Different strategies are appropriate to different retirement funds, and although many fund managers pay lip-service to this theory, in practice they often ignore it.
According to a senior actuary, who asked not to be named because he was expressing personal views, the objectives of a defined benefit and a defined contribution fund are different and that should be reflected in different investment philosophies.
A defined benefit fund pays benefits to an employee on retirement based on a formula of the employee's length of service and earnings at or near retirement. The employee pays a fixed contribution towards the pension and the employer a varying contribution to balance the cost of the benefit. The employer is vulnerable to the effects of inflation on the future salaries of employees.
"That should lead to an emphasis, in defined benefit funds, on growth assets that will benefit from inflation," the actuary said. "For example, ordinary shares and fixed property investments would be suitable for this type of fund."
However, in the case of a defined contribution fund, the benefit paid on retirement is the accumulation of the fixed amounts paid by the employee and the employer. The fund manager's objective is to build up the fund to give the best possible lump sum.
This fund should still be invested in growth assets, such as equities and fixed property, but because the members bear the brunt of poor performance in a market crash, the fund manager should be more conservative. The type of equities in defined contribution funds should be blue chips, rather than emerging companies, and there could be some gilts holdings too.
In defined contribution funds it is increasingly becoming the practice for members to receive annual statements showing how the fund is performing. If they receive a statement one year showing good returns, and the following year, after a correction in the market, are shown a lower return, they could panic.
"The sheer transparency of defined contribution funds and the move towards full communication should also exert an influence in moving assets towards a more conservative approach," the actuary suggested.
However, Rael Gordon, MD of Alexander Forbes Asset Consultants, disagreed.
"I would recommend fund managers select assets, whether for a defined benefit or a defined contribution fund, in line with the risk and return profile agreed with the trustees. The factors determining the risk and return of a fund would not only be whether it was a defined benefit or defined contribution fund. Other factors include the age of the members and whether there is a surplus or deficit in the fund."
Generally an adviser, such as Alexander Forbes, would determine these criteria with the fund's trustees and this would determine the assets selected.
Asset allocation is specific to each fund, and it is not possible to be prescriptive, Gordon said. Investments in small companies as well as in blue chip shares could be appropriate for a defined benefit or a defined contribution fund. However, if the trustees did not specify guidelines, the the fund manager would have the discretion to choose suitable assets.
Andrew McGinn, head of group benefits at Fedsure, said because the members of a defined contribution fund are individually carrying the risk of the fund's performance, the liability should be segmented in line with individual member's risk profiles.
Younger members have a higher risk tolerance than older members because they have more time before retirement and can afford to weather the ups and downs in the equity market. As members of a defined contribution scheme approached retirement, they should take a more cautious approach, moving most of their investments into gilts and cash or a scheme with a capital guarantee.
A problem with membership of an employment scheme is that employees cannot always choose when they retire. If they turn 60 or 65 in a year when equity markets are performing poorly, the fund's rules may not permit continued membership or it may be inconvenient for the member's employers to continue employing the member until the market has improved.
In practice, members of a defined contribution fund rarely have a number of investment options, because the fund is run as an entity. But in other countries, McGinn says, "lifestyle portfolios" are available which have different strategies for different age groups. South African companies are likely to follow this trend in the near future.
The growing practice of issuing members of defined contribution schemes with regular statements showing what their lump sum is likely to be worth when they retire is misleading. The projection is usually based on the fund returning two or three percent above inflation each year. It tends to show a telephone-sized rand amount which looks substantial now but, taking inflation into account, is less impressive.
A better idea would be to show an inflation-adjusted amount, or, as some underwriters do, the percentage of the member's current salary that he or she will receive on retirement.
The problems associated with many employees moving from defined benefit to defined contribution schemes will only become evident in the next few years. But one problem is almost certainly going to be the need for more counselling.
For fund management companies, being answerable to a thousand or more employees, each of whom has liability for his or her own retirement fund, is a very different matter from dealing with a single employer, usually represented by the company's financial director, who looks at the pension fund liability from one perspective.
A constantly churning board of employee-represented trustees will afford little shelter from hurricanes of confusion and complaint.