The UK Defined Contribution (“DC”) market has long been
characterised
by a focus on cost competitiveness, often prioritising low management
fees at the expense of long term value. While this has reduced headline expenses, it has also
contributed to sub-optimal asset allocations across many DC schemes. Historically,
higher-cost strategies with the potential to add meaningful long-term value
have been overlooked, largely because they were not designed with the needs and
constraints of DC in mind. Our Protected Equities Strategy directly addresses
this challenge. It was built for the DC environment:
cost-competitive as a stand-alone solution, while aiming to deliver value in
terms of potential risk adjusted return.
The Challenges of the Later Stages
During the mid-growth phase, many DC members 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 deliver the expected equity-like returns with lower volatility they were designed to achieve. In many cases, returns were markedly lower than those of equities, while still experiencing drawdowns of similar magnitudes. Fee levels for DGFs also tend to be significantly higher than for traditional equity strategies. Our historical data and modelling suggest that our Protected Equities Strategy would have outperformed DGFs over comparable periods, delivering higher returns with similar risk characteristics. Moreover, the cost of our strategy is much lower than the average DGF's fee, making it well-suited to the value-for-money demands of the DC market.
A critical concern also arises for those approaching retirement. In the later stages of the lifecycle, portfolios are often heavily allocated to government bonds, money market funds, and low-risk fixed income instruments. While this conservative positioning aims to reduce short-term volatility, it typically results in low equity allocations, raising concerns given that many retirees’ remaining life expectancy often exceeds 20 years.
This lack of exposure to growth asset means many retirement portfolios are not optimally invested and may be missing out on the potential for higher long-term returns. High allocations to bonds also introduce inflation risk, which can gradually erode the real value of savings over time. The underlying challenge is that individuals nearing retirement are often unable or unwilling to accept the volatility associated with more equity exposure, creating a need for solutions that can balance growth potential with risk managements. To date, this issue has not been sufficiently addressed, even as the number of DC members with growing pension pots continue to rise and the average age of these members increases.
The Protected Equities Strategy:
A Game-Changer
This approach, long used by institutional investors such as DB schemes and insurers, now presents a compelling proposition for the DC market.
- It provides members in the mid-growth phase and those nearing retirement with a way to maintain, or even increase, their equity exposure without materially increasing their risk profile.
- Protected Equities is a proven investment approach that enables investors to participate in the potential upside of equity markets while incorporating a defined level of downside protection.
- Our strategy combines core equity investments with exchange listed options, which are used specifically for risk mitigation purposes, in order to construct a portfolio designed to deliver long-term growth with reduced risk.
- We only use exchange listed options due to their regulated and standardized nature, which enhances liquidity, improves transparency, and significantly reduces counterparty risk.
How Protected Equities fit within a Portfolio
The Protected Equities Strategy can be used to replace or complement allocations to DGFs and bonds during the mid-growth and pre-retirement phases. When implemented efficiently, it has the potential to enhance a portfolio’s long-term expected returns without significantly increasing overall risk, especially when replacing DGFs or bonds. It also provides valuable diversification benefits, particularly during periods of high inflation or rising interest rates, when traditional bonds and multi-asset strategies may be under pressure.
The strategy can be tailored to meet different objectives depending on the stage of the DC member journey. While the structure is flexible, two illustrative versions set out below show how it can be applied in practice.
- A version focused on protecting against Tail Risks that aims to limit annual drawdowns to less than 20%, maintain volatility of around 10-15% annually, participate at least 90% of positive equity market returns, and deliver higher risk-adjusted returns than equities. This version is well suited for members in the growth/mid-growth phase, and can serve as a complement or replacement to DGFs.
- A High Protection version that aims to limit annual drawdowns to around 10%, keep annual volatility under 10% and provide better long-term return potential than global bonds. This version is ideal for the pre-retirement phase, prioritising capital preservation and downside protection.
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.
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