How has your pension fund performed and what are the assets in it worth? Few members of collective schemes, even finance professionals, can answer this simple question. Most of them just pay their monthly contribution and assume that the managers of the fund, watched over by the trustees and the consultants who advise them, are clocking up good returns. But is that a safe assumption?
Members of defined-benefit schemes shouldn’t have to worry. If performance is poor, the sponsoring company is obliged to make up the shortfall. The problem is that these schemes now have a collective deficit of £300bn, due to lengthening life expectancy in retirement, misguided investment strategies and poor returns.
And if your firm fails, the outlook for members of its pension funds is grim – as past and current employees of BHS recently found out. But in all the furore over Philip Green’s chicanery, nobody asked whether poor performance might also have been responsible for the pension fund’s predicament.
Members of defined-contribution schemes, however, are on their own. Few people can afford to pay enough into their pension to ensure a comfortable retirement without the benefit of investment returns. To generate those, most savers will need to take risks, the most important of which is the risk of losing money. But they can take a long-term view, because it could be as long as 40 years before they need to draw their pension. They can afford to be patient, tolerating market setbacks in the expectation that such setbacks are always recovered, often swiftly.
Unfortunately, that is not how those they have entrusted their money to see it. Collective schemes are supervised by part-time trustees who appoint managers of the fund on the advice of specialist consultants. The trustees and consultants are more worried about their reputations in the short term than the long-term interests of the members of the scheme. Consequently, they favour absolute-return funds.
It’s no surprise, then, that fund-management companies have been busy manufacturing such funds to appeal to them rather than to the customer. These funds generally project returns of 5% over inflation, which is roughly the long-term expectation of an equity portfolio subject to full market volatility. An intolerance to short-term setbacks and volatility must reduce returns and make the projected return unattainable. Of course, this projected return is a target, not a promise, but it’s not obvious that everyone appreciates the difference.
Pension-fund consultants have lamentable past form. In the 1980s and 1990s they encouraged an upward spiral in their clients’ allocation to equities only to see global equity markets nearly halve in 2000-2003. Then they championed “liability matching”, whereby funds would invest entirely in bonds to match their obligation to pay future pensions. How well that went can be judged by the huge collective deficit of the defined-benefit schemes.
In 2013 a study by a team at Oxford’s Saïd Business School estimated that US equity funds recommended by consultants underperformed other funds by 1.1% per annum between 1999 and 2011. Since this takes no account of consultants’ poor record in asset allocation, this could be a significant underestimate.
The lesson is simple. Check the returns each year over all timescales and compare them to a reasonable expectation derived from market indices. Complain to the trustees if you’re not happy – if enough members do this, they will have to respond. Be prepared to switch into a self-invested personal pension scheme managed by someone at reasonable cost who is prepared to take risks to generate returns and who takes the long view. Finally, don’t be scared of doing it yourself; at least you will have nobody else to blame if the performance is poor.