Default Funds in UK Defined Contribution Pension Plans

Most defined contribution (DC) pension plans give their members a degree of choice over the investment strategy for their contributions. Many plans also offer a ‘default’ fund for members unable or unwilling to choose their own investment strategy. We analyse the range of default funds offered by UK ‘stakeholder’ DC plans, which by law must offer a default fund. We find the default funds are typically risky, but also that they vary substantially across providers in their strategic asset allocation and in their use of lifecycle profiles that reduce investment risk as the planned retirement date approaches. We use a stochastic simulation model to demonstrate that the differences can have a significant effect on the distribution of potential pension outcomes experienced by plan members who adopt the default fund as the path of least resistance. We also analyse the fees charged for the default funds. This is a pre-press version of a paper that appears in the Financial Analysts Journal, July/August 2007. http://www.cfapubs.org/doi/abs/10.2469/faj.v63.n4.4748 ∗ Alistair Byrne CFA is a lecturer in finance at the University of Strathclyde, Glasgow UK; David Blake is professor of pension economics at Cass Business School, London UK; Andrew Cairns is professor of financial mathematics at Heriot-Watt University, Edinburgh, UK; and Kevin Dowd is professor of financial risk management at Nottingham University Business School, Nottingham, UK.