Why your clients' pensions are at risk

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Why your clients' pensions are at risk

People need to be aware of the double whammy of inflation and market risk when it comes to investing for the long-term, Tony Stenning has warned.

The chief executive of Catley Lakeman, parent company of derivative-based investment solutions specialist Atlantic House Investments, said the rise of defined contribution pensions and the transfer of risk from pension scheme sponsor to individual scheme member has made it vital for people to think more long-term about their savings. 

Stenning, who is also non-executive chairman of The Investing and Saving Alliance, warned that people needed to be putting their money to work in funds that not only mitigated the effect of inflation and risk, but also helped secure a decent income in retirement.

In reality sequencing risk starts occurring way before drawdown.

The problem is, as he told FTAdviser In Focus, too many people in the accumulation stages are either sitting on a lot of cash savings, or trying to time the markets to chase returns - and they cannot afford to take that sort of investment risk when they are in retirement.

Nor can they rely on the government paying out a state pension - the responsibility for securing a long-term financial future is on the investor.

FTAdviser: Many surveys have shown that people have saved more than ever before over the past 18 months. What should people know about putting that money to work for their pension?

Tony Stenning: Putting your cash to work for your longer-term wealth has never been more important. Interest rates are virtually zero; some countries’ rates are less than zero and you have to pay the banks to keep your money. And with inflation clearly starting to increase, that all adds up. 

FTA: Do people still not think long-term enough when it comes to their savings?

TS: It’s about the longevity of people’s thinking in terms of their portfolios. That old adage - ‘time in the market, not timing the market’.

We talk about it a lot but it is so important. Timing when to get in and out of investments can also materially affect people’s wealth if you get it wrong. 

FTA: Are people relying too much on the state pension?

TS: Many years ago, you may remember, I wrote a blog on how to rethink pensions. At the moment we don’t have a pay-as-you-go system; it’s all based on current taxpayers. 

My idea at the time was that the government could put £2,000 into an investment account for every child at birth - call it the State Pension Account. Based on current birth rates, this would be £1.6bn, then over 70 years that would have paid a pension equivalent to today’s triple lock through the power of compounding. 

Of course, for the government of today that’s a £1.6bn cost. 

FTA: Doesn’t this also mean the investor will bear the investment risk ourselves, when the current state pension risk is borne by the government itself?

TS: The idea was that the money would create, in effect, a sovereign wealth fund that would invest in all the sort of inflation-proof type of investments that you see in institutional pension schemes. 

So this would include infrastructure, healthcare - everything we would need to rely on in later life - and would help make investing more tangible. 

You could also secure the liquidity premium, create a sovereign wealth fund to build our hospitals, wind farms and future energy.

The challenge is that you add £1.6bn to the existing pensions cheques the government is writing to existing pensioners and so you are pushing up a hill. 

FTA: Atlantic House uses derivatives and you have described the fund structure being ‘maths’. Can maths really help with long-term wealth preservation and creation?

TS: Yes, we’re using derivatives and it can feel impenetrable to some people but as long as you remove as much of the credit risk as you can in a portfolio, and use various swaps you can get an income stream that is paid back to the investor. 

For example, with the Defined Return Fund, it means you can achieve the long returns of equities even in a fund that is primarily invested in gilts.

You still obviously have equity risk from the global, liquid derivatives that generate the return on capital, but you get it in a much more predictable way and that ‘timing the market’ element has been removed. 

But as always, inflation is the silent killer.

If you don’t take leverage and you remove credit risk, and you mitigate counterparty risk by spreading the risk across 13 or 14 counterparties, you can minimise the risk of something going wrong. 

It’s predictable, it’s maths and it is not subject to a fund manager having an existential crisis or delaying investing into something whereby they miss significant upside.

In every other environment, except another Great Depression where markets fall by more than 30 per cent and stay there for more than six years, this will provide approximately 7 per cent a year, net. 

FTA: What if you get to 55 or 60 and a six-year market fall does happen? How would this affect pensioners in terms of sequencing risk?

TS: Predictability of returns is important in both the accumulation and the decumulation stages. 

Investing is risky. But a fund manager needs to ensure that they are not taking undue risks with people’s capital. 

Consider someone using this fund to build a pension pot.

Now imagine they were on the point of retiring in May 2020 and seeing all the dividends being cut and volatility rising through the roof; providing the fund’s counterparties are robust and the money is sitting with the government in gilts, they would have seen the fund not just back to where it was, but up 6 per cent. 

I would argue we are diversifying the sources of risk and the sources of return, while trying to achieve the long-term equity risk. 

FTAdviser: So can the average pension investor mitigate sequencing risk by staying invested, not drawing down, not panicking when markets wobble?

TS: That sequencing risk is all on you as an investor.

We call it sequencing risk when people are in drawdown, but in reality sequencing risk starts occurring way before drawdown. Because if markets fall dramatically before you retire, you can’t retire - or you can but you will have a very different retirement outcome than before.

That sequencing risk, that worry as an investor, is all on you. Now 4 per cent seems to be a number used as a rule of thumb to draw down from your pot - unless you have enough other savings to use up first and allow your pot to accumulate and use it as a last resort.

But as always, inflation is the silent killer. People do not realise their pensions and savings are at risk because prices are going up. So as a society, as an industry we could do better to help encourage people to make their savings work for them.

simoney.kyriakou@ft.com