Are pension savers sleepwalking into disaster?

Millions of savers opened their pensions years ago, when the pension system looked very different. Assuming they would one day turn their savings into income through an annuity purchase, they signed up for lifestyle funds that automatically moved their cash into bonds and other supposedly safe assets in the run up to that moment.

It’s a strategy that has backfired: the bond market collapse of the last year has sent many lifestyle funds into a tailspin; and most savers are opting for income drawdown solutions rather than annuities.

The bottom line is that people now need a different approach as they transition from the accumulation phase of pension savings to a period of decumulation. The premise of income drawdown is that you leave your savings invested even after you start withdrawing from them; the fund can then continue to grow, and money not spent can be passed on to heirs. In which case, a wholesale shift into bonds makes no sense, but savers may still want to take a step back from aggressively risky investment strategies.

One obvious contender for this “compromise strategy” is the Flexible Investment sector of the investment company industry. These funds – there are about 25 of them – invest with a much less constrained mandate than most vehicles. Managers typically have the freedom to mix up asset classes as they see fit in the prevailing market climate. At times of stress they can move money into more defensive assets, offering protection; they can also be more aggressive when they are feeling more confident.

In practice, managers make use of a wide variety of assets. Bonds and equities are certainly mainstays of many Flexible Investment funds, but real estate, infrastructure, commodities and private equity are all common holdings too. Some funds also invest in more esoteric holdings.

What you’re getting with many of these vehicles is a one-stop-shop for diversification; rather than having to use a bunch of different funds to secure exposure to different asset classes and markets, you get that through just one vehicle. Plus the manager makes all the decisions about the details of that exposure, adjusting over time as market conditions dictate.

The overarching goal for several of these Flexible Investment funds is capital preservation. They aim to keep savers in the black, even after the effects of inflation. In the current economic climate, that feels particularly welcome, but it is a goal that pension savers should have at the forefront of their minds at all times when they’re in an income drawdown arrangement.

For advisers looking for convenient and straightforward solutions for clients in drawdown, the Flexible Investment sector therefore has much to offer. It takes the work out of diversification and outsources the decision-making process to a professional investment manager.

That’s not to absolve the adviser of all responsibility, of course. Indeed, the choice of fund is particularly crucial here. Investors in Flexible Investment funds are taking a big leap of faith – they’re betting on the manager’s ability to read the market outlook accurately so that they invest accordingly. Missteps will often be expensive.

Still, for advisers and savers who now need to turn their back on the lifestyle approach to pension investment, the sector has much to offer. At the very least, it offers responsiveness and relevance – rather than money automatically moving from one home to another, there is a manager making proactive decisions about the right options at any given time.