Hands on
May 01, 2010 | Brooke Smith

Most consultants and money managers would say that the best default fund for a defined contribution (DC) pension plan is not to have one. However, this is far from reality. “Plan sponsors find that, despite trying to do their best in terms of education and increasing employee awareness, there’s still a large cohort of employees that won’t make a choice,” says Jaqui Parchment, partner and Canadian director of consulting with Mercer’s investment consulting business. Those employees who won’t make an investment choice will inevitably end up in a default fund.

Historically, it was enough for plan sponsors to focus on getting plan members enrolled in a DC plan and contributing to it regularly. Now, however, plan sponsors also have to make sure that their members are invested appropriately. Ken Devlin, assistant vice-president, investment solutions, group retirement services, with Sun Life Financial, says there has been an evolution in terms of the way plan sponsors look at default funds. “Sponsors want to make sure that when a member defaults, it is to an investment appropriate for the purpose of the plan, usually a long-term investment.”

About one-third of Canadian plan sponsors still opt for a default that focuses on capital preservation. According to Mercer’s 2009 Global DC Survey, of the more than 90% of plan sponsors that had a default fund, 29% had a money market or short-term fund.

Historically, a DC default option was one that focused on capital preservation at the expense of greater gains, but that has shifted over the past few years. “Plan sponsors are looking not only at capital preservation [but also at] capital appreciation with moderate risk,” says Robin Stanton, director, investments, group savings and retirement solutions, with Manulife Financial.

Consequently, if one-third of sponsors have their unengaged members in a default such as a money market fund, that’s not going to help them gain funds for retirement. “If these employees never make a choice, being in a short-term fund permanently will not give them a great return over a long period of time,” says Parchment.

U.S. leads the way
Canada is not as fortunate as the U.S. in terms of its retirement legislation. Under the Employee Retirement Income Security Act (ERISA), employers are granted “safe harbour,” which means that if employers offer a range of funds in their DC plans, they are immune from liability relative to their investments.

The safe harbour legislation specifies three appropriate default funds for plan sponsors:
• a balanced fund;
• an asset allocation or target risk fund; and
• a lifecycle fund or target date fund (TDF).

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