Investment Considerations

The factors that the trustees of a scheme will need to take into account when determining the investment strategy of their scheme will depend on whether it is a defined benefit (DB) or defined contribution (DC) scheme, though there will be some common factors. 

When considering the way in which the investment portfolio is constructed the provider of the product, or in the case of a pension scheme the trustees, will be concerned about the:

  • Diversity of the portfolio (diversity reduces the risk associated with holding a small number of stocks, which may perform badly)
  • Level of income
  • Price variability of the asset (volatility)
  • Marketability of the asset
  • ‘Opportunity cost’ of investing in one type of asset when better returns may be available elsewhere

Diversification in investments is important, e.g. concentrating investments in a similar industry to the employer will increase the risk of underperforming if there is a downturn in that industrial sector.

Before constructing a portfolio of assets to meet particular objectives, e.g. to invest for capital growth, or to invest for income, or to invest for a specified level of total return, you need to consider certain issues.

The most important of these are:

  • the level of risk the investor is prepared to take
  • whether to use active management or passive/index tracking
  • matching assets to liabilities
  • measuring performance
  • for trustees only, the interests of the employer and the member

Active investment management is the use of a human element, such as a single manager, co-managers or a team of managers, to actively manage a fund's portfolio.  Active managers rely on analytical research, forecasts and their own judgment and experience in making investment decisions on what to buy, hold and sell.

Passive investment management (also referred to as index tracking) is an investing strategy that tracks a specified index or portfolio, often a market-weighted index.  The most popular method is to mimic the performance of an externally specified index by buying an index fund.  By tracking an index, an investment portfolio typically gets good diversification, low turnover (good for keeping down internal transaction costs), and low management fees.  With low fees, an investor in such a fund would have higher returns than a similar fund with similar investments but higher management fees and/or turnover/transaction costs.

Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds.

For example, if an investment is to be made in UK equities, then it could be made in a fund that tracks the FTSE All Share Index.  This will give a broad spread of investments across the whole of the UK stock market (over 800 shares).  If a manager actively seeks to outperform the index then they will select fewer stocks, which they hope will outperform the index.

Further help with the investment term definitions in bold above and other investment terminology used throughout this document are available using the Pensions Terminology .

For defined benefit (DB) schemes, the investment strategy aims to ensure a scheme’s assets are sufficient to cover its liabilities as they become due.  The trustees will need to take into account the amount of the existing assets, the contribution levels, and the employer’s and their own attitude to risk.

The trustees will work closely with the employer to come up with an appropriate investment strategy.  This is because the investment strategy will influence the amount and timing of contributions the employer may need to pay to the scheme.  For instance, a low risk investment strategy might result in the need for higher employer contributions immediately while a high risk investment strategy may lead to higher and potentially unexpected contribution requirements in the future.

The trustees should consider how different strategies may affect the scheme’s funding position, the employer’s plans for sustainable growth and the employer covenant.  The investment strategy should be consistent with:

  • the funding objectives
  • the appetite for risk, based on the funding objectives and the level of employer covenant and tolerance to risk
  • the scheme’s liquidity needs
  • the trustees’ assessment of the employer’s position and any plans they have for sustainable growth (including how these might strengthen their covenant).

In the case of defined contribution (DC) schemes it is the members themselves who have the power to shape their own investment plan.  However, employers and trustees should offer clear information about investment options to help members understand investment strategy and the interaction between risk and return in order to help individuals make informed choices.

Where a workplace has a diverse employee profile - especially in terms of age - employers and trustees may want to ensure the scheme offers a suitable number of funds to fit different risk profiles and requirements of members.  Where a scheme has a default fund for those members who choose not to take an active investment decision, employers and trustees should ensure that the default investment funds are appropriate and that risk is reduced as the member approaches retirement.

If a member decides to invest in any default fund or lifestyle fund offered by an arrangement it is important they make sure its aims match their own.  Even where members decide it is right for them, they should review their choice from time to time to make sure its aims continue to match their own.

Informed choice is at the heart of effective decision making - monitoring and communicating investment performance can help members find the right investment strategy for their circumstances and thereby to hopefully get better returns.

With the changes introduced from April 2015 trustees will need to review their default options because now that members do not need to buy an annuity and can drawdown from their DC pot the underlying investments may well need to change.

All occupational schemes must have a Statement of Investment Principles (SIP).  This sets out an appropriate investment strategy and investment objectives.

For DB schemes the SIP must include the trustees’ policy on:

  • choosing investments
  • the kinds of investments to be held, and the balance between different kinds of investment
  • risk, including how risk is measured and managed
  • the expected return on investments
  • the realisation of investments
  • the extent to which, if at all, you take account of social, environmental or ethical considerations when taking investment decisions
  • using the rights (including voting rights) attached to investments if you have them
  • fee structures

Additionally, in this case the SIP should cover: the investment governance structure, investment beliefs (if any have been developed) and investment objectives, risk capacity and appetite, the long-term journey plan (if one has been developed) and short-term milestones, the strategic asset allocation, any strategic liability hedge ratios, cashflow management plans, details of fee structures and details of how the investments will be monitored.

For trust-based DC schemes an appropriate investment strategy and investment objectives for all investment options, including the default strategy should be set.  The SIP would set out information such as the investment objectives and how investment decisions are made.  The employer would also be consulted and decisions taken would be reviewed regularly.


1. References

This section relates to Investment Considerations and can be found in the relevant pages of the Retirement Provision Certificate Study Manual 2023

2.Think about it

Investment decisions

Danny (aged 22) and his father Martin (aged 56) both have personal investments. Click on each of them to see what sort of investment they have chosen.

Danny - "I am just starting to invest and have decided to go for equities"

Martin - "I have invested in equities in the past, but over the past few years I have been moving my money into bonds"

What do you think the reasons are behind the different investment choices that Danny and Martin have made?

Write your comments down as part of your revision structure/practice.

3. Fact Finding

Track it down

If an investment is to be made in UK equities, then it could be made in a 'tracker fund', so here we are going to find out more about tracker funds.

Visit the Motley Fool website (investing basics) to learn more about Tracker Funds, by clicking onto the link below:

4. Test

You can now check your knowledge by a short test.  Once completed then check your answers against those given.

Investment Considerations Test

Investment Considerations Test Answers