By Lee Halpin

It is in time of stress that the best-laid plans are put to the test and this year has illustrated this in the extreme with the adverse effects that Covid-19 has had on financial markets. In situations like this, just how well investment portfolios have been constructed to account for people’s attitude to risk and capacity for loss becomes fairly obvious.

Unsurprisingly, managing investments is an area where the majority of people feel outside of their comfort zone and want support and education.

But with the continuing shift from defined benefit to defined contribution pension provision (some 26.7 million members have £739 billion held or invested in contract-based workplace and non-workplace defined contribution pensions) and the subsequent transfer of investment risk from the employer to the individual that goes along with it, aligning your pension arrangement with appropriate investments can be a particularly complex task.

An obvious example in getting this wrong is simply defaulting into cash holdings or cash-like assets. How wrong you might ask? Someone who wants to draw down their pension pot over a 20-year period could increase their expected annual income by 37% by investing in a mix of assets rather than just cash.

The Government’s 2015 pension freedoms gave consumers more flexibility in how and when they can access their pension savings but also added another layer of considerations when it came to selecting pension investments. Consequently, 2021 will see the regulator take action aimed at helping at-retirement consumers make more informed choices about how their retirement savings are invested.

Described in the regulator’s own words as a significant market intervention, pension providers will be now be required to offer ready-made investment solutions for clients entering drawdown of their pension fund without seeking independent financial advice.

Investment pathways, as they have become known, will see consumers selecting from a simple list of standardised objectives and matched with a ready-made investment solution.

The mandated objectives to be picked from are: I have no plans to touch my money in the next five years; I plan to use my money to set up a guaranteed income (annuity) within the next five years; I plan to start taking my money as a long-term income within the next five years; and I plan to take out all my money within the next five years.

Crucially, providers are not allowed to present a consumer with more than one pathway solution per investment pathway objective - the rationale being that limiting the number of choices that the consumer has to make should lead to maximum engagement.

But many people in the financial services industry argue that the outcome-focused and single-choice design is flawed, as it does not take account of the consumer’s risk profile, nor does it offer diversity.

When presenting the investment pathways solutions to consumers, pension providers must only describe the riskiness of each investment solution that they offer, to enable consumers to make this assessment. So the ready-made investment solution falls away where it is not matched with the consumer’s particular attitude to risk.

The difficulty with matching an investment based on consideration of an individual’s circumstances is that it is likely to fall within the definition of a personal recommendation and this could be construed as advice. This is a line in the sand for providers who do not want to stray beyond simply giving generic guidance. The regulator has already stated that they are not able to provide a safe harbour for providers by guaranteeing to them that, by offering investment pathways, providers will not be providing a personal recommendation.

Another criticism aimed at the investment pathways design is that simply asking consumers to select one objective could lead to a lack of diversification, especially where there is no default or mandated mechanism to act as a prompt where an individual might be considering more than one objective. Here Covid-19 is stated as the type of market shock that could have profound consequences for people who do not have suitably diversified investment portfolios.

A complex issue by definition consists of many different and connected parts. There is rarely an easy fix. The investment pathways are at least an attempt to better align investment solutions with a consumer’s broad objective for retirement. But, to really get to grips with the inherent complexity and deliver mass improvement, measured by more individuals enjoying a higher income in retirement, I’d imagine that this will take more focus on driving engagement for consumers to seek financial advice and/or not-for-profit guidance.

Lee Halpin is head of technical services at @SIPP