DC Pension Schemes: Improving Investment Returns

DC Pension Schemes: Improving Investment Returns
November 11, 2024 6 mins

DC Pension Schemes: Improving Investment Returns

DC Pension Schemes: Improving Investment Returns

With DC schemes growing across Europe, many organizations are realizing the importance of ensuring strong performance from their investments. Here’s how asset owners and managers can optimize DC outcomes through the right investment strategy.

Key Takeaways
  1. As many companies shift focus away from DB toward DC schemes, there is increasing concern that employees are not financially prepared for retirement.
  2. Having the right default investment strategy is crucial to help employees generate enough retirement savings.
  3. Regulators are looking at ways to boost investments while also supporting growth in local economies. This opens the potential for better DC investment strategies.

Note: For Professional Clients only

As defined contribution (DC) schemes grow across the globe, a top concern for plan sponsors is ensuring they meet the retirement needs of their employees. “The big theme we’re talking to clients about is the adequacy of their DC funds to meet members’ retirement needs,” says Jenny Swift, a leader in Aon’s Wealth Solutions practice in the UK. “There is a massive savings gap and auto-enrollment only takes people so far. Ensuring good investment returns is the main way a provider can influence outcomes for members, so scheme managers need to make the best investment decisions they can.”

The spread of DC participation across Europe is fueled in part by the introduction of auto-enrollment requirements. Ireland is one country in Europe that doesn’t yet require auto-enrollment, but that will soon change. The Irish government plans to introduce auto-enrollment pensions on September 30, 2025 — signifying a massive step toward helping people maintain a higher standard of living in retirement.

With many workers automatically enrolled in DC schemes, it’s inevitable most of them will remain in the default investment option. This makes it even more important to have the right default strategy in place.

The vast majority of DC scheme participants are invested in a default investment option. It’s therefore important for employers to ensure it is monitored and delivers maximum value. A good default option can have a huge impact on financial outcomes. For example, our research finds the gap in returns between the UK’s top and bottom performing master trust default funds for early career employees was over 7 percent per year over a five-year period to the end of 2023. This amounts to a massive difference in retirement savings over a full career.

To ensure default investment strategies are suitably diversified for growth with acceptable volatility, schemes should optimize allocations to different asset classes. They should consider investment in newly available, high-performing options and regularly monitor the performance of aggregate returns against targets.

43%

of private sector employees in the UK will not achieve adequate retirement income as defined by the Pensions Commission.

Source: Institute of Fiscal Studies, September 2024

Optimize Investments and Focus on Ongoing Performance

There is a risk that schemes focus too much on what others are doing, leading to a herd mentality in investment design. Data from Aon’s UK 2024 Defined Contribution Pension Scheme Survey shows the most popular approach is aligning pension offerings with competitors at 42 percent. Thirty-six percent said their main driver is to prioritize delivering sufficient funds for retirement at a reasonable age. That’s a big drop from 46 percent in 2022.

“Across DC markets, we see employers focus on benchmarking to competitors rather than retirement adequacy for their own employees. It raises the question of whether pension strategies are sufficiently aligned with employees’ retirement needs,” says Catherine Engelhardt, a leader in Aon’s International Wealth Solutions practice.

29%

of plan sponsors consider investment returns in aggregate for a member invested in the default investment option.

Source: UK 2024 Defined Contribution Pension Scheme Survey

A provider herd mentality toward investments not only risks leaving employees with inadequate savings in their retirement, but also diminishes the value of the schemes as a tool for recruitment and retention in the present.

With principles in place like the Mansion House Compact (see below for more details), focused on diversifying investments to increase returns, there is an opportunity for plan sponsors to consider new investment options, such as private markets, alongside transitional assets like renewable energy and technology.

“There is enormous opportunity, but also risk, in investing in transitional assets as the economy moves away from fossil fuels,” says Aon’s Swift.

This commitment to integrating alternative investments, including infrastructure that supports clean energy and climate resilience, is a positive example of aligning evolving market trends with a focus on long-term sustainability. Capitalizing on new growth opportunities will further enhance retirement outcomes for members.

There is a huge range of investment approaches, including both realized and expected future returns, across asset managers. Understanding the approach your provider takes and monitoring it over time, as well as considering alternatives, is crucial. DC schemes can benefit from working with an investment advisor to help with strategy development, asset allocation and research services.

65%

of DC schemes do not know the expected outcome for a typical lifetime member of their plan.

Source: UK 2024 Defined Contribution Pension Scheme Survey

Regulations Aimed at Increasing Investment Returns

Regulations

Regulations Aimed at Increasing Investment Returns

The UK launched the Mansion House Compact in 2023 to improve pension outcomes due to low returns on funds invested through auto-enrollment. It calls for allocating 5 percent of assets in default funds to unlisted equities by 2030. The reforms also introduce a value for money framework to ensure pensions make investment decisions based on long-term returns rather than solely on costs. Plan sponsors must publish similar performance data on their investment options. Ireland’s regulator, the Pensions Authority, is also focused on value for money. This year, the regulator welcomed the Irish Association of Pension Funds’ Cost Transparency Standard. This helps trustees better understand investment costs they pay and benchmark costs against peers.

Five Tips for Better Investment Decisions

When looking to optimize the performance of DC schemes, employers should follow these five best practices.

  1. Consider the company’s own objectives, as well as the preferences and needs of the employee population. This can include preferred investment approaches, such as responsible investing and focusing on renewable energy and technology.
  2. Regularly review the existing investment approach and how it meets the needs of the firm and its employees.
  3. Seek comparative data on returns from other schemes to ensure the plan/provider is competitive.
  4. Understand the asset manager’s plans for future developments with an eye toward long-term performance.
  5. Focus more broadly on how the scheme offers value for money. This entails looking across the investment approach, administration services, communications, achieved member engagement levels and employer support.

32%

of DC schemes said reviewing their investment strategy is one of their top three priorities.

Source: UK 2024 Defined Contribution Pension Scheme Survey

Aon’s Thought Leaders
  • Nigel Aston
    Investment Specialist, Wealth Solutions, United Kingdom
  • Catherine Engelhardt
    Associate Partner, Wealth Solutions, United Kingdom
  • Julie Gillen McDonnell
    Senior Retirement Consultant, Wealth Solutions, Europe, the Middle East and Africa
  • Jenny Swift
    Proposition Specialist, Wealth Solutions, United Kingdom

General Disclaimer

This document is not intended to address any specific situation or to provide legal, regulatory, financial, or other advice. While care has been taken in the production of this document, Aon does not warrant, represent or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the document or any part of it and can accept no liability for any loss incurred in any way by any person who may rely on it. Any recipient shall be responsible for the use to which it puts this document. This document has been compiled using information available to us up to its date of publication and is subject to any qualifications made in the document.

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