Sarah Coles, Senior Personal Finance Analyst: “People who are members of defined benefit pension schemes do not need to worry – this is a problem for your employer to resolve, not you. In defined benefit schemes it is the employer who is ultimately responsible to make up any shortfall in the funding of the scheme, not you. However, this issue acts as a good prompt for you to review your retirement savings.
If you have a defined contribution pot, and retirement is a long way away, there’s not necessarily any need to make any changes. Default funds (which is where your money ends up if you don’t make a decision where to invest) in the ‘growth phase’ have fallen year to date, but that’s to be expected. On average the fall is around 12%. Over the long term they are still delivering for members, up around 15% on average over the last 5 years. You should check the default fund meets your needs, but there’s no need to make any sudden moves.
For those whose retirement is closer whose money is in a defined contribution pension, the key issue will be in the de-risking element and particularly the ‘old style’ de-risking, which often moved to 75% in gilts and bonds to hedge moves in annuity rates and 25% cash for a lump sum. These ‘old style’ de-risking approaches which will be prevalent in many old personal and workplace pensions (those set up before 2015 in particular) have fallen on average by 38% year to date. This is clearly terrifying for someone approaching retirement where we are naturally more risk averse.
If someone was due to buy an annuity, then whilst they may understandably be unnerved by a big fall in value their income has held up reasonably well. As these ‘old style’ de-risking policies have fallen, so annuity rates have improved. Annuity rates have improved by 45% from the start of the year. Back then £100,000 would have bought a 65-year-old a non-increasing annual income of £4,950 (rate was 4.95%). Today it would be able to buy an income of around £7,190 (rate is 7.19%).
If you were planning to use drawdown to access the money, the good news is that you won’t need it all on day one, so you can leave it invested and grow over the decades of your retirement. However, you will need to revisit your investment strategy to find the right balance of assets for your needs.
What bond changes mean for pensions
Defined Benefit pension funds have faced difficulties partly because of something known as leveraged liability driven investing (Leveraged LDI). The liabilities of a scheme are essentially the incomes they have promised to pay to those who are currently part of the scheme. They depend on how big those incomes are, how long people live and if the scheme is inflation-linked, they depend on inflation too. When they’re measured, liabilities in the future also have to be tracked back to their cost today, and for that, the schemes use interest rates.
Pension schemes have to try and match these liabilities, which they do by investing in bonds and gilts. Leveraged LDI uses financial instruments to magnify the impact, essentially borrowing to invest. This means they can use less of the pot to insure against falling interest rates and so use the rest of the pot to invest for more growth.
Leveraged LDI uses swaps and other derivatives for this magnification effect. When these deals are done, the pension companies only have to put up some of the cash to back them. They also agree that if the deal goes against them, e.g. due to gilt prices falling, they’ll put up more cash.
As interest rates have risen, gilts prices have fallen and so they have already had to put up more cash, but interest rates increased slowly enough to give them time to sell other assets sensibly to cover it. The almost overnight collapse of gilt values gave them no time. They were forced to sell gilts to cover the extra cost, depressing the price of gilts even more, and creating a vicious circle. The Bank of England stepped in to put a stop to it but has warned pension companies that they need to find an alternative solution before it stops buying gilts on Friday.”
Market reaction
Sophie Lund-Yates, Equity Analyst, Hargreaves Lansdown: “The pound has not taken kindly to news that the Bank of England is planning to suspend its emergency intervention in the bond markets. While sterling isn’t quite at its yearly-lows, it’s not far off – hovering at around £1.11 against the dollar. The FTSE100 is nonplussed, with minimal moves arising in the aftermath of the announcement.
Part of the reason for this stems from the realisation that markets must be allowed to function freely, without external intervention. At some point, the bond market needs to find its own feet. It’s not impossible for the Bank of England to delay its exit from its bond-buying plans, but Andrew Bailey, and the market, know that this would simply be kicking the can down the road.
The anxiety surrounding this topic is understandably palpable and next week will bring a lot of scrutiny. The one thing that won’t be resolved, no matter what the Bank of England does next, is the surging uncertainty surrounding government economic policy, which lit the match under the bond market in the first instance. Tax cut funding, recession fears and inflation projections remain the tallest, perhaps currently insurmountable, orders of the day.”
|
