Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
It’s your money, not theirs. But the government is making no secret of wanting to use your pension to support the UK economy.
As he said in his Mansion House speech this week, chancellor Jeremy Hunt wants to increase returns for pensioners, improve outcomes for investors and unlock capital for UK growth businesses.
And so, among other things, the biggest defined contribution (DC) pension providers are being asked to redirect into UK private equity 5 per cent of the investments held in their default schemes.
As the name implies, these are the schemes into which your money goes unless you actively choose an alternative scheme, usually a higher-risk equity-rich offering. As most of the 18mn people saving into workplace DC pensions stick with the default option, Hunt’s plans affect millions.
But the plan is controversial, principally because it pushes even cautious pension savers into illiquid, high-risk investments. A stake in private equity is a holding in businesses that aren’t listed on the stock market, often early-stage companies or distressed firms.
Fine if you want this. If not, there are fortunately ways to avoid Hunt taking this gamble with your pension.
It’s most pressing if your pension is with Aviva, Scottish Widows, L&G, Aegon, Phoenix, Nest, Smart Pension, M&G or Mercer. This cosy group, holding two-thirds of our DC pensions, have formally signed up for the private equity injection to their default schemes under the so-called Mansion House Compact.
You might think the extra risks of having a small amount invested in private equity are not worrying. Most wealth managers advise having a bit of money invested in private equity for diversification away from equities and bonds.
But the big danger sign is the lack of caution around the Treasury’s announcement. In the financial services sector, any firm that promises a given investment return in any form of “financial promotion”, could be blasted by huge fines from the financial regulator. Yet here we have His Majesty’s Treasury blithely asserting that “reforms to defined contribution pension schemes will increase a typical earner’s pension pot by 12 per cent over the course of a career”. That’s will, not might or could.
As Tom Selby, head of retirement policy at AJ Bell, says: “It is, of course, possible that these assets will deliver greater returns than existing investments — but to suggest this with such certainty without mentioning the risks involved is dangerous.”
There are always additional risks when investing in illiquid investments that can’t be easily bought or sold. If a fund manager says: “I am going to add private equity to my equity fund and guarantee you an extra return,” the strategy won’t get off the ground. The regulators will stop it.
If you need proof of the risks of trying to enhance performance by adding PE, look no further than the demise of Neil Woodford’s Equity Income Fund, which ran into trouble with too many illiquid investments.
Unfortunately, trouble may be exactly what pensioners can expect from the government’s irksome pact with Britain’s biggest pension companies.
For starters, it remains a basic principle of investing that you shouldn’t over concentrate in any national market, so any exposure to private equity in your pension fund should be diversified around the world. That makes a 5 per cent allocation to UK unlisted companies unpalatable. You would need perhaps 10 times more in other markets, not least the US, for global balance.
Also, there are high fees involved, as the Treasury admits, which will have the effect of “lowering the overall return”. It specifies a 2 per cent per annum charge with a further 20 per cent performance fee for returns above 8 per cent.
That’s eye-watering, compared with the usual 0.5 per cent annual fee on a default fund, and more than most private equity investment trusts charge: 11 out of 17 trusts in the Association of Investment Companies’ private equity sector keep their ongoing charge well below 2 per cent.
If you don’t want the risk of private equity or the higher fees, you can opt out. But only by engaging properly in how your pension is managed.
Most workplace DC pension plans give members a choice over investment strategy. But almost all participants are in default funds. They barely look at the alternatives: these vary, but usually include growth funds that have 100 per cent in shares, green funds, and sometimes specialist funds such as for infrastructure.
You might think that default is best — after all, it’s what your employer has offered you, and what most of your colleagues are using. It might also feel “safer” than picking “self-select” choices.
But perhaps you simply have not thought hard enough about it. There have always been reasons why the default pension option might not be the best option for your circumstances. The chancellor’s private equity plans introduce another reason to look again at your options.
Remember, insurance company default fund performance is highly variable. A May 2023 report from Corporate Adviser found the Aon Managed Core Retirement Pathways default fund delivered the highest cumulative return in the five years to 31 December 22, at 53.5 per cent. This compared with 3.6 per cent delivered to savers in the poorest performer over five years — the default managed by Now: Pensions, a provider.
It’s also possible that the “one size fits all” level of risk in the default fund might not fit you. Perhaps you are in your twenties and able to tolerate higher levels of risk to give your pension the chance to grow faster over the next 40 years.
Plus, many default funds automatically switch your investments into less risky assets as you near retirement age. Some start doing this 20 years in advance — it can give you a less bumpy ride but it also means you could lose out on growth potential.
Also, performance and risk aside, you may prefer a sustainable or responsible investment option, with many providers now offering these as standard.
Prime responsibility for your pension outcome lies with you, but this type of government interference with pensions shows that employers need to do more to educate employees.
We should avoid the temptation of asking the pension providers to help with this advice: the industry has too many vested interests and too much inclination to go along with government wishes. This needs to be impartial information clearly provided at the point of delivery.
Just as you have to do health and safety training when you start work, you should be given a tour around your pension options before you sign up to the scheme — even if it’s just knowing the provider, the fees, and the investment choice. Then, if the right investment option isn’t there, complain to the trustees. Or, if your employer allows it, ask for a transfer out to a self-invested personal pension, where you make your own investment choices.
Once this is all in place, when the chancellor comes along looking for soft targets, our pensions will be less of a sitting duck.
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