THE pension debate on these pages has highlighted a number of key themes, not least the shift in responsibility for pension provision from the state and the employer to the individual.
In years gone by, employees would go through their working lives content in the knowledge that when they reached state retirement age they could enjoy their retirement courtesy of the state, as a result of their National Insurance Contributions, and/
or from their employer, through a final salary scheme reflecting many years of service for the same firm. Those days have gone.
The real value of the Basic State Pension has eroded when compared with average earnings, such that it is commonly recognised that relying solely on the State pension effectively means poverty in retirement. Trends indicate that this situation will get worse.
Employees in the private sector also no longer work their whole careers at the same company and this increased mobility has coincided with the decline of final salary pensions, and a move toward defined contribution schemes such as group personal pensions. In these schemes, the individual makes the investment decisions and takes all of the investment risk.
This last point is important and causes real concern. The vast majority of individuals will not be investment experts and so will look for guidance from their adviser, employer or pension provider.
Most company pension schemes will have a default investment fund. This is a fund for those employees who do not want, or do not feel able, to make their own investment decisions. The pretext is that these funds will be 'balanced' and so will effectively diversify risk. It is therefore little surprise that typically between 80 per cent and 90 per cent of employee and employer contributions go into the default fund.
However, the reality is that many default funds are not fit for purpose.
Employees without the knowledge or experience to actively select, monitor and blend together their own funds should have confidence that the default pension fund, as seen to be recommended by their employer, should be a sensible and a safe option for them.
Unfortunately this is often not the case. Many default funds have a large weighting in shares, perhaps 60 per cent, 70 per cent or sometimes much more. This means that if stock markets are volatile then pension investment performance is also volatile. We have witnessed this in recent times with the fall-out from the credit crunch.
What perception will an employee have if they have invested in the default pension fund and yet they see the value of their pension fund reduced by 30 per cent from one valuation statement to the next? Their view is likely to be that their pension scheme offers poor value, and probably that pensions per se offer poor value.
Pensions as a whole receive a very bad press and the public do not always differentiate bad news between state pensions, final salary pensions and defined contribution schemes. All pensions are considered to be bad.
Employers can, with effective engagement, help to quell this negative perception. However, if employees' investments are performing poorly then this effort may be in vain. The result for the employer is that they will be spending money on a benefit that is not valued by their employees. In these difficult times this does not seem like a good strategy.
The solution is simple. Default investment funds should not be over-exposed to any one asset class, but rather invested in a wide range of investments that do not all go up and down together.
All types of investment have periods when they perform well and periods when they perform badly. If you are over-exposed to any asset class then you have to accept that there will be periods when the value of your whole pension fund will suffer.
By investing in a truly diversified portfolio, with the right balance of different asset classes including shares, fixed interest, property and other investments, then it is likely that while some of your assets are falling others will be rising. This should give you a much smoother journey and more consistent returns.
To illustrate this point, in 2008 the FTSE All-Share Index fell by 30 per cent and UK smaller companies fell in value by 47 per cent. However, over the same period UK Government bonds rose by 13 per cent, gold increased by 43 per cent and world Government bonds rose by a staggering 53 per cent in sterling terms.
This message needs to get through to employers. We are gradually seeing more of them looking at using truly diversified multi-asset funds as their default pension option. While this will not solve the national pension crisis, it is likely to provide more consistent investment returns for employees who invest in these funds and will mean better value for employers as the money they are spending on pensions will be more appreciated by their employees.
Bryan Innes is senior client partner at Towry Law in Aberdeen