Pensions may not have been at the front of many people’s minds when entering the polling booths on June 23, but the Brexit referendum result is likely to have a lasting impact on pension schemes for years to come.
The immediate aftermath saw sterling plunge and markets fall, taking a toll on investors’ savings. But the longer-term effect may be just as significant.
While the impact of the EU referendum on markets may have trustees and pension scheme members seeking out the latest performance of their investments, there have been implications for the pension industry as a whole.
Ongoing annuity rates
For some scheme members close to retirement, the referendum result has had a major impact on their choices as annuity rates fell sharply post-Brexit.
“The cost of buying an annuity has got more expensive for DC [defined contribution] members close to retirement,” says Joanna Sharples, investment principal at consultancy Aon Hewitt. “Post-Brexit it will be really interesting to see how this translates across different annuity providers; however, quotes from one provider suggest that annuities are about 4 per cent more expensive, which is quite meaningful.”
Trustees and scheme members may need to get used to new market conditions and a longer-term, low-growth environment
Yet, the introduction of pension freedoms in April 2015 may have offered members a wider range of choices to mitigate the referendum result. Data from insurer and long-term investments industry body ABI suggests that annuity-buying activity has fallen away since the introduction of pension freedoms, with income drawdown products enjoying a corresponding rise in take-up.
Pension freedoms are likely to have a bearing on the type of investment decisions that are made in the post-referendum period, opening up opportunities to members they may not have enjoyed in previous years.
“Pensions freedoms have put existing default life cycles into question and there has been a sizeable shift from annuities to drawdown,” says Maya Bhandari, fund manager and director of the multi-asset allocation team at global asset manager Threadneedle Investments.
“We are now able to start on a blank sheet of paper and ask two crucial questions: what do people want and what do they need? Ultimately what people need is relatively simple tools and solutions that help them identify, manage or mitigate the three risks they face in retirement – financial market volatility, real returns and longevity.”
In light of the uncertainty brought about by Brexit, more scheme members might choose to take greater control over their pension savings. So-called Brexit-proofing pensions may appeal to many investors, although they will face a number of challenges.
“Pensions freedoms are still relatively new, which means people are currently faced with very mixed messages about how best to act in times of market uncertainty,” says Catherine McKenna, global head of pensions at law firm Squire Patton Boggs.
“We already know that one of the biggest trends of 2015 was the rise of the pensions scam and individuals should be careful to guard against Brexit uncertainty being used as a trigger to cash out their fund if this isn’t right for them.”
While the referendum decision and subsequent government shake-up may have ramifications for pension freedoms, any changes to existing pension legislation are unlikely to emerge in the immediate aftermath of the leave vote.
“In terms of legislation on pension freedoms, it is unlikely that the government will look to repeal what is already in place but, irrespective of Brexit, there may be further regulation to impose better value by reducing charges and product design for freedoms to develop,” says Ms McKenna.
Taking greater control of investment decisions in the current environment may pose a number of challenges, however, particularly with the increased level of volatility in markets seen in the wake of the result.
“From an investment perspective, Brexit has created much greater uncertainty and volatility in the markets, and made them more than usually reactive to political events,” says James Redgrave, European retirement director at asset management research and consultancy provider Strategic Insight.
“The FTSE 100 fell 500 points on June 24 – below 6,000 – and savers entitled to access their pots were advised to wait to take cash, if they could afford to do so.
“These markets have settled largely on the quick and orderly transition to a new government, after David Cameron’s resignation, and will have been buoyed by the Bank of England’s conclusion that an interest rate cut is not economically necessary.”
James Horniman, portfolio manager at investment manager James Hambro & Partners, says: “Investors have to position portfolios sensibly with insurance against all outcomes. Sterling is likely to come under continued pressure and there will almost certainly be volatility.
“As long as valuations are not unreasonable, it makes sense to weight any UK equity holdings towards businesses with strong US-dollar earnings rather than those reliant on raw materials from overseas – companies forced by adverse currency movements to pay extra for essential inputs from elsewhere in the world could see their profits really squeezed.”
The impact of home bias is likely to take a toll on some pension investments as fund managers have warned of being too exposed to the UK market. Under normal circumstances higher UK equities exposure may be expected, but the uncertainty introduced by the referendum result in local markets may harm returns.
Long term plans
Experts note that many trustees have already begun diversifying portfolios to mitigate geography and asset risk. The financial crisis remains a fresh memory for many trustees who will have taken a more robust approach to diversification in recent years.
“There’s been a general trend over the past decade of moving away from fund manager mandates that are very specific and narrow to wider mandates, such as global equities or multi-asset,” says Dan Mikulskis, head of defined benefit (DB) pensions at London-based investment consultancy Redington. “Trustees making fund manager changes will be more motivated to move to less constrained mandates.”
Yet, trustees and scheme members may need to get used to new market conditions and a longer-term, low-growth environment.
“Following Brexit, the conversations we’ve been having with investors are similar to those we’ve been having since the start of the year,” says Ana Harris, head of equity portfolio strategists for Europe, the Middle East and Africa at investment manager State Street Global Advisors.
“We haven’t seen a big shift in money or allocations, but there has been some realignment. What we are advising clients is not to be reactive to short-term volatility in the market and make sure plans for long-term investment are in place.”
“In the short term, it is likely there will be quite a lot of volatility in the market and members need to be aware of that,” says Aon Hewitt’s Ms Sharples. “One option is that everybody carries on as before with no change to strategy; however, the other option is trustees think about whether there are better ways of investing and opportunities to provide more diversification or add value.
“For people who are a bit further away from retirement, the key is what kind of returns can they expect going forward? Returns are likely to be lower than before because of pressure on the economy and lower growth expectations. To help offset this, members have the option of paying more in or retiring later, or a combination of both.”
There are opportunities for trustees to harness innovation and consider new investment portfolios
With further details yet to emerge about what access the UK will have to EU markets and restrictions on free movement, the full impact of Brexit remains to be seen.
“Unfortunately, no one has a crystal ball. Even the best investment strategies may be adversely affected by current market volatility, but this is not to say members, trustees or fund managers should begin to panic,” says Ms McKenna of Squire Patton Boggs.
“There is little doubt that Britain leaving the EU will mean there are challenges ahead for investment funds; however, there are also opportunities for trustees to harness innovation and consider new investment portfolios.”
RISK MANAGEMENT POST-BREXIT
A greater focus on risk management has emerged as trustees attempt to mitigate some of the impact of June’s EU referendum result on pension schemes.
While attention may be focused on markets, pension scheme trustees will also have to consider a number of other risk management issues brought about by Brexit.
“I don’t think pensions should be focusing too much on whether sterling is going up or down, or whether one asset manager is performing,” says Dan Mikulskis, head of defined benefit pensions at investment consultancy Redington.
“Getting a risk management framework set up is sensible. With a simple framework to go by, there will be opportunities in a volatile market environment, but it’s always best left to the asset manager.”
Mr Mikulskis says regular reviewing of investment decisions and performance is likely to depend on the size of the scheme and the governance arrangements, adding that trustees may be put under pressure to communicate more frequently and effectively with scheme members.
Despite low interest rates, trustees should take care over possible liability hedging, while also recognising the challenges presented by a low-yield environment for bonds.
“We don’t think that just because rates are low they can’t fall further,” he says. “A lot of trustees that haven’t hedged will feel like they’ve missed the boat, but there are still risks on the down side.”