Well that’s how it is isn’t it. You do your admin report which is tickiteeboo, have a discussion about how few or your members are using the OMO and then do the bit about investments noting that for another quarter no-one has joined the expensively researched Sharia law fund and that the default lifestyle fund is- well the default lifestyle fund.
Not so fast DC governance committee
You may think you’ve got it all sewn up; you’ve got your global 50:50 tracker lifestyling in the accepted manner into long dated gilts and cash
WHAT COULD GO WRONG?
Well let’s start with that tracker fund. You think you are buying a BlackRock or L&G Fund that’s going to do just what it says on the packet but wait-what’s this- it’s consistently underperforming or outperforming the index -often by 50bps a quarter…
How can this be?
Tour fund may invest in a tracker my friends but it is not “the tracker”-it’s a reinsured version of the tracker with a little cellophane wrapper round the outside that means its a n XYZ or an ABC life tracker. Therein lies the rub.
The difference in the performance track between your lifestyle fund and the index may not matter in the early years- swings and roundabouts- one quarter you win , one quarter you lose. But it matters a lot if you’re close to retirement and you’re being forced (through lifestyle) to transfer out of your fund- you sell when the price is artificially high-you lose. Losers get cross-winners never seem to notice. Who do losers whine to- your trustees, or your sponsor who’s accountable – you are- and you are off to the pub.
Where did this tracking error arrive from? The chances are that it’s the result of poor cashflow management – contributions to DC plans come from all over the place- the DWP, employers, transfers in, even the odd random cheque. While almost all DC funds deal daily, not all the money is invested- money sits around in cash within that little cellophane wrap I mentioned before – and cash and equities seldom perform in the same way.
The dangers of tracking error are as nothing to the perils of transitions. In DB, transitions are a rarity and dealt with care. In Dc they happen every day as members chose to switch or more commonly – get switched from fund to fund as part of the lifestyle device. Here there’s the opportunity for real trouble. Many trackers have the most odd dealing cycles which rarely tally with those of active gilt or cash funds, it’s like putting a ford engine onto a Vauxhall gearbox- don’t expect synchroicity-expect out of market risk– especially where those nasty reinsurance wrappers are in use.
And before you slope off for your rather “guilty “pint, let me give you one more thing to think about- charges. In the USA there is a small industry of forensic accountants busy working out whose taking what and where. Over here-despite the best effort of regulators to abolish “soft commissions” there are still all manner of admissible expenses that can be charged to the fund as “additional fund expenses ” and all manner of odd places to hide them in fund accounts.
Wheer there are fund expenses there are two set of accounts (each chargeable)- one for the underlying fund and one for the cellophane wrapper and fund expenses lurk within each. Unlike the issue of cashflow management where there are swings and roundabouts- charges only create a negative drag on performance -like seaweed on the bottom of a racing yacht.
If you are reading this and your job is DC governance-whether as an adviser or as a trustee or most likely because you sit on an investment committee, think about this.
I’ve presented to over a hundred of these committees and I cannot remember once (as an insurance rep) being asked a pertinent question about tracking error- out of market risk or about additional fund expenses as they relate to the default lifestyle fund.
Considering this fund typically carries 90% of the investment risk within the DC plan this is frankly flabbergasting.
I can only assume that one day investment consultants will wake up to these realities but that will be the day that they start to think as DC experts and not as DB consultants looking for something to do.
Very good Mr Tapper, and lets throw in there “why is a lifestyle suitable for my membership”? Has anyone done any net replacement ratio analysis on the membership to understand if members will retire with a quality of life similar to theirs today.