PensionsMay 31 2013

Pension lifestyle funds could put clients at risk

Search sponsored by
ByBob Campion

It is the received wisdom of most pension experts that it is sensible for investors to reduce risk in the run-up to retirement to protect their pot from any sudden falls in equity markets. That typically means increasing exposure to bonds and reducing equities, a process commonly adopted in ‘lifestyle’ funds. But that received wisdom is being questioned by two dynamics – the fear of a bubble in bond prices and the growing popularity of a new method of reducing risk called ‘target-date’ funds.

Many advisers are starting to question whether lifestyle funds are providing their clients with the protection they need. So should advisers be wary of lifestyle funds or recommending that their client take an alternative course of action?

The bubble effect

There has been talk of a bubble in bond prices for the past two years and that fear has grown recently. It is well known that prices of gilts have been driven up by quantitative easing (QE), which has seen the Bank of England buy £375bn of bonds – almost entirely gilts – accounting for almost one third of the total market. Combined with fluctuating fears of further bouts of economic crisis in the eurozone – which has seen increased demand for comparatively safe-haven assets such as gilts – the price of gilts has risen to an all-time high, with 10-year gilt yields in May falling below 1.7 per cent.

In February, Moody’s downgraded the UK, stripping the country of its prized AAA credit rating and Fitch followed suit in April. But on neither occasion was there a tangible dent in gilt prices – demand remained as high as ever despite significant and worsening problems with the UK’s national balance sheet. In April, Fitch cited “a weaker economic and fiscal outlook” following the IMF’s assessment that same week that the UK’s 2013 growth forecast should be cut to 0.7 per cent from 1 per cent.

Many experts now fear that unless the Bank of England expands QE, the price of gilts could tumble to a more realistic level that properly takes account of the real credit risk of the UK (see Graph 1). As equities continue to perform well there are also concerns of a ‘great rotation’ that could see investors selling out of bonds in favour of equities, causing further damage to bond prices.

Of course, neither of those fears may materialise. Investors may continue to be wary of equities and the BoE may indeed expand QE at the request of a government desperate to maintains its low borrowing costs.