Pensions freedoms and investment companies

David Prosser takes a look at income options in retirement.

Not long to go now: with just 10 days remaining of the 2014-15 financial year, pensions freedom day is almost upon us. From 6 April, anyone over the age of 55 will have far greater freedom to access their pension pots and make withdrawals from them. That will enable many more people to opt out of buying an annuity income to provide them with a pension in favour of dipping direct into their savings one way or another.

Financial advisers, naturally, are well aware of the potential dangers of pensions freedom – even those savers who avoid the fraudsters and cowboys who are now reportedly circling the sector may find themselves in difficulty if the investment decisions they make don’t go to plan. Many advisers are therefore looking for financial products that may help them service clients’ more sophisticated retirement planning needs.

In that context, the changes we are beginning to see in the investment mandates and policies of certain investment companies are significant.

Take this month’s announcement from Invesco Perpetual UK Smaller Companies, which is more than doubling its annual dividend as it moves towards a strategy of focusing on both income and capital growth (previously growth was the sole focus). Though Invesco Perpetual has not said as much, the driver for this change appears to be clear: with pension savers looking for new ways to generate income in retirement, rather than lock into an annuity, assets that deliver income will be in demand.

Invesco Perpetual is not the first investment company to spot the emerging opportunity here. The old British Assets investment trust, now under new management and rebranded as the BlackRock Income Strategies Trust, switched to a much more income-oriented investment objective earlier this year. Analysts expect more trusts to follow suit.

The evidence at Invesco Perpetual is that there is clear demand for the updated strategy. The discount at which the trust’s shares trade relative to the value of its underlying assets has fallen by almost 5 percentage points during the course of March.

Now income-generating investment companies have been to the fore for several years now, as investors and their advisers struggle to find yield in the low interest rate environment, so the Invesco Perpetual shift was always likely to increase interest interest.

However, such demand is a temporary phenomenon – when rates finally begin to rise again, income-producing assets may not look so competitive. By contrast, the pension freedoms are for life. Each new generation of pension savers reaching an age at which they want draw down on their savings is going to face the same question: do I put up with rock-bottom annuity rates, or do I use an income drawdown approach to generate income direct from my pension pot?

There is no one-size-fits-all answer to this question. But financial advisers will need to find new vehicles for servicing those clients who do decide they favour income drawdown.

Investment companies can certainly be part of the solution. Their ability to keep back some income in good years in order to smooth out disappointments in others is potentially very valuable to savers who require consistent income in retirement. So too is their ability to draw down on capital in order to finance income distributions, as long as investors have agreed.

For these reasons, Invesco Perpetual UK Smaller Companies is unlikely to be the last investment company tempted to revisit its dividend policy and investment mandate.