When investing for the long term, it is important to define the desired outcome and timeframe. Our responsibility to DC members is not only to grow their current savings, but to do so in a manner that keeps them contributing to their pension pots, since long-term wealth creation – for younger members in particular – is heavily dependent on future contributions. That means taking ownership of members’ experience as well as their investment returns.
When designing a robust strategy for DC members, we believe it is important to show that their savings are growing over a reasonable, identifiable timeframe – perhaps three years. This is long enough for investment ideas to generate returns or recover from short-term market ‘noise’, and short enough to ensure a focus on capital preservation and minimising capital drawdowns. Such a period should enable the disciplined delivery of investment objectives while also ensuring the experience does not discourage continuing contributions.
There are three core principles that we believe can help to deliver attractive returns, while seeking to limit the volatility that members experience.
Disciplined diversification – Returns can be diversified across different risks – asset classes, geographies, market capitalisation and industries – using bonds, equities and alternatives, such as renewable-energy and infrastructure assets. A philosophy of fundamental diversification can help provide an understanding of why an asset will provide diversification benefits in the future, not just why it has been uncorrelated with other assets in the past.
Fundamental, active and flexible investment – Understanding what you own and why you own it is paramount. Fundamental research into an investment helps to provide context and allows decisions to be made quickly when something goes wrong. Furthermore, while tracking a benchmark can anchor a portfolio to any arbitrary allocation, having the flexibility to make a compelling opportunity a meaningful part of a portfolio can help to ensure the investment makes a marked difference to returns. An active approach also provides the freedom not to own a security if it appears unattractive.
Capital preservation – In our view, thoughtful diversification – striking a balance between amortising and limited-life assets (such as bonds and infrastructure) and long-term growth assets (such as equities) – can aid capital preservation. It is also necessary to consider where we are in the capital cycle to determine the preferred balance between growth assets and ‘haven’ assets, or to what extent derivative protection may be needed.
A focus on capital preservation should help to minimise the probability of significant losses; by avoiding these losses, there is a better probability of compounding returns over the longer term and providing an experience that can encourage members to be more engaged and contribute to their pensions in order to deliver long-term wealth creation.
Newton defined contribution investments
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