How to de­velop an ef­fec­tive de­fault

Finweek English Edition - - COLLECTIVE INSIGHT - At Stan­lib. is strat­egy devel­op­ment man­ager

By Farai Muronda

To ini­ti­ate op­ti­mal de­fault choices, trus­tees first need to un­der­stand the con­text of their mem­ber base, which will dif­fer based on dif­fer­ent in­dus­tries as well as de­mo­graphic pro­files. Some in­dus­tries have a high turnover of staff, while in other in­dus­tries em­ploy­ees are re­tained for a long pe­riod, of­ten for an en­tire life­time.

Trus­tees also need to con­sider the evo­lu­tion of a mem­ber through the fund and what that would look like. What in­vest­ment choices should be avail­able to the mem­ber at what time of their life or sav­ings life-cy­cle?

Once a trustee has de­vel­oped a ro­bust pic­ture of the mem­ber base and the con­text of that mem­ber base, they ideally want to put them into “buck­ets” ac­cord­ing to a hand­ful of cat­e­gories us­ing fac­tors such as risk pro­file or de­sired re­turn out­come.


There have been many be­havioural eco­nomic stud­ies show­ing that when peo­ple are faced with choice, they tend to de­lay de­ci­sion-mak­ing for as long as pos­si­ble, to their own detri­ment.

By in­tro­duc­ing de­fault port­fo­lios, trus­tees are able to re­move the “de­ci­sion bur­den” from mem­bers and au­to­mat­i­cally as­sign them to an in­vest­ment. This is not to say that a mem­ber’s choice is taken away – mem­bers still have the right to ex­er­cise their own choice. But for the ma­jor­ity of mem­bers who are un­cer­tain what choice to make, de­fault port­fo­lios are a guide based on well­re­searched pa­ram­e­ters.


To aid mem­bers in un­der­stand­ing de­fault port­fo­lios avail­able to them, the in­dus­try needs to start us­ing a dif­fer­ent lan­guage.

For ex­am­ple, an av­er­age per­son would re­late to a port­fo­lio that pre­serves their money rather than a “low volatil­ity port­fo­lio”. It’s about say­ing the same thing but re­ally un­der­stand­ing the con­text of the mem­ber and en­sur­ing you can con­nect with them in a way that they un­der­stand.


Risk pro­fil­ing plays an im­por­tant role in achiev­ing op­ti­mal de­fault op­tions for mem­bers. How­ever, trus­tees should be care­ful of re­ly­ing solely on this. Risk pro­fil­ing looks at how much risk tol­er­ance a mem­ber has and places them in the right bucket for that level of risk tol­er­ance. In ad­di­tion to this, trus­tees should give a sig­nif­i­cant amount of weight to the in­vest­ment out­come that an in­vestor is seek­ing.

A risk pro­file may in­di­cate that a mem­ber is an ag­gres­sive in­vestor, but no­body likes to lose money – not even ag­gres­sive in­vestors. Sim­i­larly, a risk pro­file may clas­sify a mem­ber as con­ser­va­tive. How­ever, ev­ery in­vest­ment needs a cer­tain level of risk in or­der to earn a re­turn. A mem­ber can­not choose to be so con­ser­va­tive that they don’t earn a re­turn that keeps up with in­fla­tion.

Trus­tees should com­bine risk pro­fil­ing with a mech­a­nism that con­sid­ers the re­turn out­come that a mem­ber wants or needs.

One ex­am­ple of a de­fault in­vest­ment prod­uct that ac­com­mo­dates the need for a chang­ing risk pro­file is called a “tar­get date port­fo­lio” (a vari­a­tion on a life-stage port­fo­lio). If a mem­ber is tar­get­ing re­tire­ment in 30 years’ time, the port­fo­lio ad­justs ex­po­sures to risky as­sets ac­cord­ing to how far away from re­tire­ment the mem­ber is.

As a mem­ber gets closer to re­tire­ment, the port­fo­lio au­to­mat­i­cally re­bal­ances to in­clude more con­ser­va­tive and less volatile as­sets. The idea is that a mem­ber near­ing re­tire­ment doesn’t want to risk los­ing their base cap­i­tal – they are nat­u­rally en­ter­ing a pe­riod of preser­va­tion and con­ser­vatism. How­ever, a mem­ber that is 30 or 40 years from re­tire­ment should be in a growth and ac­cu­mu­la­tion phase and can, there­fore, have ex­po­sure to more volatile and high earn­ing asset classes.

trus­tees should

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