, revealing that, as of 31 December 2023, 86 per cent of DC schemes had set targets to reach net zero by 2050, with 18 per cent of these targeting 2040.

The survey found that 15 out of the 22 default DC pension strategies included had targets in place to reach net zero by 2050, while four have targets to reach it by 2040, and just three have no net-zero targets currently.

Of the schemes which have set net-zero targets, "encouragingly", all but one (81 per cent) of these have committed to achieving interim targets, which in many cases see the scheme aiming to achieve a 50 per cent emissions reduction by 2030.

Of the three schemes that have not set formal, long-term net-zero targets, two have set no targets at all.

Meanwhile, the other said it is prioritising immediate action rather than long-term targets, instead focussing on significantly reducing its portfolio's carbon footprint by over 60 per cent compared to the market.

According to the survey, most providers are using index-tracking funds to incorporate sustainability, although some more innovative strategies are being employed by providers.

This included investing in green bonds, investing in impact equities with specific biodiversity targets linked to the Sustainable Development Goals, and working to access opportunities that address both societal and environmental needs.

With demand for sustainable investment showing no signs of slowing, BW partner and head of DC investment, Sonia Kataora, said it is "encouraging" to see that schemes are listening and driving positive outcomes for members.

And whilst she admitted that reaching the ‘holy grail’ of net zero will by no means be an easy feat for schemes, she argued that the fact that the vast majority have committed to this target, with interim goals, is a sign that we are moving in the right direction.

“But there are different shades of green," she clarified, with Barnett Waddingham's research revealing that climate considerations vary between providers and different investment phases.

In particular, Barnett Waddingham noted that, since its initial analysis in 2021, it has observed a 23 per cent increase in schemes' investment in assets with climate targets during the growth phase.

In contrast, many schemes are yet to take action when looking at the ‘at-retirement’ phase, as most sustainability strategies focus on equities markets rather than fixed income markets, with an average of just 20 per cent of fixed income assets having built in emissions targets, excluding government bonds.

Barnett Waddingham argued that this is "especially concerning" given bonds serve as a significant but often overlooked source of climate risk, as it estimated that corporate bonds alone contribute up to 50 per cent of fossil fuel financing.

Given this, the firm warned that, by neglecting to address bond investments, DC pension schemes could be leaving themselves vulnerable to potential legal risks further down the line.

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