Why investment is critical to CDC
This content is AI generated, click here to find out more about Transpose™.
For terms of use click here.
In this CDC investment series, we explore the investment-specific aspects of a CDC pension scheme, from early strategic decision making to a framework for success, and what we can learn from other investors.
70% of your expected CDC pension is driven by investment strategy; only 30% from contributions. That’s why investment matters so much to CDC.
CDC is not nirvana. We take a rational look and analyse the sources of value.In future Chapters we’ll dive into the issues, showcase frameworks for assessing risk in a CDC world, analyse the impact of different investment strategies and the learn lessons from history and abroad.
Why can CDC offer better outcomes?
Because it can invest in growth assets for much longer
Why can CDC sustain growth exposure?
CDC is structurally better able to remain invested in growth assets because it:
- pools longevity risk across members
- shares investment and sequencing risk collectively
- avoids the need for individuals to self-insure through early de-risking
By contrast:
- DB schemes are typically focused on securing promises already made, limiting appetite for growth.
- DC schemes often de-risk as retirement approaches — precisely when pots are largest.
Investment strategy impacts everything(!) for a CDC scheme
Subscribe to our thinking
Get relevant insights, leading perspectives and event invitations delivered right to your inbox.
Get started to select your preferences.
Why you should think about CDC investment strategy sooner rather than later
-
Take two investment portfolios which experience returns of (1) 7.0% and (2) 7.3% pa, respectively, over 60 years. By the end of that time, portfolio (2) outgrows (1) by c20%.
So, a big increase can be achieved by minor differences in investment allocations which do not materially impact risk. Specifics of investment strategy matter for expected member outcomes.
-
Do you secure inflation protection by buying assets with explicit linkage (and lower yields), or take your chances on a looser link but higher yielding investments?
Have you assessed how inflation linkage could break down in (e.g.) high inflationary scenarios? This will impact how you advertise a CDC scheme to members.
-
CDC is most likely to “go wrong” on the terms converting contributions into pension, and increases in pension provided. If these are inconsistent with the investment strategy, the risk of generations inadvertently cross-subsidising each other increases.
More closely aligning these terms and investment strategy can drive better trustee decisions.
An implementation perspective
Whether you are a provider or individual scheme considering launching a CDC structure, these issues are key to consider up front, and are all impacted by investment strategy.
Reputation
Expected return will impact expected outcomes, but potentially more importantly, risk will drive the likelihood of benefit cuts. In a competitive market, avoiding cuts (especially in early years) could prove a big advantage.
Resource
Using existing building blocks is an obvious way to manage resource, but will they maximise risk-adjusted returns and can they smoothly support large-scale asset deployment?
Additional needs will be influenced by investment approach but will also influence feasibility.
Costs
All the issues in this article will impact costs and the approach to charge cap compliance. It is better to understand these implications sooner rather than later.
