With defined contribution (DC) it is someone else’s money – it belongs not to the plan sponsor, but every member of that scheme. DC is supposed to be all about the member, but the old DB mindset hasn’t quite got to grips with the new paradigm.
No Silver Bullet In the last five years, risk has been reappraised and there is confidence we not only know where it is, but how to monitor it and make it work for us. But we are still looking for a single solution to deliver the bulk of the ‘win’. In DB, it has been variously LDI and fiduciary management, which seems to get more than it’s share of coverage. Certain strategies, such as risk parity, balanced risk or total risk have had their moments, but have been rejected because they don’t wrap up enough of the portfolio to make them ‘worthwhile’. In DC, risk was all about getting sued or incurring the wrath of the regulator, as opposed to the structure of the investment strategy. In many cases, there rarely is any investment strategy, with diversified growth funds (DGFs) operating as a de facto bundled derisking tool.
There needs to be a total reappraisal of how we look at risk. DB will be with us for for many decades, because until sponsors can reach the derisking nirvana of buyout, they need to manage it. In DC, risk is managed on the ability to pay, or the ability of the sponsor to buy the right bundled package that will offer members value for money. It’s not enough to pin our hopes on a single solution to do the job, whether that’s DB or DC. That is where we’ve gone wrong in the past. Risk is an ever present and dynamic force within a portfolio, so to think we can manage it with a bolted-on DGF is patent folly. It’s time for sponsors with foresight to stop accepting what they (or their members) can afford and ask what the industry can offer. With prescription on the cards for DC, there is a real danger no investment strategies will ever deliver meaningful income to investors. Padraig Floyd is a freelance journalist and commentator on pensions.
For Pension Trustees Issue 3 2014