On the go: Investors approaching retirement should look closely at their pension plans after a type of fund popular with pension holders saw its value crash in recent months, AJ Bell has warned.
An estimated 850,000 pension savers are invested in lifestyle funds, which have lost 13 per cent in two months, according to the company.
Most of these people will have been automatically invested in a default strategy that they signed up to many years ago, resulting in many of those invested in these plans not knowing about this issue.
“Many investors probably won’t be aware this is going on, but they could be sleepwalking into a bond market nightmare,” said Laith Khalaf, head of investment analysis at AJ Bell.
Lifestyle funds are invested in long-dated bonds, known as annuity-hedging funds, which invest with the aim of hedging annuity rate movements.
Switching into one of these funds as you approach retirement makes sense if you are going to buy an annuity with your pension, as any falls in annuity rates are made up for by rises in the value of the lifestyle fund.
However, since the pension freedoms were introduced in 2015, those of a pension age have the option to draw their pension in cash, or invest it to provide income.
Data from the Financial conduct Authority shows that in 2020 to 2021, 10 per cent of retiring investors bought an annuity.
AJ Bell estimated that the number of pension investors holding the funds by looking at the amount of money held in these strategies (£15bn, according to Morningstar) and the average defined contribution pension pot of 55 to 64-year-olds, which is £35,000, as well as the “simplifying assumption” that the typical pension saver in one of these funds will have 50 per cent of their pension pot invested.
Khalaf said: “That number doesn’t include people who might have a lifestyling programme sitting patiently in the background, waiting for them to hit 55 or 60 years of age, and then starting to shift them into annuity-hedging funds.”
The funds’ performance is determined by bond prices, which have enjoyed the rising tide of low interest rates since the pension freedoms were introduced in 2015.
However, since inflation began to rise and interest rates were hiked up by the Bank of England, bond prices have fallen, driving the value of lifestyle funds down.
“The logic behind lifestyling funds is that if they are falling in value, annuity rates will be rising to compensate. But that’s little comfort if you’re not going to buy an annuity with your pension,” Khalaf said.
He recommended investors approaching retirement should take a look “under the bonnet” of their pension plans to ensure they are making an informed judgment on whether an automatic switching is appropriate for them.
“If you are going to buy an annuity with your pension, you might consider sticking with a lifestyling strategy,” he said.
“But if you aren’t, then you should give careful consideration to picking another type of fund to see you through to retirement, and beyond.”
This article originally appeared on FTAdviser.com
