Solving Defined Contribution challenges with global investment principles

Many countries are grappling with the challenges of defined contribution (DC) pensions, each at a different stage of maturity shaped by unique demographic, regulatory, and policy factors.

Despite these differences, a set of broad investment principles can provide a strong, adaptable foundation for pension frameworks. These principles integrate human behavior, outcome-driven investing, and scalability into a flexible approach that can be tailored to local needs while maintaining a consistent global perspective on DC challenges.

We explore the key drivers behind these principles and examine how they can be applied to UK defined contribution schemes.

1. Define the objective

The first investment principle is anchored in defining the objective for retirement portfolios. This involves a mindset shift, away from relative investing that dominates accumulation investing towards outcome-driven investing. We are conditioned to build portfolios utilising an optimisation approach. While this is still relevant for post-retirement, it is critical to define what the investment portfolio should optimise for and incorporate factors that influence decision making in retirement.

The range of investment requirements for retirement can be relatively broad, but typically the objective is anchored around an income target and then tailored based on precise time horizon, risk tolerance, and degree of flexibility preferred.

How we encourage individuals to think through what may be right for them or consider at a holistic level what most people may want from their pension, means we need to understand how people think about their pensions. Defining pension investments in terms of asset type can be overwhelming, whereas thinking through what outcomes need to be achieved such as how much income is required, how much cash makes someone feel comfortable, and how much they would like to leave invested for future flexibility makes retirement far easier to navigate.

This is why we developed the 4-Life framework, to align investment capabilities and solutions to the outcomes that individuals want to achieve in retirement. Success should be measured not on a relative basis but through delivering targeted outcomes to help people enjoy a comfortable retirement.

The 4-Life framework helps lay out four key areas to consider:

1. Life events: Define how much cash is needed given cash requirements in the early years of retirement.

2. Lifestyle: Define the amount of income that is desired / needed through time.

3. Lifetime: Decide the proportion of savings that is not needed immediately for income that can be left to grow to fund future income needs.

4. Legacy: Consider whether to leave a proportion of savings to family, friends or a charity.

2. Define the building blocks

Simplicity is often best. However and this is important retirement solutions must be fit for purpose. Sometimes that means moving beyond the simplest option to embrace the most appropriate one.

In our view, building a platform of investment building blocks, where each building block plays a different role within a post-retirement portfolio, allows for clear alignment of investment strategy with outcome. This approach also allows for flexibility to swap in and out various building blocks depending on the want or need of the individual. For example, a scheme member may want flexibility to change their portfolio over time if their circumstances are uncertain. Therefore, using a more flexible fixed income cash flow matching strategy may be more appropriate than purchasing an annuity. The key to building an effective post-retirement platform is ensuring each building block is clearly defined, and the drivers of how to select each building block align to the outcome one is trying to achieve.

As a broad approach, thinking of asset allocation in terms of outcomes instead of asset classes helps align a post-retirement portfolio with the way individuals think about their retirement planning. Once we have defined the outcomes, having a menu of strategies aligned to that outcome builds flexibility into a scheme’s post-retirement offering.

3. Building customised but scalable solutions

There is no one-size-fits-all for retirement, and therefore thoughtful customisation is paramount. Self-select options can offer customisation, but a pension scheme cannot reasonably offer a one-to-one solution for all members under their default umbrella.

In the UK, Targeted Support has formally introduced the concept of member cohorts, which translates into the need to define investment personas. This links directly to principles 1 and 2 above, where defining the objective helps people define their cohort membership, with principle 2 aggregating the investment building blocks that can deliver those pre-defined persona outcomes.

To enable a more tailored journey for pension scheme members, technology is likely to play an important role. The 4-Life framework helps define outcomes, but cash flow planning tools help bring those outcomes to life and lift them into the real world. Members may desire a targeted income throughout retirement, but pension pot size and how early they are taking their pension will impact how achievable that retirement income is. Cash flow planning tools bring this to life to help align the reality of DC pots with the outcomes they need to deliver.

Modelling these pre-defined personas using different combinations of building blocks serves to illustrate how optimal a portfolio is relative to the persona objectives and secondly highlights the benefits of incorporating different building blocks to achieve an income or growth outcome.

To enable a more tailored journey for pension scheme members, technology is likely to play an important role. The 4-Life framework helps define outcomes, but cash flow planning tools help bring those outcomes to life and lift them into the real world. Members may desire a targeted income throughout retirement, but pension pot size and how early they are taking their pension will impact how achievable that retirement income is. Cash flow planning tools bring this to life to help align the reality of DC pots with the outcomes they need to deliver.

Modelling these pre-defined personas using different combinations of building blocks serves to illustrate how optimal a portfolio is relative to the persona objectives and secondly highlights the benefits of incorporating different building blocks to achieve an income or growth outcome.

A focus on the UK

These global investment principles apply directly to UK defined contribution schemes and assets. In our view, regardless of pathway, be that advised, do it yourself, guided or supported retirement there should be a degree of consistency to what is available for individuals’ entering retirement.

There are still several grey areas from a regulatory perspective, and some areas where we just don’t know the answer yet. In our view, that doesn’t mean you don’t start to build solutions, we just need to build a framework that can flex to future regulatory changes.

For example:

• The pensions dashboard will be a significant step forward, but how that information will be used by individuals and scheme providers is yet to be seen. Visibility on other pots could be an important factor for defining investment objectives.
• Targeted support will in part drive how many investment building blocks are required to deliver each outcome. If annuities are not appropriate for all to deliver cash flow matching strategies, alternative liquid solutions for delivering stable income need to be available through the framework.
• There is likely to be a need for schemes to balance offering guided retirement with supported retirement. A building block approach to customisation helps build a framework to support both consistency and flexibility.

Collaboration is key

Defined contribution presents its own unique investment challenges. Building a robust and fit-for-purpose framework comprising outcome-driven investment building blocks is crucial to deliver better outcomes for scheme members. As noted at the outset, this is a global issue: We are all working towards the same goal, better member outcomes. At Invesco, we recognise that achieving this requires collaboration across the industry. As a global DC provider, we bring the advantage of deep experience across multiple markets, enabling us to share insights, best practices, and innovations that have proven successful elsewhere. This global perspective allows us to identify what works, adapt it to local regulatory and cultural contexts, and accelerate progress toward better outcomes.

We are actively partnering with providers, consultants, and policymakers to leverage this expertise and address differences in member characteristics, policy, and market structure. Our approach is built on flexibility and partnership: We can deliver a holistic solution that supports providers in meeting their members’ needs or complement existing in-house capabilities with targeted components. This model ensures schemes benefit from global best practices while tailoring strategies to the unique needs of their members and regulatory environment, keeping member outcomes at the heart of everything we do.

Defined contribution pensions

For more than 30 years, Invesco has worked alongside defined contribution schemes and consultants across the globe to help optimise member outcomes.