DC Quarter: Changing DC Investment choices

In a DC scheme there will generally be a range of investment funds for the member to choose from, including a default fund. Trustees must formally and regularly review the range and appropriateness of investment funds available. However, when it comes to making changes to investment options, things are not always straight forward. This News looks at why trustees may wish to change the investment options on offer, the legal considerations, some key practical issues and recent developments.

In this issue

• Why change?

• Power to change: check the scheme rules!

• Whether to change: is it in members’ interests?

• Some practical pointers

• Recent developments in the DC investment market

Why change?

• Monitoring of investment performance suggests that current funds are not performing well or investment advisers recommend a change of funds.
• A desire to refine choices on offer (either by expanding or reducing options available).
• To move to “white-labelling” – where funds are referred to by their generic investment mandates rather than specific investment managers. This makes it much easier for trustees to select and change the underlying managers for each fund from time to time and helps members to focus on the asset strategy rather than the manager name.

Power to change: check the scheme rules!

Scheme rules will usually allow trustees to change investment choices, but legal advice should be sought on the exact scope of the trustees’ investment powers. In particular, trustees should ensure that they have power to change investment options for past as well as future contributions. In some cases, a rule amendment may be required.

Trustees should also check historical member communications to check if the previous messages are consistent with the trustees’ investment powers. Any past statements linking investments with a particular manager or with a particular type of fund will need to be reviewed carefully.

Whether to change: is it in members’ interests?

The IGG’s “Principles for investment governance of work-based DC pension schemes guidance on DC investment“ makes it clear that trustees have a duty to ensure that they select appropriate investment options for the scheme membership, monitor the performance of investment options and make changes if appropriate (where they have power to do so). Therefore trustees have a responsibility to actively review investment options and periodically consider whether changes are needed. This should be built into the business plan for trustee board meetings.

In deciding whether to change investments, ultimately the trustees must decide if this is in members’ interests. In doing so, trustees must take investment advice on the suitability of the replacement fund/s for the scheme membership. If the trustees conclude that it is in members’ interests then it will generally be reasonable for trustees to make the change.

Some practical pointers

1. Communications with affected members – these need to make clear:

• what the replacement funds are and why the changes are being
  made.
• the costs of switching for the member.
• the ability of members to “self-select” replacement investment funds from the new range;
• the impact of the transition process on members.

2. Costs

• Generally speaking, it is inevitable there will be a transition cost when switching investments, but trustees should ensure these costs are minimised.
• The employer may meet the costs but in many cases they are borne by the member.
• In deciding whether the transition is in members’ best interests trustees should carry out a cost/benefit analysis.

3. The transition process

• Amendments to existing investment documentation or new investment documents are likely to be required.
• There will need to be a “blackout period” when members cannot make changes to their investments in order to allow the transition to take place – trustees will want to keep this to a minimum, consistent with achieving the transition safely.
• Depending on the circumstances, trustees may want to consider if a third party transition manager should be appointed.
• Matters will need to be kept under review right up to the proposed transition date to consider whether there are any market circumstances that mean that it would be unacceptably risky to proceed at that point.

Recent developments in the DC investment market

A current trend is for DC schemes to consider the use of diversified growth funds as an alternative to equities during the growth phase of an individual’s membership.

Schemes may also be contemplating how increases in state pension age and the absence of a default retirement age might affect the shape of a scheme’s lifestyled funds.

Looking forward, schemes may start to look at what NEST provides when considering their own default strategies. There may be greater use of target date funds and, if NEST’s strategy of using lower risk investments during a “foundation phase” for younger members is successful, trustees may begin to consider reviewing the lifestyle strategy employed in their own default funds.