(This is post 4 of 7 on the 2016 Thinking Ahead Institute global roundtable, held in London on 2 and 3 November. The theme of the event was “Fuller measurement, broader integration, better decisions”)
Tim Hodgson proposed that investment success is about compounding wealth, through time, exploiting and controlling for risk. However, within this conception, the investment industry:
- tends to over-measure risk and under-emphasise uncertainty
- is more concerned with objective than material measures
- does not pay proper heed to the benefits of diversification across time
Sequencing risk, too, is in general poorly managed in a DC context: depending on the sequence of returns experienced, two cohorts, that over their accumulation phase experienced the same time-weighted return, might end up with very different outcomes in retirement.
On a related point, Tim compared the role of objective and material measures in guiding DC members towards their goals. Although objective measures may be universal (eg time-weighted fund return) they are difficult to control and have little direct relevance to the member’s mission. While such measures have their place in reporting and analytics, there is a need to balance these with more material measures. The latter are typically more subjective and more open to influence by organisational actions. Tim therefore proposed that a balanced scorecard for monitoring progress should incorporate both objective and material measures. For example, for the principal target measures, an objective measure might be return-to-date per cohort, while a material measure might be projected retirement income. Material measures add complexity to the scorecard, but (arguably?) increase its relevance and usefulness.
Attendees considered the criteria of a successful DC system. Compounding wealth and the conversion of wealth into consumption are key. Financial planning – in particular consideration of a member’s DC assets within the context of their overall wealth – is also critical as a means of engaging members. There may well be ways to make it more cost-effective and accessible, eg robo-advice, but successful engagement depends heavily on the provider having accurate and relevant member data – which is often not the case.
The extent to which schemes should engage with their members was hotly debated: views ranged from educating members and encouraging them to take control of their retirement planning, to creating better default arrangements and limiting members’ involvement to a few, simple decisions. The latter point of view goes hand-in-hand with the investment/pensions industry taking greater responsibility for members’ outcomes. Investment expertise resides with industry experts, and in order to justify their remuneration pension providers should be more paternalistic in providing appropriate guidance/ recommendations. This includes protecting members from the risk of making bad decisions, and obstructing value-destructive member behaviour (eg evidence showing that c.10% of the DC population in the UK are systematically gambling with their DC assets). Countering this, it was suggested that the industry (pensions/investment) was only responsible for the provision of information that could be used to make decisions, and not for the decisions themselves.
The quality of a member’s journey through the DC system was discussed: in order for the journey to be worthwhile, the system should incorporate incentives and generate the return necessary to encourage members to save, and develop measures to shield members from excessive volatility (eg reduced equity exposure early on). Eighty percent of attendees agreed on the importance of improving the quality of the journey for DC members, even if this meant sacrificing some potential upside. In order for this to happen, trust in the DC system needs to be built up from the current low levels.
Attendees agreed that there was more mileage in this subject and proposed that the DC research stream be carried into 2017. As part of this stream, the Institute would convene an asset owner-only project team to look at the application of whole-of-life money-weighted return in meeting the DC challenge. There is also potential to apply the integrated reporting framework to analyse how pension providers (asset owners or commercial platforms) create value for their members, and how they could do this more effectively.