Long-term pension planning
Why the pensions investment strategy matters for all clients
Pensions planning is an integral part of any financial adviser's client work but it does not start when the client is about to retire.
Instead, it often starts the moment someone realises they need to start saving for their retirement, no matter how far away that event might be.
For many Britons, it begins when they become automatically enrolled into a workplace pension and their hard-earned money is put to work in a default investment strategy which, hopefully, will provide them with a decent pensions pot when they eventually reach 55 or decide to retire.
But how can advisers make sure the pension investment strategies underlying such schemes are suitable for long-term investing of this nature?
And what, for that matter, is 'long-term investing'?
This report, which includes a feature that qualifies for approximately 30 minutes' worth of CPD, aims to address some of these issues.
Income and flexibility vie for top spot when it comes to advised clients
Generating an income is still the most important factor for advisers' clients, but flexibility is also key.
Since the pensions freedoms and choice regime came into force in April 2015, people in the UK have had far more control and flexibility over how they take their pension pots at retirement age - or whether they remain invested into their 70s.
For financial advisers, this means clients have been asking far more questions about how to make their pension savings last longer into retirement, while giving them the ability to take an income from the pension pot.
In a snapshot poll carried out by FTAdviser via Twitter, advisers were asked what seems to be the most important consideration for clients as far as their pension savings were concerned.
Some 41 per cent of advisers responding to the poll cited income as the primary consideration, with flexibility coming in a close second, at 40 per cent.
Neil Adams, pensions and investment specialist for advisory firm Drewberry, commented that people need to understand the income has to last far longer than they might originally have expected, giving we are now living longer and in better health than ever before.
He said: "It's always important to invest for the point funds are required. You're no longer just investing until your retirement date, especially with the introduction of widely available income drawdown.
"Your investment horizon is now far longer. That means a pension could be a lifetime investment."
Moreover, the need for flexibility also should reflect the fact that the pension saving might need to be divvied up into different pockets or buckets for various purposes.
According to Mr Adams, these could include long-term care, inter-generational financial planning or simply providing an income that lasts for the duration of one's retirement.
However, the poll carried out by FTAdviser suggested that inter-generational planning, or passing on benefits to a spouse or offspring, was only a key factor for 10 per cent of advised clients.
However, as one respondent, adviser Darren Cooke of Red Circle Financial Planning pointed out, what is most important to clients often changes based on where they are in the investment journey.
He commented: "It depends if they are in the accumulation or decumulation phase."
CPD feature: How good pension planning turns pipe dreams into reality
A goal without a plan is just a wish – this is among the sayings of author Antoine de Saint-Exupéry, famous for his book ‘Le Petit Prince’.
People may wish for a good retirement: golfing, walking the dog or enjoying languorous days by a pool in the Costa del Sol, sipping on sangria, but failing to plan for that is just wishful thinking.
While people may consider retirement in itself to be exciting, they also need to consider how they will fund that retirement.
People need to be excited about their investment choices, their pension package and how they can start saving now to meet those long-term goals.
What is ‘long-term’?
For advisers, getting their individual or corporate clients to consider what long-term pension planning means is perhaps the first hurdle, as Neil Adams, pensions and investment expert from financial advisory firm Drewberry points out.
“You’re no longer just investing until your retirement date,” he says.
He has a point. The state pension age has been rising since 2010 when the former Coalition Government came into power, and will reach 66 by 2020.
This will rise further to 67 and then to 68 under existing legislation. However, in February this year, the Government Actuary announced a series of assumptions that suggested the state pension age will be 70 in the 2050s and 71 in the 2060s.
This means anyone aged 30 or below will not get their state pension until they are 70 years old. And those aged 20 or younger will have to wait until they are 71.
Millennials – those born in the 1980s – and the Tech Generation – those born in the 2000s – can expect to have to wait 40 to 50 years before they will get their state pension.
What this means is if they wish to retire before 70 or 71, they will need to make the most of their private and especially workplace pensions.
"It is always important to be thinking and planning for the long-term, be it 10, 20 or 30 years," says Claire Felgate, head of DC investments at BlackRock.
"We know people are living longer and pensions need to stay invested post-retirement to provide sufficient retirement income. However, time horizon and risk need to be factored in.
"For example, a 22-year old investor who cannot access their pension savings until their 55th birthday, will have a much longer investment horizon than an individual nearing retirement."
Accordingly, the government in 2012 created auto-enrolment pensions, which means every single workplace in the country, big or small, is now required by law to provide a workplace pension for staff.
The genius behind this idea – which according to latest figures from the Department for Work and Pensions has brought an additional 9m people into a workplace scheme – is people will be automatically enrolled into the scheme, and told they can opt out.
Because people are less likely to opt out than to opt in, thanks to a behavioural trait called ‘inertia’, opt-out rates are low, approximating at the moment to less than 10 per cent of all people who have been auto-enrolled.
For people in such schemes, long-term means at least up to the age of 55 when, thanks to the 2015 pension freedom and choice regime people are allowed to access their workplace pensions benefits flexibly.
This sounds like a good plan: invest in a workplace scheme until 55, take benefits in a form that best suits the individual, and then wait until whenever the state pension kicks in.
If it does still exist by then, of course.
The problem is, according to Paul Todd, director of investment development and delivery for the National Employment Savings Trust (Nest), the underlying investment proposition needs to be suitable for long-term pension saving.
For Mr Todd, this means the investment funds, strategy and asset allocation has to be robust. He explains: “Nest’s youngest member is 16 years old and around a third of our membership is under 30.
“That means their investment horizons can be up to 50 years. In this context, short-term results, such as monthly or quarterly returns, can be a distraction.
“If you’re looking at the short term, you might not recognise or manage risks that are likely to play out over longer time horizons, such as the impact of climate change.”
He believes it is “very important” to keep an eye on these long-term risks and opportunities for members, which is why Nest has advocated incorporating environmental, social and governance (ESG) factors as an integral part of the investment process.
For Mr Adams, the fact that someone can access their workplace pension savings at 55 does not mean this is the date at which someone’s long-term pension investment strategy finishes.
They might not want to retire at 55. Or they might want to take their pension assets and do something else, or go back into part-time work.
Or they might want to remain invested, particularly if they are in good health and expect to still be living la vida loca well into their 80s.
He says: “Your investment horizon is now far longer. This means a pension could be a lifetime investment.”
This is very pertinent for people whose only main pension pot will be their workplace pension – and with individuals now bearing the investment risk on their defined contribution pensions, they need to be confident the workplace scheme is investing their money appropriately.
Moreover, the majority of Britons in a workplace pension, according to research carried out by Hargreaves Lansdown, are invested in the scheme’s default fund.
This means the default funds have to work well or millions of people are at risk of a worse-than-expected retirement.
The key findings were:
• Overall, workplace pension default funds had a return, on average, of 10.2 per cent every year over the past five years.
• This is roughly 10 per cent more every year than opting to hold a pension in cash.
• Over this period, pension cash funds fell by 0.09 per cent every year.
• Default funds underperformed the average global equity fund by 3.72 per cent every year.
But long-term planning does not just depend on getting a default strategy right for auto-enrolment; it also means advisers working with clients to see what sort of use the pension pot might have in retirement.
“In fact”, Mr Adams continues, “the pension may be earmarked for a number of different purposes, such as retirement income, long-term care or intergenerational financial planning.”
This means that if there are a number of different goals, the adviser must have a plan in place to find different investment strategies that will help the client achieve all of these different goals.
So what sort of investment strategy or strategies should be put in place to help make those retirement goals and ambitions a realisable plan, rather than a pipe dream?
Aligning needs and interests
Carolyn Jones, head of pensions product at Fidelity International, says the traditional way of investing pension assets was to set a “lifestyling” approach during the accumulation phase.
This fell broadly into three categories – early life, mid life and pre-retirement – and, generally, this translated into investing in riskier assets (such as having a high equity allocation) in the early stages and gradually rolling down into the lower-risk assets “as the customer creeps towards retirement age”.
While this worked for a while, she says the pensions freedom and choice regime has made this traditional approach less helpful to follow when making long-term pension plans.
Ms Jones explains: “Pre-pension freedoms, strategies would target annuity purchase for the majority of savers, so the length of the investment period was known.
“But the introduction of pensions freedoms has shifted the wisdom and suitability of this approach, due to the increased uncertainty about when income will be drawn, and retirement planning has become much longer term.”
Mr Todd says there is no one “right way” to invest for the long term but it is absolutely the right thing to make sure that pension investment strategies align with the interests and needs of the membership.
He comments: “The introduction of auto enrolment has completely changed the profile of the ‘normal’ defined contribution (DC) pension scheme member.
“From a population of savers with other pension arrangements alongside their DC pot, many future auto enrolled members will rely almost entirely on their workplace DC pension in retirement.
“Investment strategies in the DC market need to adapt to the needs of this new market. That means thinking far more carefully about how to manage downside risk as well as seeking good long-term returns.”
Avoiding home bias
Part of long-term planning is also making sure that the underlying investment strategy is properly diversified, avoiding concentration risk.
This is particularly the case for workplace pension schemes, which have tended to like UK blue-chips over and above all else. For too long, according to Mr Todd, traditional DC pensions were often heavily invested in UK equities, our ‘home market’.
This home bias made sense in that the companies and stocks were well known and denominated in sterling, which made communicating the slings and arrows of outrageous stockmarket fortune easier.
However, this posed a serious problem, which Mr Todd outlines: “[Having such a home bias] meant their future wealth was tied up with the UK economy in more ways than one, through their jobs, their homes and their pensions.”
If one domino fell, all would come crashing down.
Mr Adams also highlights this point: “It’s true that people in the UK tend to have higher proportions of UK assets in their portfolios, but a well-diversified portfolio tends to avoid home bias.”
This means, says Mr Todd, it makes sense “to diversify away from UK equities to avoid this home bias, as well as benefit from the opportunities of global growth”.
For example, in Nest’s globally diversified equities portfolio, it has added asset classes such as emerging market debt and global high yield bonds, to further diversify members’ pots and seek different return opportunities uncorrelated to the UK economy.
Ms Felgate agrees it's important to avoid home bias, but cautions: "We're seeing clients reduce their strategic allocation to UK equities to avoid a heavy home country bias but this simultaneously raises the issue of currency hedging.
"As more overseas exposure comes into the portfolio, it is important to keep an eye on unintended currency risk."
But diversification for the sake of it is not the be-all and end all. Too much diversification simply adds cost and, while it might mitigate the risks of sector or geographical concentration, it also diminishes the potential returns.
As Matthew Phillips, managing director at Thomas Miller Investment, explains: "Diversification mitigates some of the effects of risk but too much can also dial the returns down.
"It will dilute the returns from a more concentrated portfolio and one will need to understand how the portfolio is going to achieve the returns."
Dan Kemp, chief investment officer for Morningstar, goes further: "By over-diversifying, a multi-asset solution will hug the benchmark and create unnecessary costs.”
Ms Jones says getting the diversification plan is partly down to suitability: how are the funds going to be used? When?
For example, if a client is going into drawdown, then rolling their fund down before age 55 into cash and bonds may no longer be suitable.
She says getting the investment strategy right is down to the financial adviser, matching specific segments of their client’s pension arrangements to clearly defined objectives, which reflect the following:
3) Tax efficiency.
“Financial advisers will need to be mindful of ensuring the customer is invested in an appropriately diversified range of assets, with a risk-return trade-off acceptable to the client and appropriate given their individual and overall financial situation,” she comments.
Mr Adams believes, crucially that clients should understand they must not chase returns over other factors, such as risk and suitability.
“They must be comfortable with the risk they’re taking, first of all. It’s also important they do not chase investment returns based on last year’s performance – strong performance last year does not necessarily equal the same this year.”
Simoney Kyriakou is content plus editor for FTAdviser