Are we in the middle of a DC revolution?

The DC market has not been short of developments over recent years. On the investment side, we have seen a clear trend - providers are reviewing their investment solutions more frequently and shouting about their latest developments. But do these announcements point to a noisy revolution in the DC market? Are they moving the dial in terms of improving member outcomes?

These are critical questions across the DC market. Not only are these investment solutions the bedrock of DC providers’ master trust and contract-based offerings, but own trust schemes are increasingly using them, or providing access to them through bolt-on master trust partnerships.

The announcements have covered changes to their strategic asset mix, the introduction of tactical asset allocation, and underlying funds. Breaking the announcements down like this helps us start to answer those questions. 

Strategic decisions are key

"We believe getting the strategic asset mix right is the most important driver of member outcomes - and, historically, these strategic decisions have driven differences in performance amongst providers."

Just under 45% of the 22 provider investment solutions we monitor have made some form of strategic change in the last year, with the majority of these centred around increasing allocations to return-seeking assets in the growth phase. 

This more regular cycle of strategic asset allocation reviews is positive to see. We believe this has the potential to drive significant improvements for members and that changes in the growth phase are materially moving the dial for member outcomes. However, the impact of these changes raises interesting questions around the risk of herding. 

Herding implications

Herding is where strategies become increasingly similar. Herding could mean worse overall outcomes for members, due to the market not embracing individual thought or searching for innovative ways to drive improvements. Although on the positive side, it can push underperforming providers to align their investments with best-in-class approaches. The Department for Work & Pensions (DWP) and Financial Conduct Authority (FCA) have recognised the risk in their respective consultations on value for member assessments. 

The heat maps below are from our interactive tool that we use to support our clients to monitor and select providers’ solutions. Each blue marker shows the asset allocation for a provider we monitor, across each asset class. Darker blue markers suggest multiple providers share the same asset allocation.

These charts show how the spread of asset allocations amongst DC providers in the growth and at-retirement phases have changed over just two quarters, by comparing the asset allocations from each provider as at 31 December 2023 to 30 June 2024.
 

Growth phase

There is a still a wide range in allocations, but there are signs of herding in the growth phase. Just look at the developed market overseas equities - as at 31 December 2023, there was little consensus, with a 68% difference in allocation for providers with the biggest and smallest allocation. As at 30 June 2024, the spread is much tighter with the vast majority separated by only 35%.
 

At Retirement phase

There is less evidence of herding once members reach retirement. We think this reflects the lack of consensus amongst providers in solving the decumulation challenge. This area is ripe for innovation in the coming years. 

If these trends continue, trustees and employers will need to ensure they understand what points of difference between providers’ solutions are driving returns. Though strategic decisions are the most important factor, tactical decisions and underlying fund choices all have parts to play in driving returns. 

As providers use more active management (including private markets) these decisions will only become more important. Our recent webinar highlighted the importance of manager selection when investing in private markets, but how significant are announcements in these areas today?
 

Tactical decisions

We have seen some providers adopt a more tactical approach to the management of their strategies covering two avenues.

1. First is the ability to bring forward or postpone the start date of glidepaths based on recent market experience. 
2. Second is the ability to flex the asset mix around the strategic allocation.

Our study earlier this year found that 37% of providers use tactical asset allocation to boost returns. In practice, data we collect from providers each quarter suggest these tactical changes are limited. Less than 27% of providers made a tactical asset allocation change in their at-retirement allocations. This number becomes even lower in the growth phase, with less than 15% of providers making tactical changes over the year period. 

Underlying fund choices

New underlying fund choices have also been adopted. For example, nearly one quarter of all providers have announced core-satellite equity mandates. This allows them access to both index tracking investments, supplemented with active investments to target outperformance.

For most, this has meant investing a small portion of their equity portfolio in an actively managed fund looking, for example, at sustainable investment opportunities targeting higher returns over the long-term. This is striking as a move beyond the traditional focus on risk, as identified in our report earlier this year.

We broadly support these changes. However, we are aware that trustees and employers may have a wide range of opinions here. It’s important to remember that you have choice - in some cases that might mean looking at alternative providers. However, providers are increasingly offering multiple solutions. 

This multi-solution approach is largely being driven by developments in private markets. While a number of providers have announced allocations to private markets, all but two are creating additional strategies. We are also seeing an increasing number of providers offer choice around sustainability and faith-based investing.

What does all this mean for trustees and employers?

While our analysis shows initial signs of herding in the growth phase, the range of asset allocations in the at-retirement phase remains striking.

Making sure the solution is appropriate for your members as they approach retirement is critical.

Ask yourself questions such as:

• Is the asset mix at retirement a good fit for how I expect most members to take their benefits?
• Do I understand my provider’s plans for enhancing their investment strategy during retirement?

These strategic decisions remain key. However, with DC providers looking to become more sophisticated investors, tactical decisions and underlying fund choices will become increasingly important differentiators.

Understanding what is driving performance will become harder and solutions may evolve away from what you originally chose.

Ask yourself questions such as:

• Is my provider able to articulate how their tactical decisions and underlying fund choices are adding value, both in absolute terms and relative to their competitors?
• Do the underlying fund choices match up with my own beliefs around how best to generate competitive long-term returns for my members?

Next steps

We are seeing significant shifts in the DC landscape. Many providers have made material strategic decisions in the last year and we are seeing more differentiation in terms of underlying fund choices. 

Don’t forget you have options. The right default strategy – and, by extension, the right provider – will depend on your membership. You can help drive value for your members by asking the right questions, thereby ensuring the strategy remains the best fit for your members.

Are you interested in hearing more about your provider’s solution or our interactive tool? Are you a trustee of an own-trust scheme, seeking ways to reduce the governance burden of managing a bespoke strategy of your own? If the answer to any of these questions is yes, please do get in touch.

The content of this document is for information only and is not intended to provide, and must not be construed as, investment advice. For professional clients only.

Raj Dhot, Investment Client Specialist, Barnett Waddingham, contributed to this blog.