Be careful with your nest egg

Financial advisers are recommending retirees put their money into active funds. Natalie Stanton explains why there are better places to invest.

George Osborne's pensions freedom rules have given retirees much more control over how they invest their nest eggs. However, financial advisers are "overwhelmingly" recommending they invest in actively managed funds instead of cheaper passive alternatives, says the Financial Times.

About 95% of cash that has moved into drawdown retirement products (where you draw an income from your pension pot, which remains invested, rather than swapping it for a guaranteed income via an annuity) has gone into actively managed funds, according to two unrelated studies conducted by insurer Zurich and broker Hargreaves Lansdown.

That's unfortunate. The selling point of active funds is that their managers are able to pick and choose investments, with the aim of beating the market, rather than merely tracking it. That's why they charge more than passive funds, which merely aim to track a market, using an automated strategy.

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The trouble is as you'll know well if you're a regular reader of MoneyWeek that active fund managers often fall short of expectations. A recent report by S&P Dow Jones index demonstrated that, over ten years, a staggering 86% of European active funds failed to beat their benchmark. An even more shocking 98.9% of US-focused equity funds underperformed, as did 97.8% of global equity funds.

As the FT puts it, this raises questions about whether advisers are "serving their clients' interests appropriately". It also suggests that if you're using a financial adviser when you move into drawdown, you should be checking exactly what your money is being funnelled into and why.

Always remember that the only factor you can have absolute control over when you invest is what that investment costs you. Higher costs mean a manager has to generate higher returns before you get to see any profit. And given the odds, as a rule of thumb we'd opt for cheap passive funds over expensive active ones unless there is a very good reason to do otherwise.

The defined-benefit pension schemes of FTSE 100 companies now hold 59% of their assets £315bn in bonds, according to JLT Employee Benefits. Those with particularly high proportions include Direct Line and Rolls-Royce, which hold 96% and 92% of assets in bonds respectively. Property giant British Land is at the other end of the spectrum, holding only 2% of its assets in bonds.

Meanwhile, the overall pension deficit across FTSE 100 schemes went up by £7bn to £73bn. As JLT Employee Benefits director Charles Cowling put it, higher bond holdings may be the result of a desire to take less risk. However, "greater bond holdings are likely to put more pressure on companies to fund pension-scheme deficits through cash contributions".

Natalie joined MoneyWeek in March 2015. Prior to that she worked as a reporter for The Lawyer, and a researcher/writer for legal careers publication the Chambers Student Guide. 

She has an undergraduate degree in Politics with Media from the University of East Anglia, and a Master’s degree in International Conflict Studies from King’s College, London.