Market volatility prompts concerns over pension lifestyling funds

Industry experts have suggested that lifestyling approaches may need to evolve in light of the impact of recent market volatility, with industry analysis revealing that the average annuity-hedging fund has fallen by 38 per cent so far in 2022.

The analysis from AJ Bell also found that the average annuity-hedging fund, which holds £9bn of pension savers’ assets, has fallen by 5 per cent since the mini-Budget, warning that the "calamity" of the sharp drop in annuity hedging funds is twofold.

"Pension savers are shifted into these funds just as they are about to retire, so have little or no time to rebuild their pension savings after sustaining losses," explained AJ Bell head of investment analysis, Laith Khalaf.

"What’s more, many of them probably won’t even know the switch to an annuity hedging fund is happening."

Khalaf also clarified that while there will be some recompense for pension savers opting for an annuity in retirement, as annuity rates have "shot up", only around one in 10 pension savers now buys an annuity.

“The obsolete nature of these lifestyling strategies since the pension freedoms has been disguised by the flattering effect of ultra-loose monetary policy," Khalaf added, clarifying however, that monetary policy has "rapidly changed direction and the latest round of fiscal policy has added further fuel to the bond fire".

In addition to this, Khalaf noted that while institutional investors have benefited from the Bank of England's intervention in the gilt market, those invested in annuity-hedging funds aren’t in line for any bailout, and will "simply have to wear their losses".

The current circumstance has prompted broader concerns around lifestyling funds, as Khalaf explained that the situation has "really exposed the folly of relying on defaults which put in place an automatic investment strategy many years, or even decades, before that strategy starts to be executed".

"During this time there can clearly be changes in capital markets, consumer behaviour or regulation, which can render such strategies obsolete and potentially dangerous," he continued.

However, speaking to Pensions Age, Now: Pensions head of DC platform, David Bird, stressed that while savers may be "unnerved" by a fall in their pension value, they should avoid a "knee-jerk reaction" to the recent short-term volatility.

Instead, Bird suggested that the nuance for today’s lifecycles is that not all members will retire at their forecast retirement age, buy an annuity, and take their tax-free cash.

"An up-to-date approach, much more reflective of the environment today, would be to consider how members are expected to draw their benefits when they come to retire," he suggested.

“For those with smaller accounts that are likely to take their full pension in cash this may require a different approach to pension savings than those with bigger accounts that traditionally take their pension in the form of a drawdown."

Independent financial advisers have also raised concerns around lifestyling approaches, however, as Values to Vision Financial planning director, Nick Lincoln, warned that the most cautious portfolios have "turned out to be the riskiest, not just in terms of short-term and unusual volatility but for perpetually carrying the real risk that is the long-term destruction of purchasing power through the insidious effect of inflation".

"This destruction is what will see many retirees outliving their money," he argued. "Lifestyling strategies deserve their own box, six feet under."

Adding to this, Trusted Financial Advice chartered financial adviser, Darren Bilkey, argued that “lifestealing” may be a more accurate description for the strategy for many investors in the current market.

“Without sufficient interest in their pension planning, many are sleepwalking into more defensive assets too early, which in turn damages their potential returns,” he added.

Permanent Wealth Partners co-founder, Adam Walkom, also warned that pension companies could risk “sleepwalking into another PPI-style nightmare with the insistence to push unsuspecting investors into lifestyle or target date funds”.

This concern was shared by Wildcat Law co-founder, David Robinson, who suggested that many financial service companies, both advice and insurance alike, will be speaking to their legal teams and bracing for a wave of mis-selling complaints.

He continued: “Lifestyling is one of the key culprits for many who have taken significant falls. To their credit the large pension providers have moved away from it for exactly these reasons but there are thousands of people in legacy pensions that still use this approach.

"The majority will be those who have not sought financial advice and have been re-assured by the fund fact sheets they have received.

“They will not have read or understood the short section of wording regarding interest rate risk and so are left facing potentially life-changing falls in their pension funds. So yes, lifestyling is obsolete, but the real villain is the risk rating system that, at best, is confusing and at worst downright misleading."

Despite these concerns, AJ Bell noted that the Financial Conduct Authority (FCA) is currently consulting on introducing default funds for individual pension schemes, and has said that it would expect providers to build lifestyling into the design of such funds to de-risk pension portfolios in the approach to retirement.

Khalaf commented: "It’s very unlikely that providers building such a de-risking strategy today would use annuity-hedging funds, given the fact so few people are buying an annuity with their pension pot.

"But that doesn’t mean that contemporary strategies will be future proof against the changes in pensions and markets we will inevitably see in the 2030s, 2040s and beyond, when these default choices will start to kick in for today’s younger savers.

“It might instead be preferable to confront the issue of pension apathy head on through communication and engagement, rather than trying to sidestep it with default strategies that are undoubtedly well-intentioned, but still often found wanting.

"Those who suggest that ordinary folks will never be able to get their heads around pension saving and investment might reflect on the fact that millions of people take on hundreds of thousands of pounds worth of housing debt, without a default mortgage product in sight.”

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