What is the miracle cure for DB?
If defined benefit (DB) pension schemes want to improve their health, they should focus on tried and tested methods rather than hoping for magic.
We all know pseudoscience when we see it. How many times have you seen an invented term used to advertise a beauty or diet product? Has anyone been tempted by the ‘scientifically proven’ benefits of Liveforeverandadayium cream?
Naturally, when you look down at the ‘scientific’ small print, it turns out that 60% of 10 respondents agreed with the supposed benefits – and we know we’re just buying a dream.
Of course we realise that leading a healthy lifestyle with some exercise probably increases the chances of maximising our longevity. But where’s the harm in trying the cream? If you think it may make you feel better, fine; if it doesn’t, at least it shouldn’t prevent you from doing the things that actually make a difference.
What can make a healthy difference to the lifecycle of a DB pension scheme? Studies – such as those by Brinson, Hood and Beebower (1986) or Ibbotson and Kaplan (2000) – have long shown that asset allocation is hugely important, typically accounting for the vast majority of the variation in portfolio returns over time.
No quick fix
So focusing on asset allocation, alongside rigorous risk management and cost control within a strong governance framework, is what should drive improved outcomes for schemes. That in turn can create a more stable corporate balance sheet and improve benefit security for members.
However, we often see significant time spent picking lots of different investment managers – either directly or via a fiduciary manager – who come with the promise of added value, despite there being no comprehensive evidence either way. On the contrary, this activity can actually make asset allocation and overall portfolio risk management more difficult, by making it harder to react quickly and to understand aggregated exposures across the whole portfolio.
In addition, like the special creams, there is a cost to this – but unlike the special creams, the true cost can be difficult to analyse and can be significant. Schemes may then have to take more risk to target the same return. For example, to target offsetting costs of 1% per annum an investor would have to hold an additional 25% of total assets in equities rather than government bonds, based on a typical 4% per annum equity risk premium.
If there was a cream that not only cost more but accelerated ageing, I doubt it would last long on the market. If you would like to assess the health of your scheme from a governance or strategic perspective, have a chat with our Advisory Team by contacting your Client Director or visiting https://www.lgim.com/uk/en/capabilities/defined-benefit/fiduciary-management/.