The Pensions Policy Institute (PPI) has outlined a number of policy options that could help ensure defined contribution (DC) default investment strategies meet the needs of a wider range of members, including a push towards alternative assets.

Research from the PPI, sponsored by the Association of Investment Companies, found that the majority of DC pension members do not select an investment strategy for themselves, with 90 per cent of savers in a master trust or multi-employer scheme remaining in the default.

It emphasised that as more people are now saving into DC pensions, the default investment strategy design will affect the future retirement incomes of more people.

However, it warned that a one-size-fits all investment strategy "by its nature" fits some savers better than others, suggesting that some people with particular characteristics may benefit from an increased focus on enhanced returns or reduced volatility than found in standard DC default strategies.

Those accumulating marginal amounts of savings, those with defined benefit (DB) savings and higher earners, for instance, could benefit from a focus on enhanced returns, whilst those without supplementary savings would benefit from reduced volatility.

In light of this, the PPI identified three policy options that could help DC default strategies to meet a wider range of member needs, including increasing asset allocation to alternatives to enhance returns whilst also increasing diversification, "potentially benefiting all members".

The report acknowledged that many DC default strategies have a limited range of asset exposure due to the increased cost of this, with concerns that higher charges could result in a loss for some members, particularly those in smaller schemes.

However, it emphasised the need to look at the portfolio-level impact of expanding the range of assets, rather than the characteristics of the alternative asset class in isolation, explaining that assets offering volatile return patterns may nonetheless serve to reduce a portfolio's overall volatility.

The PPI also flagged previous research, which found that net of fees, a median earner contributing throughout their working life into a pension with 10 per cent to 15 per cent of funds in illiquids could have a pension pot at retirement around 2 per cent to 3 per cent higher than if their pension was not invested in any illiquids.

Alongside the use of alternative assets, the report recommended that schemes use existing data on members, such as pot size, in order to provide prompts about using self-select investment strategies.

It explained that where more information is available, such as account balance data, this could be used to achieve greater customisation even without direct member engagement, suggesting that, as technology advances, such greater customisation is likely to become more feasible in practice.

It also recommended that schemes gather more data on members in order to either make DC default investment strategies more tailored or to provide prompts about self-select investment strategies

PPI head of policy research, Daniela Silcock, commented: "DC scheme default investment strategies determine how the contributions of millions of pension savers are invested.

“They provide a service to those who cannot or do not want to choose their own investment strategy, one that involves judgements about the balance between risk and reward and does not levy unduly high charges on members.

“However, default investment strategies are inherently broadbrush as they are required to meet the needs of many people and are generally designed with the 'typical' member in mind.

“The inherent nature of defaults make it difficult to target variations at particular people, but there are potential strategies, for example, using existing data on members, such as pot size, to provide prompts about using non-default investment strategies or gathering more data on members in order to make DC default investment strategies more tailored or to provide prompts.

"In addition, judicious investment into illiquids and alternatives could, in some cases both enhance returns and reduce volatility, benefiting the whole membership.

“However, these strategies will require extra time and resources. In seeking to implement them, it is important not to lose the benefits of default strategies, in particular, the low cost and simplicity of the safety net that they provide for those with low financial capability.

"As scheme managers look to provide a better service to a greater number of members, the benefits of defaults must be kept in mind.”

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