The active vs passive investment debate: how to offer the best value for members?
Value for members is a hot topic in the defined contribution (DC) space right now, particularly within the master trust market, where schemes must be able to demonstrate that the benefits they deliver to members are consistent with the charges they levy.
There are currently two main strategies for investing – active management and passive management. The debate over which is the best route for members is a topic of never ending debate.
In this article we discuss what good value really means for pension scheme members and whether this can be achieved from active or passive investments.
What constitutes good value?
What is more important is what represents good value for members which is the key measure for determining whether any DC scheme is delivering good member outcomes once we exclude the level of employer and member contributions.
To start with, it’s important to recognise that good value for money doesn’t always mean the cheapest possible route. We believe that trying to maximise value for members in DC is achieved through a combination of member focused investment design, a communication approach that will help them make better decisions about their pension savings and building scale to reduce investment, transaction and other operational investment costs.
A short list of good practice for achieving good value for members:
- A focus on the design of the default fund to ensure it is appropriate to the needs of the members who won’t select an investment strategy
- Options designed around member objectives so that members are more likely to make choices
- Member’s risk appetite being managed by offering them options to tailor asset allocations more closely to their objectives
- Using scale to make the whole offering low cost, including transaction and operational investment costs
- Adding value to the investment performance through active asset allocation
- Using passive funds where the potential rewards of alpha do not compensate for the additional governance and risk
Recognising that the market will continue to evolve both in terms of the offerings from the industry and the needs of the members, so that a continual evolution is both necessary and desirable.
Value for the many, not the few
Investment options, and particularly the number on offer to members, is an important part of the good value debate. Following the recent Freedom and Choice reform, every member’s needs are unique at the point of retirement. This makes it even more vital to offer a choice that enables them to meet their objectives for how they want to access their pension benefits.
There is no right answer to the active-passive debate and it is futile to try to find an answer. As we look ahead it is merely a matter of opinion and if we’re looking back we are influenced by the benefit of hindsight.
Whilst there is no single magic formula to delivering good value to DC members, those schemes that provide strategic investment options and encourage member involvement with them, will go a long way in doing so.
Above all, we need to focus on how we can achieve good outcomes for members and good value is an important part of that. Dogmatic adherence to one side or the other in the active-passive debate should merely drive the focus on where good investment practice and governance can add value to the investment process.