The risk of the 'default' option on pension funds

People choosing to invest their money in the "default" option on a pension fund could be placing themselves in financial peril, JPMorgan Asset Management argues.

Over the last ten years there has been a steady move away from pension schemes that pay out a percentage of someone's final salary, and a move towards pensions where companies and individuals put money into an investment fund that provides a steady income based solely on how much money it is worth.

But this can prove problematic as the vast majority of investors simply tick the "default" box when asked where and how their money should be invested.

The default option is typically an equity or balanced strategy managed passively, but a recent report from The Pensions Institute at Cass Business School warns unless more innovative default funds are introduced, pension holders are far more exposed to market downturns than they ever were when final salary schemes were used.

This is because if someone's whole fund is invested in the market, and their pension payout is dependent on the value of the fund, a market downturn could heavily hit their retirement incomes.

"We believe that total return funds offer a far better match with member expectations and requirements than traditional direct contribution default/core options such as global equity and balanced funds," said Peter Ball, head of UK institutional business for JPMorgan Asset Management.

"For example, total return funds offer the potential for consistent positive return, actively look to limit downside risk and specifically 'reward' investors for moving capital out of cash.

"Moreover, they offer a highly explicit time/reward trade off that can allow members to make a much better link between their investment goals and their time to retirement."

However, Mr Ball did emphasise that total return funds were not the entire answer.

"We do not suggest these funds should be a wholesale replacement for traditional relative return funds," he argued.

"But by introducing total return strategies as a default/core proposition, we believe direct contribution pension schemes will be much better placed to meet the priorities that are most important to their members."