Reject passive, return to active for pension funds
Active management will be increasingly important for defined contribution (DC) retirement savings schemes as value-for-fees, expected lower future returns and sustainable investment preferences come to the fore, according to a new MFS white paper.
The analysis says the rising exposure to index investments in DC schemes has been built on at least three “misconceptions about active versus passive that need to be corrected”, namely that passive leads to better retirement outcomes; that future performance will match historical returns; and that fiduciary duty excludes sustainable investing.
For example, the MFS report says scheme managers must consider a wider range of features other than price when choosing underlying funds or designing investment options.
“Fiduciaries should not simply choose the least expensive funds for plan members; rather, they should follow a well-documented, process-oriented, ‘fee for value’ framework for fund selection,” the paper says. “This concept becomes even more important when looking at target date funds, for which glide path design, asset allocation and investment process will be the drivers of successful retirement outcomes.”
As well, the study says future returns are likely to fall below recent historical levels, putting passive performance assumptions under pressure.
MFS estimates a typical balanced portfolio of 60 per cent equities and 40 per cent bonds will return an annual 3.2 per cent and 5.8 per cent over the next 10 and 30 years, respectively: by contrast, balanced fund investors received an average 9.1 per cent and 7.8 per cent annual return over the past respective 10- and 30-year periods.
“We believe that investment returns in the next decade will be markedly lower than they have been historically, and skilled active management can play an important role in helping members achieve the additional returns needed to meet their retirement goals,” the MFS report says.
“Accordingly, we believe that following a prudent fiduciary process in the selection of actively managed strategies can greatly benefit plan members in achieving their retirement goals while also offering them an opportunity to access sustainable investments through an integrated approach.”
Furthermore, the paper says increasingly important environmental, social and governance (ESG) factors require an active approach.
“While active management has always played an important role in retirement plans, today’s environment has added new layers of complexity to the active versus passive debate,” the paper concludes.
“With returns likely to be lower in the coming years than what we have seen over the past decade and environmental, social and governance (ESG) issues growing in importance for retirement plan sponsors, we believe that skilled active management will be critical to helping plan sponsors and members sort through these complex issues as they work towards successful retirement outcomes.”
The ‘Back to reality’ report was authored by MFS head of investment solutions group, Jonathan Barry, and Sarah Donohue, consultant relations managing director.