Employers must recognise that defined contribution default funds are “far from standardised” and so must monitor their progress, Punter Southall has said.

Punter Southall Aspire’s second annual report, Who’s performing well?, highlighted that while employers may assume default funds are standardised, in reality, it is the opposite. As funds vary in design and construction, investment risk and volatility, asset allocation strategy, return benchmarks, management and critically, performance, more scrutiny is needed be employers to avoid putting their employees’ pensions in jeopardy, the report noted.

The report, which examined nine major DC pension providers’ default pension funds in their growth phase, found large variations that deliver varied outcomes for savers.

While the allocation to equities, bonds and other asset classes varied considerably between these funds, in general, the average default options for the providers saw most having a significant exposure to equities to maximise growth. The average equities allocation was around 62 per cent. Scottish Widows’ default had the highest exposure at 85 per cent and Legal & General had the lowest, 45 per cent.

In addition, the default funds were also found to have a significant portion of fixed income, 26 per cent on average. Legal & General and Fidelity have the highest allocation with 47 per cent for both, while Royal London had a lower holding of 4.92 per cent in fixed income.

Of the providers in the research, Zurich’s default fund was the best performer over the last three years, with 11.8 per cent compared to the other defaults, however, with a higher level of risk, 9.3 per cent. Punter Southall noted that this result is not surprising as the fund has high levels, 77 per cent, of equities. In contrast, Standard Life produced the worst return, 6.5 per cent, in the same period, but it did have a consistently lower level of risk, 5.2 per cent, than all the default funds in the report.

Punter Southall Aspire identified that providers including Royal London, Standard Life, Fidelity, Aviva and Legal & General have developed more diversified default offerings with their own asset management arms. Nonetheless, it was also noted that there is no standard approach to measuring performance of DC default funds as providers use a variety of comparators based on the strategy’s objectives and asset allocation.

Punter Southall Aspire chief executive Steve Butler said: “Our analysis highlights for the second year running that DC default pension funds are far from standardised - there are still huge variations in fund structures, objectives, asset allocations, the level of risk taken by providers and fund sophistication and employers need to take note.

Considering the varying exposure to equities, Butler added: “It begs the questions? What is the optimum level of risk and exposure to equities and should some providers be more cautious and others less risk averse?

“There were huge contrasts in fund diversification too. Some providers are spreading their investments across a range of asset classes in the UK and globally and others a far more limited range.”

He added that most default funds do not use alternative investments, such as commodities, property and absolute return strategies, mostly due to cost constraints. The average allocation to this within defaults is almost six per cent, with Standard Life and Royal London placing the highest percentage on these investments with 21 per cent and 19 per cent, respectively.

“Investment diversification is key to managing risk during volatile periods. But again, the market varies widely… Greater diversification can lead to higher risk adjusted returns, especially in stress markets but on the flip side there can be more illiquid on occasion and investments are more costly, risky and more difficult to monitor.

“Employers must examine all aspects of their DC default fund carefully to understand exactly what they are getting and how their funds are performing. Default doesn’t mean standard – far from it… With greater numbers of savers now enrolled in pension funds, employers have a duty to scrutinise their schemes to ensure they are on track to deliver the best retirement outcomes for their people.”

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