Merrill Lynch Investment Managers (MLIM) has launched a new approach for defined contribution (DC) pensions schemes, Target Driven Investing (TDI).
TDI is a set of practical solutions that increase the chances of DC members achieving their true investment goal, namely a target level of income in retirement, whilst better reflecting their appetite for risk.
A majority of DC scheme members are invested in their scheme's default investment option throughout their career, regardless of their target income or attitude to risk. Typically this default uses a 'Lifestyle' approach, whereby contributions are generally invested in equities until between 10 and 5 years before retirement and then evenly switched into less volatile bonds and cash.
New research by MLIM shows that the risks of lifestyle are much higher than generally understood, and questions its suitability as a default strategy. For example, around one third of the time, members invested in Lifestyle can expect to end up with a pension lower than if their fund had been invested in a risk free portfolio.
These findings led MLIM to propose a new investment philosophy for DC - TDI.
TDI comprises a strong focus on achieving a member's target level of retirement income, and better controlling risk en route to that target. From this philosophy MLIM has developed practical tools and products to offer a total DC solution for the first time to Trustees, employers and members:
The dedicated online modeller 'Target Plan' allows members to set their pension target and gives them a road map on how to achieve this target in terms of contributions, investment strategy and date of retirement.
DC Target Return (TR) investing has twin objectives: generating a target return of cash + 3% and preserving accumulated capital. To achieve this, the fund is invested in a diversified basket of assets without being constrained by a traditional benchmark since the objective is to achieve a desired level of return rather than beat a benchmark (which in most cases will be irrelevant to the needs of members). Target Return offers a much better fit with what a typical DC member is looking for.
DC Banking - DC Banking works on the principle of setting a long term target rate of return measured over a member's career and includes a regular banking mechanism whereby a proportion of the risk assets is switched into safer assets every time the return target can be locked in.
MLIM's research shows that, compared to Lifestyle, DC Banking reduces the likelihood of a member's pension fund being below that produced by the risk free asset from over a third to a fifth and significantly improves the median outcome for members.
'Since so many millions of workers now depend on DC for their wealth in retirement, it is vital that we modernise the tools and techniques used,' says Andrew Dyson, Head of Institutional Business at MLIM. 'To do this effectively, we have to put members at the centre of the process. Education and communication must play a vital role.
'Today there is too much dependence on a standard approach irrespective of each member's goals. There needs to be a far greater focus on what members are trying to achieve, and on having those goals drive the right investment strategy. Using the experience and skills MLIM gained in developing and implementing our successful liability-driven investment approach for defined benefit pension schemes, where we now have GBP 11 billion under management, we developed this new Target Driven Investing concept for DC Schemes. For the first time it provides DC Trustees and members with a total package oriented to their individual needs
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