Since Pension Freedoms, some pension schemes have looked to supplement a single default strategy with one or two alternative strategies designed to optimise risk management for alternative retirement decisions. In this short analysis, we compare the quality of outcome from a single or multiple strategy approach, particularly given the increased governance burden and costs associated with offering more than one strategy.

Many in the industry choose to optimise risk management on approach to a retirement decision through the use of multiple strategies. However, we feel this mindset may be a hangover from the pre-Pension Freedom world, given that retirement is no longer a cliff-edge decision and many members want to make use of the greater flexibility in timing and investment horizon. We believe there are three good reasons to take a different approach:

• Decision-making that is done well ahead of time can be significantly affected by changes in market conditions and affordability. Ultimately, members need flexibility on their approach to retirement, which is best done through maximising expected pots. Retirement itself is also seen as more gradual, with significant UK policy emphasis around keeping skills in the workforce for longer.
• While much of the industry focuses on relative performance (against annuity rates or inflation, in the case of lifestyle strategies), members are far more concerned about absolute performance. Recent market conditions have clearly demonstrated this, as members who invested in annuity-targeting strategies complained about lost value through 2022, even though the strategy had preserved and, in fact, improved value relative to their objective. This indicates a disconnect in objective for members that intend to purchase an annuity. We explore this in more detail on the next page.
• If we look at member engagement across four of our largest schemes where we have annuity and cash glidepaths, we can see (in Table 1) that just 0.1% of members overall select an alternative strategy. Even when focusing purely on members over 60, who are more likely to see retirement planning as a priority, the number using alternative strategies increases to only 0.8%. Instead, 97% of members who choose to make an active choice prefer to self-select their investments from the fund range in order to more accurately reflect their specific objectives for retirement.

More recently we have seen volatility in the bond market, particularly in September 2022, which resulted in significant losses within annuity targeting strategies. Some of these strategies lost up to 50% in three months, but were compensated with improvements in annuity yields.

While we recognise that interest in the annuity market is picking up as central bank policy looks to curb inflation, we have also learnt a lot recently around members selecting an annuity targeting strategy.

Fidelity has received significant feedback and questions from members around the performance of our Pre-Retirement Fund and what the negative performance of 2022 meant for their pension. This was particularly interesting as it performed around 10% better than our peer group of pre-retirement strategies and their purchasing power was actually improved by 3.3% relative to annuity prices. However, it was clear that what these members were (naturally) concerned about was the loss in value.

This highlighted a disconnect between member expectations and the objective for the fund. Our conclusion was that the relative gain was less important than the absolute loss. This means there is a higher-level member objective around maximising pots together with a sensitivity to losses on the approach to retirement that conflicted with managing risks relative to purchasing an annuity.

Interestingly, the member sensitivity to loss only appears to apply to visible losses, as it does not extend to inflation when we think about cash glidepaths. Members were relatively unconcerned about lost purchasing power amid higher inflation.

^{*Average annuity rates for 65-year-old, single life with five-year guarantee.}

This has led us to a central thesis of increased sensitivity to absolute value loss on approach to retirement, rather than relative value or relative purchasing power for their chosen retirement strategy. It also highlights members’ need for flexibility and the ability to change their minds based on what is most affordable to them at the moment of retirement and their specific circumstances at that time.

We continue to see interest in cash-targeting strategies from Hybrid DB/DC schemes, where the DC benefits are often used as a lump sum, and from high-turnover schemes that have significant levels of small pots for deferred members. However, we feel there are good reasons for cash not to be the optimal solution for most members in either of these cases too:

• High turnover schemes: For these schemes, where we see high levels of small pots and cash being taken, it is our belief that these members are best served either by using a growth-oriented strategy to maximise the growth potential and make a difference to their standard of living. In Table 2, we have illustrated the impact on expected outcomes that selecting a cash glidepath with a de-risking period of three years has. This shows that FutureWise offers a better outcome than a cash glidepath in this percentage of cases over each time horizon: 10 Years – 90%; 5 Years – 80%; 3 Years – 70%; 1 Year – 60%. On top of this, the expected improvement of outcome of FutureWise versus cash for a median member is: 10 Years – 10.5%; 5 Years – 8.3%; 3 Years – 5.7%; 1 Year – 2.1%. These benefits of maintaining growth exposure while the pot is at its largest are material for a member expected to take cash at retirement. While this position is not without risk, it is a material benefit to the majority of members and helps to manage inflation risk in the process.
• Hybrid DB/DC schemes: While we appreciate that members in these schemes might want to take their pot as cash, as we have just articulated above, we believe an improved outcome is delivered through maintaining exposure to growth assets. We think the risk of real loss in value and inflation risk is of increased importance and growth assets will help mitigate some of this risk. Economists have often cited the relationship between cash and inflation rates being highly linked and that base rates rise to bring inflation under control. However, more recently we have seen the Bank of England attempt to take a longer-term view of inflation, looking through some of the shorter-term Russia and Ukraine impacts on energy markets, in order to focus on the longer-term inflation indicators such as labour markets. This decreases the short-term correlation between cash and inflation rates, reducing the effectiveness of cash-targeting strategies at mitigating inflation risks on their approach to retirement.

Table 1 - Retirement Engagement

Source: Fidelity, Alternative Strategies references any different glidepath administered within the scheme, often targeting a different retirement outcome to the default. Pre = pre-retirement, Post = post retirement, 60+ is members of an age greater than 60.

Table 2 - Member Outcomes - Simulated percentile growth of £100