DCIF's first discussion paper questions the legal framework around DC investing and asks whether changes should be made to the significant use of passive funds in UK DC schemes.Passive (or index) funds have an important role in helping DC members achieve their retirement goals. But comparing the very different ways that UK and US Defined Contribution pension schemes use these vehicles clearly shows that their significant use in the UK today amounts to a structural imbalance that may damage the interests of DC scheme members. Today, new industry group the Defined Contribution Investment Forum launches its first discussion paper, calling for a new perspective on DC investing.
It is presumed that the UK must have some very good reasons for putting up to 69% of DC scheme assets in passive funds, while the US DC industry limits its passive fund usage to 16%. This unbalanced investment in passive funds is principally attributed to six key factors - cost, manager risk, legal liability, asset class selection, low maintenance, and advice.
However, members of DCIF, along with a leading US DC industry expert, have identified some serious flaws in this reasoning behind the current profusion of passive funds in the UK. By placing emphasis on issues such as reducing cost, avoiding manager risk, and ensuring low maintenance, the UK DC industry increases risk elsewhere.
Consequently, the paper concludes that not one of these six frequently cited reasons for using passive funds in the UK justifies their current significant use in many UK schemes.
The problem lies not with passive funds, which offer real benefits in moderation, but with default fund design. The paper proposes that there is a very serious argument for placing the decision on whether to use active or passive funds at an appropriate stage in the DC default fund design process. It also calls for similar rules in the UK to the Employee Income Retirement Security Act (ERIS) in the US offering more clarity around risk minimisation.
The opinions expressed in this paper are those of the report authors - Spence Johnson - and do not necessarily represent the views of DCIF members.
The Defined Contribution Investment Forum (DCIF) is a group of organisations formed to exchange ideas and develop initiatives to promote investment excellence in Defined Contribution (DC) pensions in the UK. The group website is at DCIF.co.uk
To view the full white paper visit the DCIF website: www.DCIF.co.uk
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