As the decade closes , it’s a time to look back as well as forward. For the vast majority of us, our financial health depends on valuations of assets the price of which we cannot directly control. We may build an extension on our house but we are making a lifestyle decision and the utility of that investment is less in the realisable gain on the property as in the space it gives us and our family.
As regards the investments within our pension pots, ISA pots or general savings accounts, we are entirely dependent on how the markets fared and we do not control those markets.
If we look at how the markets have performed in recent times (I’m looking at Morningstar sector averages) we see what we would expect, that riskier assets have produced better returns, and that more pedestrian assets have returned less.
This is particularly the case in 2019 when the gap between the average return on shares and cash has been enormous. Not to put too fine a point on it, if you weren’t in equities over the past five years, you have missed out.
Some will already be interpreting this blog as advice to invest over one , three and five years in shares. Which it isn’t. It is however pointing to a reality which many DC trustees, pension providers and IGCs will have to face – when reporting to members.
That reality is this.
Diversified strategies that intend to smooth the returns delivered to savers have fared considerably worse than simpler strategies investing purely in shares. Disinvestment into cash from anything has been a disastrous strategy over the past five years and all kinds of de-risking – whether through diversification or disinvesting , have reduced savers’ outcomes.
For all the talk of volatile markets, returns for equity investors have been consistently higher than for bond investors and just about anything that aimed to provide a cash- plus type of return is providing pretty sickly outcomes.
While the leverage supplied by Liability Driven Investment , (where the bond return is magnified by what is essentially borrowing), has worked out for huge investors like the PPF, the private saver has not got as much out of saving into corporate or government bonds as by investing purely in shares , absolute return and money market funds have produced very little real return and when Morningstar measure blended portfolios, the lower the allocation to real assets , the lower the return.
And yet if you are over 50, the chances are your pension savings were moving in 2019 away from equities into lower returning investment strategies. And if I were to show you the impact of that by way of AgeWage scores, you would see your scores reducing over the year, because the average pension pot in the UK (the benchmark) has been investing predominately in equities and has not been “de-risking”.
De-risking carries its own risks
One of the arguments against giving people information on how their pension pot has done, both in absolute and relative returns, is that it gives rise to discontent.
If the result of measuring a saver against other savers is to show that the saver has fared less well , then there is a risk that saver is going to turn round to the person who made decisions on his or her behalf and ask “why?”
Collectively, the cohort of defaulted pension savers between 50 and 65 will almost all have paid dearly last year for de-risking.
For some, that price may have been worth paying, if you were cashing out your pension, that your pension had been moved into a money market fund, may have reduced the chances of you being caught by a short term drop in the market.
But these cases are exceptional. Most of us have paid twice for de-risking, firstly in the cost of moving from fund to fund (through the hidden spreads of the “single swinging price”) and secondly through the under-performance of bonds and other diversifiers – especially cash.
This year, de-risking has been a risky strategy for pension savers and few have benefited in terms of what their pot is worth at the end of this year.
Most people over 50 would have been better off outside a lifestyle strategy.
We need to seriously review how lifestyle works
In 2020 , we will see a new kind of life styling with multiple options available to savers – known as investment pathways. These pathways could take you to a number of destinations, including “cash-out”, “annuity purchase”, “drawdown” or just rolling on as an investor with no plan for the pension pot.
Working out how these investment pathways work is the easy bit, but the saver needs to start thinking , well before exercising his or her choice, which pathway to take and how fast to walk along it. In technical terms , we all need to tell our pension provider when we want our money and how we want it paid.
I am very far from clear how people will go about making those choices. Ideally it would be face to face with an adviser who is genuinely independent. In practice it may be a decision taken by an algorithm based on what little your provider knows about you.
But there is a big problem in this, and it brings me back to where this blog started. We are taking decisions on other people’s money – blind. We do not know what most people want to do (neither do they), we don’t know how the market is going to treat them and we have no idea what the consequences of those decisions might be on the people we are trying to help.
2019 was not a year to hedge your bets.
People who stayed invested in shares last year did well and those who de-risked, lost out.
Old Mutual run a sentiment indicator for financial advisors who want to know the views of the fund managers.
This is how they saw the world in January 2019
and this is now they see the world now
and this is what has actually happened
If you want to, you can see which managers had a lucky crystal ball and which didn’t.
In 2020, we may see things turn the other way round. but there is no more certainty that you will be better off de-risking than there is consensus among the managers as to whether the equity bull run will continue.
But one thing we do know, there is no point in cashing-out on a long-term strategy to hedge against supposed short term volatility.
Pay attention to your pension
I would advise any DC saver over the age of 50 to find out what is likely to be happening to their pension pot next year and to ask the question, “how have I done so far”/
I can help you with the second question – just mail firstname.lastname@example.org and we’ll get you an AgeWage score showing how you’ve done against the ordinary saver.
But I can’t help you with the first question, because the only person who knows what you are likely to be doing with your money over the next decade – is you.
Pay attention to your pension!