Is short-term memory loss affecting DC investment strategies?

The performance of asset classes over the past few years has left the defined contribution (DC) pensions market with a conundrum.

A period of strong equity market returns since the lows of the pandemic (until recently, at least) has generated significant support for taking higher levels of risk and investing entirely in stocks for the majority of the DC investment journey. On the flipside, we believe the recent turbulence in markets suggests a more diversified strategy could help manage risk while still delivering potentially strong long-term returns.

It’s worth looking at this a little more closely and unpacking historical returns for DC pension savers.

(Credit) crunching the numbers

If we cast our minds back to the 2008 Credit Crunch, markets fell sharply, wiping an average of 25% off the value of a DC pension member's pot, according to Aon DC tracker.

Following the crash there was significant momentum in the DC pensions industry for diversification to provide better risk management and to access different growth opportunities in different market environments. In this period the popularity of diversified growth funds soared.

The global economy took many years to recover from the Credit Crunch, but various pockets of the market performed well during this period of recovery.

In fact, until the end of 2019, a diversified strategy is likely to have delivered similar or better returns than the equity market, as shown in the chart below:

But this is when we see a marked divergence. Equity markets fell sharply in March 2020 amid great uncertainty about the possible economic impact of the pandemic. They then mounted an impressive recovery, driven by exceptional central bank largesse and the development and deployment of highly effective COVID-19 vaccines, spurring confidence in the economic outlook.

But was the recovery as solid as it appeared?

The weighting game

The recovery from March 2020 was largely driven by the US market, which was itself driven by its exposure to large-cap technology stocks – *Apple, *Alphabet (*Google), *Amazon, *Facebook, *Microsoft and *Tesla – to the extent that these six companies made up around 25%[1] of the US stock market.

A market-cap global equity approach to investment in this period would have placed around 60% in the US market. Therefore, a traditional passive approach would have resulted in high exposures to a small number of companies in one sector, and investors would have done well from this – until recently.

Since the start of the year, rising interest rates and the emergence from the pandemic have hit the share prices of large tech companies, many of which have suffered sharp declines as at the time of writing.

A marathon, not a sprint

What this suggests is that we need to look beyond a one- or three-year horizon and think about the experience and outcomes from a DC investment strategy longer term. This means considering the entirety of the line graph above rather than the last couple of centimetres.

DC pension savings are long-term investments, with members likely to experience many market cycles before drawing their pension. It is right to be aware of shorter-term returns from a governance and oversight perspective, but we must also look beyond that.

We believe that taking the right levels of risk at the right time is vital; so too, in our view, is providing access to different types of investments, which can also help to achieve DC savers’ desired outcomes.

*For illustrative purposes only. The above information does not constitute a recommendation to buy or sell any security.

Key risks

Past performance is not a guide to the future.  The value of an investment and any income taken from it is not guaranteed and can go down as well as up, you may not get back the amount you originally invested.

[1] Source: Bloomberg as at 31 December 2021.