Brexit shock wave hits pension investors

Pen­sions may not have been at the front of many people’s minds when enter­ing the polling booths on June 23, but the Brex­it ref­er­en­dum result is like­ly to have a last­ing impact on pen­sion schemes for years to come.

The imme­di­ate after­math saw ster­ling plunge and mar­kets fall, tak­ing a toll on investors’ sav­ings. But the longer-term effect may be just as sig­nif­i­cant.

While the impact of the EU ref­er­en­dum on mar­kets may have trustees and pen­sion scheme mem­bers seek­ing out the lat­est per­for­mance of their invest­ments, there have been impli­ca­tions for the pen­sion indus­try as a whole.

Ongoing annuity rates

For some scheme mem­bers close to retire­ment, the ref­er­en­dum result has had a major impact on their choic­es as annu­ity rates fell sharply post-Brex­it.

“The cost of buy­ing an annu­ity has got more expen­sive for DC [defined con­tri­bu­tion] mem­bers close to retire­ment,” says Joan­na Sharples, invest­ment prin­ci­pal at con­sul­tan­cy Aon Hewitt. “Post-Brex­it it will be real­ly inter­est­ing to see how this trans­lates across dif­fer­ent annu­ity providers; how­ev­er, quotes from one provider sug­gest that annu­ities are about 4 per cent more expen­sive, which is quite mean­ing­ful.”

Trustees and scheme mem­bers may need to get used to new mar­ket con­di­tions and a longer-term, low-growth envi­ron­ment

Yet, the intro­duc­tion of pen­sion free­doms in April 2015 may have offered mem­bers a wider range of choic­es to mit­i­gate the ref­er­en­dum result. Data from insur­er and long-term invest­ments indus­try body ABI sug­gests that annu­ity-buy­ing activ­i­ty has fall­en away since the intro­duc­tion of pen­sion free­doms, with income draw­down prod­ucts enjoy­ing a cor­re­spond­ing rise in take-up.

Pen­sion free­doms are like­ly to have a bear­ing on the type of invest­ment deci­sions that are made in the post-ref­er­en­dum peri­od, open­ing up oppor­tu­ni­ties to mem­bers they may not have enjoyed in pre­vi­ous years.

“Pen­sions free­doms have put exist­ing default life cycles into ques­tion and there has been a size­able shift from annu­ities to draw­down,” says Maya Bhan­dari, fund man­ag­er and direc­tor of the mul­ti-asset allo­ca­tion team at glob­al asset man­ag­er Thread­nee­dle Invest­ments.

“We are now able to start on a blank sheet of paper and ask two cru­cial ques­tions: what do peo­ple want and what do they need? Ulti­mate­ly what peo­ple need is rel­a­tive­ly sim­ple tools and solu­tions that help them iden­ti­fy, man­age or mit­i­gate the three risks they face in retire­ment – finan­cial mar­ket volatil­i­ty, real returns and longevi­ty.”

Brexit-proofing pensions

In light of the uncer­tain­ty brought about by Brex­it, more scheme mem­bers might choose to take greater con­trol over their pen­sion sav­ings. So-called Brex­it-proof­ing pen­sions may appeal to many investors, although they will face a num­ber of chal­lenges.

“Pen­sions free­doms are still rel­a­tive­ly new, which means peo­ple are cur­rent­ly faced with very mixed mes­sages about how best to act in times of mar­ket uncer­tain­ty,” says Cather­ine McKen­na, glob­al head of pen­sions at law firm Squire Pat­ton Bog­gs.

“We already know that one of the biggest trends of 2015 was the rise of the pen­sions scam and indi­vid­u­als should be care­ful to guard against Brex­it uncer­tain­ty being used as a trig­ger to cash out their fund if this isn’t right for them.”

While the ref­er­en­dum deci­sion and sub­se­quent gov­ern­ment shake-up may have ram­i­fi­ca­tions for pen­sion free­doms, any changes to exist­ing pen­sion leg­is­la­tion are unlike­ly to emerge in the imme­di­ate after­math of the leave vote.

“In terms of leg­is­la­tion on pen­sion free­doms, it is unlike­ly that the gov­ern­ment will look to repeal what is already in place but, irre­spec­tive of Brex­it, there may be fur­ther reg­u­la­tion to impose bet­ter val­ue by reduc­ing charges and prod­uct design for free­doms to devel­op,” says Ms McKen­na.

Tak­ing greater con­trol of invest­ment deci­sions in the cur­rent envi­ron­ment may pose a num­ber of chal­lenges, how­ev­er, par­tic­u­lar­ly with the increased lev­el of volatil­i­ty in mar­kets seen in the wake of the result.

“From an invest­ment per­spec­tive, Brex­it has cre­at­ed much greater uncer­tain­ty and volatil­i­ty in the mar­kets, and made them more than usu­al­ly reac­tive to polit­i­cal events,” says James Red­grave, Euro­pean retire­ment direc­tor at asset man­age­ment research and con­sul­tan­cy provider Strate­gic Insight.

“The FTSE 100 fell 500 points on June 24 – below 6,000 – and savers enti­tled to access their pots were advised to wait to take cash, if they could afford to do so.

“These mar­kets have set­tled large­ly on the quick and order­ly tran­si­tion to a new gov­ern­ment, after David Cameron’s res­ig­na­tion, and will have been buoyed by the Bank of England’s con­clu­sion that an inter­est rate cut is not eco­nom­i­cal­ly nec­es­sary.”

James Horn­i­man, port­fo­lio man­ag­er at invest­ment man­ag­er James Ham­bro & Part­ners, says: “Investors have to posi­tion port­fo­lios sen­si­bly with insur­ance against all out­comes. Ster­ling is like­ly to come under con­tin­ued pres­sure and there will almost cer­tain­ly be volatil­i­ty.

“As long as val­u­a­tions are not unrea­son­able, it makes sense to weight any UK equi­ty hold­ings towards busi­ness­es with strong US-dol­lar earn­ings rather than those reliant on raw mate­ri­als from over­seas – com­pa­nies forced by adverse cur­ren­cy move­ments to pay extra for essen­tial inputs from else­where in the world could see their prof­its real­ly squeezed.”

The impact of home bias is like­ly to take a toll on some pen­sion invest­ments as fund man­agers have warned of being too exposed to the UK mar­ket. Under nor­mal cir­cum­stances high­er UK equi­ties expo­sure may be expect­ed, but the uncer­tain­ty intro­duced by the ref­er­en­dum result in local mar­kets may harm returns.

Long term plans

Experts note that many trustees have already begun diver­si­fy­ing port­fo­lios to mit­i­gate geog­ra­phy and asset risk. The finan­cial cri­sis remains a fresh mem­o­ry for many trustees who will have tak­en a more robust approach to diver­si­fi­ca­tion in recent years.

“There’s been a gen­er­al trend over the past decade of mov­ing away from fund man­ag­er man­dates that are very spe­cif­ic and nar­row to wider man­dates, such as glob­al equi­ties or mul­ti-asset,” says Dan Mikul­skis, head of defined ben­e­fit (DB) pen­sions at Lon­don-based invest­ment con­sul­tan­cy Red­ing­ton. “Trustees mak­ing fund man­ag­er changes will be more moti­vat­ed to move to less con­strained man­dates.”

Yet, trustees and scheme mem­bers may need to get used to new mar­ket con­di­tions and a longer-term, low-growth envi­ron­ment.

“Fol­low­ing Brex­it, the con­ver­sa­tions we’ve been hav­ing with investors are sim­i­lar to those we’ve been hav­ing since the start of the year,” says Ana Har­ris, head of equi­ty port­fo­lio strate­gists for Europe, the Mid­dle East and Africa at invest­ment man­ag­er State Street Glob­al Advi­sors.

“We haven’t seen a big shift in mon­ey or allo­ca­tions, but there has been some realign­ment. What we are advis­ing clients is not to be reac­tive to short-term volatil­i­ty in the mar­ket and make sure plans for long-term invest­ment are in place.”

“In the short term, it is like­ly there will be quite a lot of volatil­i­ty in the mar­ket and mem­bers need to be aware of that,” says Aon Hewitt’s Ms Sharples. “One option is that every­body car­ries on as before with no change to strat­e­gy; how­ev­er, the oth­er option is trustees think about whether there are bet­ter ways of invest­ing and oppor­tu­ni­ties to pro­vide more diver­si­fi­ca­tion or add val­ue.

“For peo­ple who are a bit fur­ther away from retire­ment, the key is what kind of returns can they expect going for­ward? Returns are like­ly to be low­er than before because of pres­sure on the econ­o­my and low­er growth expec­ta­tions. To help off­set this, mem­bers have the option of pay­ing more in or retir­ing lat­er, or a com­bi­na­tion of both.”

There are oppor­tu­ni­ties for trustees to har­ness inno­va­tion and con­sid­er new invest­ment port­fo­lios

With fur­ther details yet to emerge about what access the UK will have to EU mar­kets and restric­tions on free move­ment, the full impact of Brex­it remains to be seen.

“Unfor­tu­nate­ly, no one has a crys­tal ball. Even the best invest­ment strate­gies may be adverse­ly affect­ed by cur­rent mar­ket volatil­i­ty, but this is not to say mem­bers, trustees or fund man­agers should begin to pan­ic,” says Ms McKen­na of Squire Pat­ton Bog­gs.

“There is lit­tle doubt that Britain leav­ing the EU will mean there are chal­lenges ahead for invest­ment funds; how­ev­er, there are also oppor­tu­ni­ties for trustees to har­ness inno­va­tion and con­sid­er new invest­ment port­fo­lios.”

RISK MANAGEMENT POST-BREXIT

A greater focus on risk man­age­ment has emerged as trustees attempt to mit­i­gate some of the impact of June’s EU ref­er­en­dum result on pen­sion schemes.

While atten­tion may be focused on mar­kets, pen­sion scheme trustees will also have to con­sid­er a num­ber of oth­er risk man­age­ment issues brought about by Brex­it.

“I don’t think pen­sions should be focus­ing too much on whether ster­ling is going up or down, or whether one asset man­ag­er is per­form­ing,” says Dan Mikul­skis, head of defined ben­e­fit pen­sions at invest­ment con­sul­tan­cy Red­ing­ton.

“Get­ting a risk man­age­ment frame­work set up is sen­si­ble. With a sim­ple frame­work to go by, there will be oppor­tu­ni­ties in a volatile mar­ket envi­ron­ment, but it’s always best left to the asset man­ag­er.”

Mr Mikul­skis says reg­u­lar review­ing of invest­ment deci­sions and per­for­mance is like­ly to depend on the size of the scheme and the gov­er­nance arrange­ments, adding that trustees may be put under pres­sure to com­mu­ni­cate more fre­quent­ly and effec­tive­ly with scheme mem­bers.

Despite low inter­est rates, trustees should take care over pos­si­ble lia­bil­i­ty hedg­ing, while also recog­nis­ing the chal­lenges pre­sent­ed by a low-yield envi­ron­ment for bonds.

“We don’t think that just because rates are low they can’t fall fur­ther,” he says. “A lot of trustees that haven’t hedged will feel like they’ve missed the boat, but there are still risks on the down side.”