Back in my day, if someone got five As for their O-Levels, they were considered a genius.
Nowadays, practically every kid I know has a string of As and A*s to their name at GCSE.
It’s called grade inflation. Over time, work that would have once received a lower grade gets a higher grade.
The problem is that if everyone’s getting As it becomes tough to tell who’s top. So the government has had to find ways to differentiate between those who are good, better and the best.
They’ve made the exams tougher, and recently they’ve changed the GCSE grading structure, replacing A-G with 1-9.
But that’s not the end of the story, because while for some kids, getting that A* is a monumental struggle – if they come from a failing primary, for example – others have an inbuilt advantage because they have always gone to well-run schools and can afford tutors.
That’s why the government also scores schools on how much progress their students have made. They recognise that all A*s are not equal. And neither are all Cs.
In short, to understand who’s performing well at GCSE level you have to look well beyond the basic grades.
It’s the same with workplace pensions
We recently updated our DC default fund survey, which looks at the performance of the standard investment options of the leading providers in the DC market.
Our findings: Overall, most of the funds performed pretty well. Over the past three years, the Zurich default was the best performer (11.8%), followed closely by Friends Life (11.5%), and Aegon/Scottish Equitable (11.4%). In the same period, Standard Life was the worst performer (6.5%), well below Royal London Model Portfolio (9.3%). Sounds like your company should switch immediately to one of the top performers, right?
Not so fast
As in GCSE results, the question of which is a “good fund” and which is a “less good fund” is a lot more complicated. In recent years, the stock market has performed extraordinarily well.
The Dow, for example, has hit a new high, on average, every 7 days since 2013. Under those circumstances, you would expect pension funds to do well. It’s a bit like grade inflation.
4 key components of a "good" pension fund:
1. Active asset allocation
Studies show that good asset allocation can account for 90% of your portfolio’s performance. It’s far more critical than picking specific stocks.
But this must be actively managed. If your fund manager sets the asset allocation and then never looks at it again, it means your investment strategy won’t respond to fundamental market shifts, and performance will suffer.
2. Active components
I’ll get back to this in my next email, but the key principle is that quality funds will have some active management.
3. Broad asset diversification
To reduce risk, you need broad diversification in your investment fund, so that when some areas perform poorly, it’s neutralised by those that perform well. Don’t put your eggs in too few baskets.
4. Inflation target
One of the most significant risks to long-term investment is that inflation can erode or wipe out returns. Therefore, make sure that your fund has out-performing inflation as one of its targets.
Reality is that no matter how well a fund performs during the good times, if it’s not doing well on these measures, it will fall fast during the bad times. And some of those that look weak(er) during the good times will be robust when the stock market heads south.
So how well is your default investment strategy really doing?
You need to look beyond the bottom line at the way it’s structured and managed.
If you’re not sure, why not ask one of our experts based near you to take a look. We offer a review service, where we can help you evaluate how good your default fund really is. Simply fill out the question form below.
Topics: Pension Investment