WHAT NEXT FOR PENSIONS?
Many UK pension funds may need to change the mix of assets they invest in as they emerge from the recent volatility caused by the government’s mini-budget.
Coutts’ Chief Investment Officer Alan Higgins says the events of the last two weeks may also lead to a limit on the amount pension funds can borrow which, on the positive side, could reduce material risk.
He adds that the government’s recent reversal, which saw new Chancellor Jeremy Hunt undo most of the tax cuts previously announced, had put pensions back on a surer footing. And the Bank of England’s temporary bond buying programme last week had helped.
Which pensions were affected by the mini-budget?
The fallout from previous Chancellor Kwasi Kwarteng’s proposed measures mainly concerned ‘defined benefit’ pension schemes, which provide a set outcome usually based on your time with an employer and final salary.
Most people, however, hold ‘defined contribution’ schemes, which were much less affected. With these schemes, the amount you get depends on how much you put in and how the underlying investments perform.
Alan says, “The Bank of England intervened to halt a selling spiral in the bond market and help the defined benefit – ‘final salary’ – pension system.
“But pension funds still had to sell off a lot of their assets to meet their obligations to their investment banks, so their asset allocation may need reviewing. They are likely now too weighted towards private markets and may need to buy back into more liquid assets – those that are in demand and relatively secure such as corporate bonds and, ironically, more government bonds.”
What about a Coutts pension?
A Coutts Invest pension is defined contribution only, and you decide the broad mix of assets to put the money into. You choose one of five funds to match your preferred approach, from almost entirely bonds to almost entirely stocks, with a range of different combinations in between.
Within the funds’ bond exposure there is now greater diversification which should help insulate them from idiosyncratic UK events. We recently moved away from investing in just gilts to a basket of bonds from the G7 countries.
How were defined benefit schemes impacted?
Pensions tend to buy a lot of UK government bonds – or ‘gilts’ – because they’re seen as relatively safe. But bonds were hit hard by the mini-budget as investor confidence in the UK dropped.
Investors told the Treasury: “If we’re going to lend you money, we’re going to need a higher rate of interest to make it worthwhile.” That hits the value of existing gilts and can lead to a sell-off – which can be bad for pension funds using derivatives, and therefore leverage, to maintain exposure.
Alan says it posed particular challenges for defined benefit funds, partly because they tend to hold a lot of gilts, but also because of something called ‘liability-driven investment (LDI)’.
“Many relevant pension funds work with their investment banks to buy bonds as a future (in fact a swap), which means they don’t have to put up all the money in advance – that’s LDI,” he says. “But if the underlying bond makes a loss, the bank comes knocking asking for the extra cash, which can cause problems for the fund.”
When investing, such as through a pension, past performance should not be taken as a guide to future performance. The final value of your pension fund will depend primarily on how much has been paid in and how well the fund's investments have performed. The value of investments can fall as well as rise, and you may not get back the full amount you invest.
To have a Coutts Invest pension, you must be over the age of 18 and under the age of 75 and be a UK resident for tax purposes. You cannot make contributions if you are a US citizen or US Green Card holder. You cannot access your pension benefits before the age of 55. Eligible pensions only. Eligibility criteria, fees and charges apply.