Second lockdown presents added uncertainty for pension schemes

The Institute for Fiscal Studies published its Green Budget 2020 in October showing a range of possible short and medium-term growth scenarios. 

While it expects economic output to have rebounded by 17.5 per cent quarter on quarter in the third quarter this year — still less than the 19.8 per cent drop in the second quarter — the report stated that this recovery is unlikely to last.

“Virus fears and weak associated demand are instead likely to come to the fore,” the report read. 

If the economic outlook deteriorates further, then that's going to start showing up in some of the values of assets in pension portfolios

David Sturrock, IFS

“In our central scenario, 2020 Q4 GDP will remain 6.2 per cent below 2019 Q4 levels, a larger fall than the 5.9 per cent peak-to-trough fall during the financial crisis. Even by the end of 2024, we think GDP will still be only 1.9 per cent above 2019 Q4 (and 4.7 per cent below its 2016–19 trend).”

The IFS’s current forecast shows what is called a ‘Nike tick’ shaped recovery, made up of a sudden contraction followed by a recovery that tapers off at the end. But its pessimistic scenario shows a ‘wonky W’ shaped recovery, in which a second, smaller contraction occurs midway through the recovery, before beginning to improve, albeit slowly, from 2021.

‘Nasty shocks along the way’

LCP partner Paul Gibney told Pensions Expert that a W-shaped recovery, wonky or not, would eventually reach the same destination as a V-shaped recovery, but not as quickly and with “some nasty shocks along the way”.

“We've had, quite clearly, the down leg of the first part of the W,” he said. We've had some element of recovery, both here in Europe and elsewhere, and it does seem right now as though things are faltering quite significantly — for the obvious reasons in relation to coronavirus and how governments are reacting to that.” 

The recovery is likely to be boosted in the near term by “some pretty significant stimulus” injected in the US, regardless of who wins the election, which could boost confidence globally, Mr Gibney added.

And “while things may get a bit hairy for some schemes”, the continued willingness on the part of governments and central banks to provide demand-side stimulus could mitigate the damage, he said.

DC savers stay the course

David Sturrock, senior research economist at the IFS, told Pensions Expert that much will depend on the ongoing response to the pandemic, as lockdown policies in particular impact on the economic outlook, and if it “deteriorates further, then that’s going to start showing up in some of the values of assets in pension portfolios”.

“What the potentially worsening economic outlook means is that we might not be expecting there to be the kind of rapid recovery in equity values to where they might have been in the absence of the crisis,” he said.

It is possible for individual savers in defined contribution schemes to compensate for some of the decline in assets and equities by adjusting the amount they draw down each month. 

But Mr Sturrock pointed to the IFS’s most recent English Longitudinal Study of Ageing, published in September. 

It showed that “42 per cent of those with an adjustable income said they believe their pension pot is now smaller, [and] among those who said their pension pot value was now lower, only 19 per cent said they had adjusted the amount of income they were drawing (10 per cent had reduced the income they were drawing and 9 per cent had stopped withdrawing an income)”.

However, he suggested that inaction is often the result of inertia, rather than “a conscious decision to stay the course”.

As for how individual savers within DC schemes will have been affected, Julian Jessop, independent economist and economics fellow at the Institute of Economic Affairs, noted that people invested in good life-path funds — where allocation to risk decreases as they approach retirement — are likely to have emerged relatively unscathed.

“If your money has been managed well, meaning either in a nicely diversified portfolio or, as you approach retirement, a lot of it has been shifted into fixed income assets anyway, then I think you should be OK,” Mr Jessop said.

K-shaped recovery

A K-shaped recovery describes a scenario following a recession under which different sectors of the economy recover at different rates, times or magnitudes, creating a split or dual-track recovery rather than a linear upward curve.

Something analogous happens within sectors, and is playing out within pensions already, Mr Jessop said.

Pensions Expert has reported on a number of occasions that the impact of the government’s lockdown policy is being felt especially keenly by pension schemes that were already in relatively poor financial shape before the pandemic struck.

Mr Jessop explained that, for investors, “if you invested in fixed income you’ve done pretty well, or if you’ve invested in some alternatives like gold you’ve had a lot of protection”.

If an individual invested in equities, on the other hand, “it’s been a real rollercoaster”, and how they fared depends on whether they held their nerve, he said.

“If you’ve had a panic in the early stages and sold your equities as they were falling, then you’ve locked in some pretty massive losses.”

The IFS’s ELSA report demonstrated a similar branching effect at the individual level, with older workers faring significantly worse than retired workers.

The report found that “fluctuations in stock markets have hit those with wealth held in risky assets”, and so a larger proportion (41 per cent) of retirees than older workers (34 per cent).

However, when asked to rate their own financial position, retirees were more sanguine than older workers, despite having taken a bigger stock market hit.

“Nearly 90 per cent of retired respondents were not at all or not very worried about their future financial situation, but among those in work, more than one-third were at least somewhat worried,” the report concluded. 

Kate Smith, head of public affairs at Aegon, noted that should the widely publicised fears of a surge in unemployment be realised, the impact on older savers in DC schemes in particular could be severe.

“People losing their jobs in the workplace means they not only lose their salary but they lose the employer contribution,” she said. 

“They will have less ability to save in the pension. Also, as a result of the economic uncertainty we’ve seen that some employers might be looking to cut back contribution rates to the auto-enrolment minimum, because many employers actually pay more than that. And employees, because of the uncertainty, might lower their contributions as well.”

However, Mr Jessop was more sanguine about the prospect of unemployment, arguing that “unemployment probably will rise over the next few months but nowhere near as far as some people fear”.

“I think [there] may be a maximum of another 0.5m net job losses — this keeps unemployment below 7 per cent,” he said.

“I understand all the pessimism at the moment, but equally I think we might be pleasantly surprised about how well the economy weathers the next few months.”