Defined contribution pension schemes choose to use passively managed funds over actively managed funds based on the fact they are cheaper, it has been revealed.

A new report by Cass Business School for the DC Investment Forum, titled Investment Strategy, a bird’s eye view, analyses pension funds' investment choices based on interviews with 20 pension schemes, with the majority of the schemes representing more than 5,000 members.

Despite the introduction of the pension freedoms, which has led to pension schemes reviewing their default investment strategy, the report found that the predominant asset class in the early stage of the accumulation phase remains developed economy equities. Furthermore, pension schemes prefer these to be managed on a passive, market capitalisation-weighted basis.

“Although equities managed on this basis usually make up a significant proportion of the risky exposure in a default fund and often 100 per cent in the growth phase, the main reason given for the use of passive rather than active funds was cost, rather than any entrenched views about the merits of active versus passive investing. The lower cost of indexed funds allows schemes to integrate other strategies such as diversified growth funds (DGFs), without violating the charge cap,” the report said.

During the late stage of the accumulation phase, the report said that schemes tend to have a more structured approach to asset allocation. For example, passive equities may be combined with DGFs, and corporate government bonds at the outset.

Cass Business School lead researcher of the project Professor Andrew Clare noted that the report has identified some of the innovative approaches that some schemes have implemented since the introduction of freedom and choice.

“It also highlights some of the challenges that trustees and their advisors have to face as they strive to offer scheme members the sort of investment opportunities that are routinely available to DB members,” he said.

However, when it comes to new options offered since the pension freedoms, such as drawdown, the report said the investment strategy in the drawdown phase of a person’s life, has received little attention so far. “The interviews revealed a number of questions that will need to be addressed in the future, if schemes decide to offer in-scheme drawdown to members,” the report added.

This lack of attention to drawdown was also shown by the fact that while some relatively large DC schemes have responded to the new pension freedoms by designing default investment strategies that accommodate a drawdown investment option, smaller schemes are more likely to still offer members only the cash and annuitisation options at retirement.

DC Investment Forum chair Rob Barrett said: “In the wake of pensions freedom and choice, we asked Professor Clare to take the temperature of trust-based pension scheme decision-makers on their current investment challenges. This report sheds light on their direction of travel, and some of their current considerations.

“It is clear that the next few years will be pivotal, as more and more data become available on the decisions people are making, allowing schemes to continue to tailor their investment options, with the help of their advisers and investment managers. We welcome this interesting snapshot and the interviewees’ clear dedication to finding better solutions for DC savers, a commitment that we echo.”

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