Month: December 2016

Record High Transfer Values: A Good Time to Act?

In a world full of uncertainties and low interest rates, final salary pension schemes are widely considered a treasure but they can be inflexible and are often not specifically targeted at individual members’ needs. Members of such schemes often transfer out for a variety of reasons. These include: to access greater flexibility under the new pensions freedoms brought in last year; to draw their cash lump sum to reduce debt and to ensure that their families better benefit from the fund, in the event of their death.

In the recent months we have seen transfer values (the capital value of the benefits promised by a scheme, sometimes called the CETV or Cash Equivalent Transfer Value) at unusually high levels – sometimes as much as 40x the annual pension income. This has been driven by recent reductions in government bond returns brought about by the Brexit vote and also the measures taken by The Bank of England to prop up the economy. It is fair to say that this combination of factors is unusual and likely to be short lasting. When Bond returns revert to their traditional range, it would be reasonable to expect transfer values to reduce. So there is a bit of a window of opportunity to extract quite a bit of value for your pension, which can not be expected to last. This is definitely a good time to review whether your final salary pension is in the right place.

Differences Between Pension Schemes

One important thing to point out is that different pension schemes use a variety of factors when calculating transfer values. These include your current age and when you are entitled to draw the benefit, as well as the scheme specification in terms of escalation of benefits before and after retirement and any spouses and dependents benefits. In general, the closer you are to retirement, the higher the CETV multiple. Conversely, the more time left for the assets to grow, the lower the present value. The only way to know the exact figure is to request a CETV quotation from your pension provider. The state of funding and therefore the security of your benefits can have a bearing on the transfer value as well. If the scheme is very underfunded, transfers values can be subject to a discount.

When to Transfer (and When Not)

Guaranteed income is the main advantage of defined benefit schemes. When you transfer to a defined contribution scheme, you lose these guarantees and your future pension income will depend on returns earned on the invested assets. When you get a CETV quotation, you can actually calculate the exact rate of return needed to beat the income which you would have received from the old final salary scheme. The current high CETV multiples make these required rates of return lower than usual – sometimes as low as one percentage point above inflation.

When transferring out of a final salary scheme, investment risk shifts from the pension provider to you. One of the key things to consider when deciding about a transfer is your ability and willingness to take this risk. The former is mostly about your financial situation and whether you have other assets and income sources to possibly rely on in case your investment returns turn out lower than expected. The latter is mainly about your risk attitude and psychological factors.

Risk and return are major parts of the decision, but not the only ones. Your existing pension plan may come with other (often non-financial) benefits which you would be giving up. At the same time, final salary schemes are typically quite restrictive and inflexible – transferring out opens up new ways to access your pension pot and thereby new options for retirement and inheritance tax planning.

To sum up, those with more wealth and other assets besides their pension, those who intend to pass a substantial portion of wealth to children, or those looking for greater flexibility and control over their retirement savings are more likely to find a transfer suitable. Conversely, those with limited assets and those who prefer security and guaranteed income will probably want to keep their existing final salary scheme. These are, of course, generalisations – the actual decision will depend on the particular numbers, as well as many unique, personal factors.

The Window of Opportunity

While a decision to transfer a pension must never be taken lightly or made hastily, keep in mind that the current high transfer values are caused by recent short term market developments and these are unlikely to last. When bond rates go up, the CETV multiples can be expected to decline.

Contact us now for a free initial consultation to check out your options. You can find more details about our pension transfer advisory process by visiting our sections on UK Pension Transfers and Expat pension Transfers

Recent FCA Asset Management Study: A Case for Passive Funds

The Financial Conduct Authority (FCA) has recently published a comprehensive study examining the British asset management industry. While the report is over 200 pages long and most of it is of little interest to the end customer, there are a few points worth noting – and some reasons for concern. We will discuss the key findings below, as well as implications for your investment strategy.

You can find the full report here (interim report; the final is due in the second quarter of 2017).

6 Key Findings

  • The FCA has found weak price competition in the UK’s asset management industry, with negative effects on clients’ net returns. Generally, fund managers are unwilling to reduce their charges, as they don’t believe a resulting gain in volume would offset the fall in margins.
  • Not surprisingly, the cost for the client of actively managed funds is significantly (often as much as four or five times) higher than the cost of passive funds. The difference has actually increased in the recent period. While charges for passively managed funds have fallen in the last five years, actively managed funds have maintained their fees at broadly the same level.
  • When a fund is marketed as active (and priced accordingly), it does not necessarily mean that its investment exposures are significantly different from its benchmark, or from passively managed funds tracking the same market. In other words, clients often pay for active management which they don’t really get. This affects as much as £109bn of assets invested.
  • Overall, the FCA has found that actively managed funds (even when they do invest actively) do not outperform their benchmarks after fees. In other words, you are unlikely to get better performance by choosing an active fund over a passive fund – quite the opposite.
  • While some investors may want to invest in funds with higher charges, expecting these to deliver better investment management skills and higher returns, there is no evidence of this being the case. In general, more expensive funds do not perform better than cheaper funds.
  • While many investors consider past performance when choosing funds, it is not a good indicator of future performance. A vast majority of active managers are unable to outperform their peers for longer periods of time.

What It Means for the Investor

If you could summarise the report’s key message in one sentence, it would be the following:
Paying more for active management is usually not worth it.

This is nothing new. There have been many reports by various academics and research institutions, working with data from different markets and time periods, and most have come to the same conclusion. It is also in line with the Efficient Market Theory, which became popular in the 1960’s, but research with similar ideas occurred as early as the first half of the 20th century.

Beating the market is extremely hard, especially after the higher costs which inevitably come with active management. Even when a manager is able to beat a broad market index in one or two years, sustaining outperformance over a longer period, in different phases of the economic cycle and in different market conditions, is close to impossible. The massive growth of index tracking and passive funds in the last two decades is an evidence that investors all over the world have noticed.

Asset Allocation and Passive Management

The above does not mean everybody should just buy a FTSE 100 tracker and sit back. Different investors have different needs, time horizons and risk profiles, and therefore should have different market exposures. For instance, an investor in his 60’s and about to retire would most likely want to have a portfolio structured differently (perhaps more conservatively) than someone in his 30’s. This should be addressed in the asset allocation phase, where the approach should be highly individual. Passive management only applies once asset allocation (i.e. the weights of factors such as equities vs. bonds, developed vs. emerging markets, large vs. small cap stocks, or growth vs. value) has been decided.

At Bridgewater, we have sophisticated models in place to find the best asset allocation for the particular investor’s needs. Once portfolio structure is determined, we invest in passively managed funds, which deliver appropriate exposures to the individual factors at the lowest possible cost. You can find more detailed explanation of our investment approach here.