Stock market turmoil: keep calm and carry on

The turmoil in the financial markets over the last few years has caused serious concern among traders, politicians and policy-makers, but how worried should the rest of us be about its effects on our pensions?

In just one day in July this year, for instance, around £29 billion was wiped off the value of shares on London’s FTSE 100, following concerns over Spain. Meanwhile, many people have seen returns on their pension investment pots fall dramatically over the last few years. Pensions in Britain are quite heavily exposed to stocks and shares rather than government bonds.

“Final salary funds have been pushed deeper into the red because the accounting rules which they follow are heavily influenced by gilt markets,” says Joanne Segars, chief executive of the National Association of Pension Funds. “Quantitative easing and the demand from international investors for UK gilts as a safe haven have pushed the yield on gilts down to very low levels. This increases the deficits of pension funds and ultimately means that businesses have to divert more cash away from jobs and investments into their pension schemes.”

As well as the effect of the fall in markets, the government’s antidote to this problem has had a detrimental effect on pensions. Quantitative easing (QE), the buying of gilts by the Bank of England, has pushed the yield on gilts down to a record low of around 2 per cent. These yields are closely linked to annuity rates and so they’ve also fallen by nearly a quarter since mid-2008, causing considerable concern to those in or approaching retirement.

Anyone who is not planning to retire imminently might well see their pension pot grow again as the world economy eventually moves out of recession

However, the government and other experts argue that QE has prevented the country from falling into worse recession which would have seen markets, and ultimately the value of pensions, fall ever further and faster. In August, Spencer Dale, chief economist at the Bank of England added that QE “has helped to prevent asset prices falling by as much as they would otherwise have done”.

For its part, the pension industry points out that pensions are a long-term investment and so anyone who is not planning to retire imminently might well see their pension pot grow again as the world economy eventually moves out of recession. According to Rob Fisher, head of marketing DC [defined contribution] & workplace savings at Fidelity Worldwide Investment, both employers and employees are largely holding their nerve, especially as they move towards defined contribution (DC) rather than defined benefit (DB) schemes.

“In general, we’re finding that employers are remaining committed to the provision of workplace pensions and many offer quite generous employer contributions which employees can top-up or match,” he says. “It’s worth noting too that, in spite of periodic bouts of stock market volatility, the vast majority of our underlying DC savers continue to pay into their plan every month from their salary. They understand retirement saving needs a long-term plan and the value of a good employer contribution alongside their own saving.”

DB and DC pension pots have both been adversely affected by recent market conditions, but in different ways. DB funds which have to show valuations every three years are under greater pressure. “It’s like a snapshot in time and it can show that if they had to pay out now they would need additional funding,” says Andrew Dickson, investment director, UK institutions at Standard Life Investments. “DC funds are more transparent for their members. The individual saver can see how his or her personal funding position is doing – bouncing around as the volatile markets bounce around.”

With bonds and equities so low, some pension fund managers are reviewing their options and deciding that alternative investments look increasingly attractive. According to the latest annual European Asset Allocation Survey of more than 1,200 European pension funds with assets of over €650 billion by HR and investment consultancy Mercer, pension plans are considering an increasingly broad range of alternative asset classes with 50 per cent of schemes now holding an allocation in alternatives, up from 40 per cent last year. Even when the markets return to normal, this could become a long-term trend.

“Funds are looking to accommodate more exotic asset classes, such as private equity, infrastructure products and insurance-linked strategies. These work like insurance policies with the pension funds receiving the premiums and, as they are linked to man-made or natural catastrophes, they’re uncorrelated to traditional financial risk,” says Brian Henderson, head of defined contribution at Mercer’s investment business. “But this move requires better governance and funds also need to make sure that the assets are sufficiently liquid, especially in the current economic situation.”

In his role as chairman of the new Defined Contribution Investment Forum, formed to exchange ideas and develop initiatives to promote investment excellence in DC pensions in the UK, Standard Life Investments’ Andrew Dickson argues that DC fund managers and trustees must be more creative and adventurous in their choice of investments.

“So far DC strategies have been pretty basic – they’ve just gone for global equities index tracker funds. If all your savings are in one asset class, that can be quite disconcerting,” he says. “Why shouldn’t DC savers have access to the same wide range of funds that DB savers do?”

The unpredictability of the eurozone and the inability of Europe’s political leaders to act quickly to find a solution remains one of the biggest macro-economic issues facing pension funds. “Consultants are advising those running workplace pensions to consider their response to several possible scenarios so that they are not taken by surprise,” says Ms Segars.

She adds: “Pension fund trustees will want to understand their exposure to eurozone sovereign and corporate debt across their portfolio, though many UK pension funds will already have withdrawn from the riskiest investments.”

Take advice, spread your risk and don’t panic is the message.