Protected Equities Strategy for DC

Revolutionising the UK Defined Contribution Market with the Protected Equities Strategy

The DC market is currently characterised by its focus on cost competitiveness, often prioritising lower management fees over the actual value added by different solutions. This cost-focused approach, while beneficial for reducing expenses, has inadvertently resulted in many DC schemes with subpar asset allocations. Many higher-cost funds that could potentially add substantial value to portfolios were not designed with DC in mind and are hence not used. Our Protected Equities Strategy addresses this by being a solution to the DC market which was specifically designed with value for money in mind that aims to deliver real value to portfolios while being very cost competitive on a standalone basis to fulfil the low-cost requirements of the DC market.

We would like to take a closer look at the following points:

The Challenges of the Later Stages

Members within the mid-growth phase typically have substantial allocations in Diversified Growth Funds (DGFs). However, the performance of many DGFs over the past two decades has fallen short of expectations, failing to provide the anticipated equity-like returns with lower volatility. Often, the returns were markedly lower compared to equities, even while often suffering drawdowns of similar magnitudes. The fee structure of DGFs also tends to significantly exceed that of equity funds. Our historical data and modelling indicate that our Protected Equities Strategy would have outperformed DGFs, offering superior returns with similar risk levels. Moreover, the cost associated with our strategy stands as a mere fraction of the average DGF's fee.

A critical concern also arises for those approaching retirement. These later stages of the lifecycle often see an over-allocation to government bonds, money market funds, and low-risk bonds. This conservative approach results in low equity allocations, which is problematic considering a retiree's remaining life expectancy often exceeds 20 years.

This lack of growth asset exposure means retirement funds are not optimally invested and could be achieving higher returns. High bond allocations also pose an inflation risk, potentially eroding the real value of assets. However, the challenge lies in the fact that investors nearing retirement are often unable or unwilling to take on the volatility associated with a more aggressive portfolio, necessitating a solution that balances risk and return. Up to now, not enough has been done to address this problem, especially as the number of DC members along with their pots keep growing and the age of the average member is increasing.

The Protected Equities Strategy:
A Game-Changer

  • The approach, which has been used by many institutional investors over the last decades, now presents a compelling proposition for the DC market.
  • It offers investors in the mid-growth phase and nearing retirement a way to maintain or even increase their equity exposure without increasing their risk profile substantially.
  • Protected Equities is a proven investment approach that allows investors to participate in the potential upside of equity markets while providing a level of downside protection.
  • Our strategy employs a combination of equity investments and exchange listed options, that are used for risk reduction purposes, in order to construct a portfolio that aims to deliver long-term growth with reduced risk.
  • We only use exchange listed options as they offer distinct benefits due to their regulated, standardized nature which increases liquidity, transparency and considerably diminishes counterparty risk.

How Protected Equities fit in the Portfolio

The Protected Equities Strategy can be used to effectively replace and complement allocations in DGFs as well as bonds within the mid-growth and pre-retirement phases. When applied efficiently, the Protected Equities Strategy can increase the long-term expected returns of a portfolio without significantly altering its risk dynamics when replacing DGFs or bonds with it. It can also provide an essential diversification away from bonds and DGFs, which are especially susceptible during periods of high inflation and rising interest rates.

The Protected Equities Strategy comes in two versions tailored to different stages of the lifecycle:

  • A version focused on protecting against Tail Risks that aims to limit annual drawdowns to less than 20%, exhibit a volatility of around 10-15% annually, participate at least 90% in positive equity market returns, and offer higher risk-adjusted returns than equities. This version is suitable for the growth/mid-growth phases as a complement or replacement to DGF funds.
  • A High Protection version that aims to limit annual drawdowns to around 10%, keep volatility under 10% annually and provide higher returns than global bonds. This version is ideal for the pre-retirement phase, serving as a complement or alternative to bonds.

Protected Equities for the DC Market

  • The Protected Equities Strategy addresses all the essential requirements for funds within the DC market, including low cost, ESG and climate considerations, high liquidity and transparency, an attractive value for money proposition, and ease of access via various platforms.
  • It is daily priced and can be traded daily, and as can be evidenced, it satisfies all DC-related regulatory reporting requirements.
  • The Protected Equities Strategy has been used by institutional investors for decades due to its appealing balance between risk and return. It's an approach that has stood the test of time, and with its recent availability to the DC market, it can serve as a powerful tool in improving investment outcomes of members throughout their journey to retirement.

Contact

Steven Gardner
Head of Asset Management Sales & Client Relations UK
Phone +44 20 3465 2714