Martin Palmer, head of corporate pensions marketing, Friends Provident, discusses the importance of getting the investment strategy right for NEST savers

The new coalition government's pledge to work with business and industry to support auto-enrolment is encouraging.

Their support will hopefully significantly increase the numbers of people within company schemes and will also help employers in their efforts to provide quality pensions for their workforce. Employers play a crucial role in getting more people to save into a pension scheme as the promise of a matching contribution from the employer is often the biggest incentive to join for the employee.

There have been no announcements about the future of NEST as yet, but it seems likely that it will go forward in one way or another. However, this means that the many open questions around NEST will still need answering. In terms of investment strategy, target-date funds are being discussed and it’s clear to see why.

They do hold real merits for NEST. The scheme will have a lot of funds under management and there will be the ability to develop varying types of funds depending on the different ages of savers.

However, it is important that we are targeting the right age for each person; this is a key issue as an individual who had the intention to retire at age 60 when they first set up their plan may find they have to reach 70 before they retire. Ongoing member engagement is clearly crucial here.

Diversification challenge
There is also the challenge of creating significant diversification so that investment returns are produced while minimising risk. We need to make sure that NEST does not offer too many funds – it needs to be a limited number of funds that are supplied at low cost. There are further issues around whether to provide guarantees on these funds: if this is going to be the case, the possible impact on returns will need to be assessed.

There are certain lessons we can learn from the US when looking at target-date funds, although a note of caution is necessary here as too often our two pensions systems get compared like for like.

Concern has risen in the US since the economic downturn that participants are not receiving adequate information about the risk associated with target-date retirement funds.

Although target-date funds have proved popular with participants and have won the approval of many investment professionals, the losses suffered by these funds during the economic downturn raised concerns about their design and transparency.

In early 2009, the Aging Committee (a US government body) conducted an investigation of these funds, which revealed that the ‘date’ in the name of the ‘target-date’ fund was not always consistent with the design of the fund, making these funds difficult for investors to evaluate and compare.

In fact, the Aging Committee found that allocation of assets among stocks, bonds, cash-equivalents varies greatly among target-date funds with the same target retirement date, with firms' 2010 target date funds' equity holdings ranging anywhere from 24 to 68 per cent. The losses resulting from the economic downturn have raised concerns among experts about investors' understanding of the construction of the glide path and its effect on the funds asset allocation.

In addition to potential design weaknesses and participant misunderstandings, the fees associated with target-date funds can also have an impact on the amount of income saved for retirement.

Clearly communication and member engagement is going to be crucial if NEST is going to be a success. Will an effective communications strategy be possible within the currently proposed charging structures? Only time will tell whether the Government has been too ambitious in keeping costs low.

There is a lot of political uncertainty around NEST, but whatever happens we do need to encourage people to make adequate provisions for their retirement.

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