To opt in or out? That’s the question

The vast majority of workers fail to make investment choices for their pensions and fall into the default option. But opinions vary on what makes a good default fund, as Simon Brooke discovers


It’s a question that an increasing number of employees are facing: should they stick with their organisation’s default pension fund or take the initiative and make their own arrangements?

Around 90 per cent of employees opt for a default fund, according to asset management firm Alliance Bernstein. At hospitality group Whitbread, for example, almost every employee has so far opted – or failed to make an alternative selection – for the company’s default fund.

“People find pensions complicated enough and thinking about investments just adds another layer of complexity,” says Lesley Williams, Whitbread group pension director.

The company, whose fund is managed by Schroders and Oxford Investment Partners Limited, offers a growth option and then, for those nearing retirement, a pre-retirement and a cash option. Ms Williams believes funds should offer this simple, but comprehensive, choice.

The Pensions Regulator expects “all occupational defined contribution (DC) pension schemes to offer a default fund”. It says: “We have set out clear standards for the quality of the default option that trustees and providers must offer to their members. Schemes need to design a default fund that is suitable for the majority of its membership and tailored to the members’ needs.”

The level of thought and effort that goes into many of today’s default funds sets a tough benchmark

Alliance Bernstein sees the growth of default schemes as a positive development and believes that the investment default strategy should be the best option available to members, getting the most attention from those responsible for running the plan.

“Our research shows that most members are ill-equipped or disinterested in managing their own investments in defined contribution schemes,” says Tim Banks, head of client relations, DC. “Indeed there’s research showing that those members selecting their own investments on average underperform those in the default investment strategy.

“For the vast majority of members, we believe that it’s appropriate they invest in well-managed default investments. Where members are looking for assistance, it’s critically important that a well-managed, regularly reviewed investment default is in place. We’d advise choosing a default investment strategy that is pro-actively managed, well-governed, can easily adapt as circumstances change and represents value for money.”

So, should employees be encouraged to make their own decisions? “In some respects, this can seem like a good idea,” says Paul Gibney, partner in the investment department at LCP, a firm of financial, actuarial and business consultants. “Members who make their own investment choices can be seen as more fully engaged in the pension arrangement and therefore better able to appreciate its benefits.

“This is typically perceived as making the cost of pension provision better value for the employer. However, there’s some anecdotal evidence from the United States that those members using default funds have better outcomes than those making their own investment decisions.”

The level of thought and effort that goes into many of today’s default funds sets a tough benchmark. However, default funds have their drawbacks. Many, for instance, have opted entirely for equities, only moving into other investments, such as bonds, in what is often a clumsy, inefficient manner.

Some investment advisers and financial consultants are challenging the default fund option. “There will always be a need for a default fund for those who don’t want to make a choice. But, for those outside the default fund, the more choice the better, provided it’s supplemented by clear, simple information to help savers make better investment decisions,” says Laith Khalaf, pension investment manager at Hargreaves Lansdown.

People need help making that choice, though. “We’re finding that people are becoming more engaged with the investment choices that they’re making,” says Mr Khalaf.

One client is Svitzer, a marine services company. So far around 25 per cent of employees have moved out of the default fund into other funds and Svitzer is not alone in Hargreaves Lansdown’s experience. Mr Khalaf adds: “It’s snowballing as we’re moving away from a more paternalistic investment world.”