What’s the best measure for IFAs to compare the performance of default funds?
Advisers weighing up a fund’s performance on behalf of their clients should be wary of simply relying on a direct comparison of providers’ historical performance.
In addition to the headline performance figure, they need to consider how far the provider’s investment objectives meet the needs of a client’s particular workforce.
They should consider the degree to which performance – in risk-adjusted terms – is consistent with that objective over a fair and sensible time horizon.
Pension scheme investment approaches come in different forms. NEST has a clear set of investment beliefs which help us approach the task of delivering high quality at low cost.
These include having a good understanding of members’ needs at retirement, with an investment strategy that aims to meets those needs. This is underpinned by the aim to grow members’ money by more than the rising cost of living, after all charges.
So it’s worth considering how well a scheme’s default fund delivers on its objectives before weighing up performance measures.
Which, as the NEST-commissioned Defaqto report, How to analyse auto-enrolment default funds, shows, is not always straightforward. Performance targets and benchmarks vary greatly across default funds.
Some providers simply aim to match the performance of a certain asset mix by fixing this allocation and sticking to it. Some don’t have performance benchmarks as such, but instead use volatility targets.
Others, including NEST, use both returns and risk to set their strategy. This can make like-for-like comparison challenging. Moreover, the report states there’s no single industry benchmark that takes funds’ volatility into account.
Measures such as the Sortino ratio, which distinguishes between the ‘good’ volatility caused by positive trending returns and ‘bad’ volatility caused by market downturns, can help. The Sortino ratio gives a more accurate indicator of performance which is adjusted for downside volatility.
This is particularly important when considering the performance of a scheme like NEST, which has an investment approach that’s particularly mindful of downside risks.
In fact, comparing the performance results of a range of providers using Sortino ratios, as the Defaqto report shows, might surprise you.
So, when comparing data of default funds on behalf of clients, advisers should bear in mind how its performance stacks up against risk.
Nonetheless, how a default fund measures up against its peers is about more than headline performance figures.
Advisers should assess how far a scheme meets their clients’ long-term needs and objectives.
The full Defaqto report, How to analyse auto enrolment default funds, offers more guidance and suggestions for better default fund performance analysis.
