My home phone rings endlessly in the daytime. There is never a person on the other end. Instead it is a silence, or more often a recorded voice telling me that she has “tried to contact me” many times to get me to press various buttons to receive my “refund” for PPI (payment protection insurance); get a new free boiler from “the government”; sort out compensation for my last car accident; or claim my “high-street shopping vouchers”.
I’m amazed the PPI mis-selling scandal is still on the go. I’m always interested to get boiler-room calls — I get more than a few flogging rubbishy unlisted firms in any one sector (rare earths, biotech etc), and it is worth wondering how near a crash said sector is. And it is fascinating to see how dodgy firms manage to manipulate taxpayer-financed renewable-energy related subsidies into entirely new business models. It might not be morally sound — at all — but it does at least keep one’s faith in British entrepreneurialism alive.
I also answer because it helps me think about where the next mis-selling scandal might hit. What, I wonder to myself, as I hang up on each PPI call, are consumers being sold that they feel they haven’t a choice about, that they don’t quite understand and that might turn out to be very expensive. The answer, I suspect, might be something to do with pensions (again).
Over the next few years, every employer in the land, however small, poor or admin-allergic, will have to set up a pension scheme for their employees over 22 and earning more than £10,000 a year (yes, that does include nannies). That means getting the right systems in place, but it also means choosing a fund of some kind for the money to go into.
Some employees will have firm views on investing and markets, and want to choose their own investments. Most won’t — and as the government guidelines put it, they “can’t be required to” either. So the employer has to settle on a default fund — as thousands of employers running defined contribution pension schemes for their staff already have.
I worry about that, because while there is no single definition of what a default fund should be. Some 80% of those who have defined contribution pensions are in them, and rather too many of them look like a very bad choice. The clue is in an innocuous sounding word — “lifestyling”. The vast majority of pension scheme providers asked say that their default fund — the one the vast majority of their members end up in — is a lifestyle fund of some kind.
Lifestyle funds invest in assets perceived as risky early in an investor’s saving lifetime, in an attempt to build capital (the accumulation phase), but then to shift into assets perceived as less risky as the saver approaches retirement (retirement itself being the decumulation phase). So the closer you get to needing your money, the less chance there is supposed to be that you might lose any. Given the state-mandated responsibilities of those choosing default funds (that the ‘retirement profile’ of the investor is taken into account as is the ‘balance between risk and potential for growth’), I suspect you will think that sounds pretty good.
It isn’t, for two reasons. First, since ‘pensions freedom’, everyone has a different retirement profile. Some people want a cash lump sum on retirement; some want a long-term income generated by their capital; and some still want an annuity. So there is no such thing as a fund that can be ‘one-size fits all’. And second, because even if a lifestyle fund was a ‘one-size fits all’ fund, the pensions industry has a pretty out-of-date attitude about what is and what isn’t risky. It considers equities to be high-risk (but high return) and bonds to be low-risk (but low return).
Look at the funds offered by Nest Pensions and you will see this in action. Those who are retiring in 2040 have about 30% of their money in bonds of one type or another. Those retiring in 2022 (still seven years away) are already not far from 45% (although they tell me some “rebalancing” is now underway to make the final allocation 40%).
The problem with this is that, over the past 30 years, the dynamic between bonds and equities has shifted: as interest rates have fallen and fallen again, bonds have returned rather more than equities (7.5% versus 8.3% in the US, according to James Ferguson of Macrostrategy Partners) in a huge bull market that has now become a bubble, and an illiquid one at that. Invest today and it is rising interest rates, and hence falling bond prices, that you need to worry about: hold too many bonds and your capital just isn’t safe.
Even two years ago, that might not have mattered too much. Before pensions freedom, most people bought annuities with their pension pot on the day of retirement. Annuity rates are based on bond yields, so if bond prices fell (and yields rose), you might have been irritated to lose capital, but you at least made it back in better annuity payments. It matters now: those of us who aren’t intending to buy annuities (most of us) don’t care about annuity rates — we care about protecting our capital so that we can eke a long-term return out of it.
We don’t want to be getting out of equities and into bonds as we approach retirement. So the last thing we want as we approach retirement is a traditional lifestyle fund — yet this is the thing most people are getting.
There’s good news here: you don’t have to stay in the default. Check yours today, and if you don’t like it, shift your money. It’s also worth noting that some providers are beginning to get the message.
Now Pensions’ default fund has started moving investors into cash rather than bonds ten years before they retire, with a view to preserving the capital for those who want lump sums, for example. And Birthstar Target Funds (a relatively new arrival to the UK market) is trying to take a different view of what risk is: its fund for those retiring in the next few years, while bond heavy, still has some 24% in international equities. But as a whole, the industry isn’t moving anywhere fast enough to reflect changes in both the market and in our legislation.
Government guidelines state that default funds have to be reviewed every three years to check that their design and performance is still suitable for their investors. When we look back in a decade, after the great bond crash (which is bound to happen between now and then), I wonder if we will all think that today’s definition of ‘suitable’ was anywhere near good enough. I strongly suspect not. I am expecting my home phone to start ringing all over again.
• This article was first published in the Financial Times.