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Is your pension affected by the ‘bond market nightmare’?

Emma Lunn
Written By:
Emma Lunn

There could be trouble ahead for about 850,000 pension savers invested in ‘lifestyling’ funds.

These funds invest in long dated bonds, which have sold off heavily as a result of high inflation and interest rate rises. This means the value of lifestyling funds have fallen in value by 13% in the past two months.

Pension savers in their 50s or 60s are often automatically defaulted into these funds, in order to hedge against annuity rate movements as they approach retirement, but experts warn that for many they are no longer fit for purpose.

Since the pension freedoms were introduced in 2015, only 10% of pension investors now buy an annuity, with most choosing instead to draw their pension as cash, or invest it to produce an income.

Laith Khalaf, head of investment analysis at AJ Bell, said: “Lifestyling funds are a relic of a bygone era when pension rules basically meant that 90% of people bought an annuity at retirement. But these strategies are still being used today, when only 10% of people buy an annuity, thanks to the pension freedoms which were introduced in 2015. Pension default strategies that could have been set up decades ago, are only now starting to switch pension investors into these outdated funds.

“Many investors probably won’t be aware this is going on, but they could be sleepwalking into a bond market nightmare. That’s because high inflation and rising interest rates have led to a 13% fall in the value of these funds in the last two months. If these trends continue, things could get even worse from here. The logic behind lifestyling funds is that if they are falling in value, annuity rates will be rising to compensate. But that’s little comfort if you’re not going to buy an annuity with your pension.”

Lifestyling funds were often used in old workplace pension schemes run by insurers, and individual stakeholder pensions. Many of these pension providers have now updated their investment strategies to reflect the fact that few people are buying an annuity in today’s retirement market.

But some older pension plans are still ploughing on ahead with their default investment strategy of automatically shifting investors out of equities, and into these lifestyling funds which hedge annuity rate movements.

For most pension investors, who aren’t going to buy an annuity, these funds are now totally unfit for purpose.

Khalaf added: “Investors who are approaching retirement should definitely take a look under the bonnet of their pension plans to see what’s going on, and if any automatic switching is taking place, they can then make an informed judgement on whether it’s appropriate for them, based on what they’re going to do with their pension.

“If you think you might be invested in a lifestyling fund, check your latest valuation or speak to your pension provider. The funds in question will normally be called ‘long gilt’ or ‘long corporate bond’, and will invest in long-dated government or corporate bonds.

“If you are going to buy an annuity with your pension, you might consider sticking with a lifestyling strategy. But if you aren’t, then you should give careful consideration to picking another type of fund to see you through to retirement, and beyond.”

Lifestyling is an automatic process which starts switching pension savers out of a managed fund into an annuity hedging fund in the five to 10 years before retirement.

Khalaf says the bond issue mainly relates to pension plans that were set up 10, 20, or 30 years ago as these can’t simply be switched across to a new investment strategy without the pension investor making an active decision to do so.

AJ Bell estimates there are about 850,000 pension investors who currently hold one of these lifestyling funds, based on the amount of money held in these funds (£15bn according to Morningstar), and the average defined contribution pension pot of 55 to 64-year-olds (£35,000 according to the Office for National Statistics).

The estimation also assumes that the typical pension saver in one of these funds will have 50% of their pension pot invested.

The figure doesn’t include people who might have a lifestyling programme sitting in the background, waiting for them to hit 55 or 60 years of age, and then starting to shift them into annuity-hedging funds.

Most of these people will have been automatically invested in a default strategy which includes lifestyling when they signed up to their pension many years ago, so few would have made an active decision to invest in this way.