Collective defined contribution schemes require an investment approach focused on members’ actual pension experience, rather than traditional measures of portfolio risk and return, according to LCP. This approach should consider the complexities of CDC schemes, where investment returns are shared collectively and feed through into future pension increases or reductions, making it distinct from both defined benefit and individual DC schemes.
This approach should start with the outcomes they want to deliver, then work backwards to the portfolio behavior needed to support them, as outlined in a new report. By doing so, CDC schemes can better manage the nuances of collective investment returns and their impact on members’ pension experiences.
Understanding CDC Outcomes
CDC outcomes are not fixed in advance, unlike defined benefit schemes, but are also not determined solely by each member’s own investment experience, as in individual DC schemes. Instead, investment returns are shared collectively and feed through into future pension increases or reductions, creating a dynamic where individual members’ experiences are interconnected.
Additionally, the collective nature of CDC schemes means that investment decisions must consider the broader membership profile, including factors such as age demographics and overall scheme assets. This subtle approach to investment strategy is critical in ensuring that CDC schemes can deliver stable and resilient pension outcomes for their members.
This nuance changes how risk and success should be assessed, with a focus on expected pensions, downside outcomes, pension stability, inflation resilience, and the likelihood of reductions. By considering these factors, CDC schemes can develop a more full understanding of their investment strategy’s impact on members’ pension experiences.
Assessing Investment Strategy
Steven Taylor, partner and head of CDC at LCP, said: “CDC investment strategy is not about avoiding risk; it is about how investment risk is translated into pension outcomes over time.” This requires a shift in mindset and a more innovative approach to investment design, one that prioritizes the collective pension experience of members.
The level of investment risk a CDC scheme can sustain depends on both its assets and membership profile, with younger demographics able to absorb market shocks over longer timeframes. Conversely, more mature schemes may need to prioritize stability and downside protection, given their members’ relatively shorter time horizons and increased sensitivity to market volatility.
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Furthermore, CDC schemes must also consider the potential impact of external factors, such as changes in economic regimes or inflation shocks, on their investment strategy and portfolio behavior. By doing so, they can develop a more resilient and adaptive approach to investment management, better equipped to handle complex and evolving market conditions.
Broader Investment Toolkit
Laun Middleton, partner at LCP, added that CDC needs a broader investment toolkit than traditional pension investing, combining long-term growth with resilience through inflation shocks, market stress, and changing economic regimes. This means considering the impact of investment decisions on pension outcomes, rather than just focusing on short-term market movements.
In practice, this could mean that CDC schemes prioritize stability and downside protection, particularly for more mature schemes with older demographics. By adopting a more subtle and adaptive approach to investment strategy, CDC schemes can better manage the complexities of collective investment returns and deliver more resilient pension outcomes for their members.
As the Pensions Regulator begins to implement new rules for CDC schemes, trustees will need to carefully consider their investment approach to ensure they are delivering the best possible outcomes for members. The Pensions Regulator’s draft CDC rulebook was laid before parliament in April, with trustees potentially on the hook for “unclear or misleading” communications in relation to collective schemes.
TPT Retirement Solutions has already declared its intention to launch a CDC scheme, and the Pensions Regulator is in discussions with several possible market entrants ahead of the CDC rulebook coming into force in October. As the CDC market continues to evolve, it is likely that we will see a growing range of innovative investment strategies and approaches, all focused on delivering better pension outcomes for members.
The development of the CDC market will also be influenced by the interactions between trustees, regulators, and industry participants, as they work together to create a framework that supports the growth and maturity of collective defined contribution schemes. By doing so, they can help to create a more resilient and sustainable pension setting, better equipped to meet the needs of scheme members and support their retirement goals.
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