The default funds of the past may not meet members’ needs in the future because people are living longer and not saving enough amid an environment of low returns and a weak forecast for bonds, said Lesley-Ann Morgan, global head of defined contribution at Schroders.
At the 2016 DC Plan Summit, Morgan outlined her concerns with the traditional default funds and explained why diversified growth funds are another option to consider.
She noted that in the first 30 of the 40 years before retirement, members would only have saved half of their account. “The impact of compounding in those last 10 years before retirement show that you make up half your account size in those last 10 years,” said Morgan. “For this reason, I think there has been too much focus on risk, meaning moving into bonds, in those last 10 years before retirement.”
Morgan compared the 30-year historical returns with forward-looking forecasts for global equities, Canadian 10-year bonds and a balanced portfolio.
When looking at 10-year Canadian bonds, the historic return was 8.1 per cent, compared to a forecast of 1.9 per cent.
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Morgan looked at what that forecast means for default funds given that target-date funds, a popular option in Canada, have a high bond allocation when approaching retirement. “Because you’re holding so much in bonds, when that compounding is really making the biggest difference, it really impacts the outcomes that you get,” she said.
Morgan pointed to diversified growth funds as a potential solution through investments in a wide allocation of asset classes. At the same time, the manager is able to move the asset allocation around to target what the member needs.
Unlike target-date funds, in which defaults have higher or fixed allocations to bonds, Morgan said diversified growth funds provide the flexibility to manage downside risk and adapt to changing market conditions.
“Today’s defaults that you are probably all using in your plans aren’t necessarily the right defaults going forward in the future,” said Morgan.
“Don’t set and forget. Don’t lock your members into bonds forever. Don’t sleepwalk into providing poor outcomes just because the past default worked.”