USS’s DC default option is invested much less cautiously than the DB fund

USS’s current DB reference portfolio is about 70% equities and property (63% equities, 7.5% property), 12.5% corporate bonds and other debt, and 17% gilts. USS plans to ‘de-risk’ their DB portfolio over 20 years into something that approximates a 50–50% split between equities and property on the one hand and corporate bonds and gilts on the other hand.

Such cautious investment is in stark contrast with the default DC option USS has constructed for members, which is completely invested in a ‘Growth Fund’ for most of a member’s career, but with ‘lifestyle’ de-risking over the 10 years leading up to retirement, into complete investment in a ‘Moderate Growth Fund’ 5 years short of retirement, and then further de-risking into a portfolio divided equally between a ‘Cautious Growth Fund’ and cash at retirement.

The DC Growth Fund is more weighted towards return-seeking assets than USS’s current DB reference portfolio. It’s about 75% equities and property (62.5% equities, 11.5% property) and 25% bonds. Significantly, all of the bonds are corporate, some of them emerging markets or ‘global high yield’. The Growth Fund is devoid of investment in gilts.

The DC Moderate Growth Fund approximates the roughly 50–50% split between growth assets (equity and property) and bonds of the DB portfolio into which USS would like to de-risk over 20 years.

Hence, USS is investing their DB pension fund more cautiously than the DC pension funds into which they default individual members for most of their working careers.

They are doing so in spite of the fact that an ongoing collective DB pension scheme such as USS is able to pool risks across members, given its ‘uniquely robust’ employer covenant over a 30 year horizon. Individuals, by contrast, must bear all the risks on their own of the investments in their DC pension pots turning out badly.

How, in the light of this fact, can one justify USS’s selection of such a risky DC default option, relative to their caution in the investment of the assets of the DB scheme?

It could be argued that, under USS’s hybrid DB/DC arrangement, individual members can afford to take on more risk in their investment of their DC pots precisely because they have the underlying guarantee of the DB pension to fall back upon. This line of argument places an important constraint on the aspiration of some employers to shift members entirely over to DC pension pots. This rationale for heavy investment in return-seeking assets will no longer be available in that event.

It is important to emphasise that even USS’s current, risky default DC option decreases our future USS pension income to 50–75% of what we could expect under a continuation of the status quo. The further de-risking of the DC default option that would be necessary to compensate for the complete absence of an underlying DB guarantee would decrease expected pension income even further relative to the status quo.

Written by

Professor, Dept. of Philosophy, Logic & Scientific Method, LSE

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