The default option for defined contribution (DC) pension schemes is typically a lifecycle approach that gradually ‘de-risks’ as an individual nears retirement. The de-risking process involves a movement from more volatile equities into the somewhat calmer waters of bonds and cash. Initially this approach was fairly straightforward, perhaps moving from global equities to a retirement point mix of government bonds and cash – that could be put to use to purchase an annuity, as was the requirement a few years ago.
Lifecycle models today are much more complicated and can involve a broadly diversified portfolio of equities and alternatives in the ‘accumulation’ phase as well as a varied portfolio at the point when the individual may start to draw down their investments to pay for retirement. The composition of the portfolio is not the only complication. Rather than a standalone default, pension schemes may use ‘target date funds’ where the date of the fund can mirror the retirement date, but even here there is debate over whether the fund is glide ‘to’ or ‘through’ the date – the ‘to’ funds hold the asset allocation at that date while the ‘through’ continue to change asset mix beyond the target date.
But what am I whittering on about DC pension retirement for? It was the front cover of the Economist this week that grabbed my attention. It shows an image of a roller coaster so high that the lower loops are shrouded in cloud, with the cars edging to the top of a very sharp precipice. The title of the piece is ‘When the ride ends. What would happen if the markets crashed?’[i] It reminded me of the other aspect of both lifecyle and target date funds that is hotly debated – when do you start switching into less volatile assets? Should it be 5, 7, 10 years before retirement date?
As a 52-year-old managing his own pension pot, this timing has prayed on my mind for a little while. The vast majority of my pension is invested in equities and a large chunk of those are invested in companies based in emerging markets. Had I been invested in a lifecycle fund, I have no doubt that I would have been in that transition mode to a de-risked portfolio. But for me, transitioning into a fixed income portfolio has just seemed to be too painful a thing to do, particularly as the small allocation I have to bonds has significantly underperformed.
But I am very mindful of the clackety sound of the roller coaster as it is pulled to the top of the loop before it starts its freefall descent and I’m wondering whether my pension is nearing a similarly perilous position. The Economist piece rattles off a range of statistics that could point to us nearing the zenith – S&P at 40 times earnings, increased volatility, S&P reaching ‘all-time highs on 70 of the 261 trading days in 2021’.
The morale of the Economist article seems to be that there has been such a change in the market structure in terms of access – how easy and cheap it is to trade – as well as the composition of the participants – much more retail rather than institutional. These changes mean it is much more difficult to predict what would happen in the event of a crash – would individuals step in and buy on the dips, or would there be liquidity events that exacerbate the decline and push the losses lower.
The other issue I have is that I really struggle to consider myself as old enough to warrant moving out of equities. The optimist in me says that surely I can weather a crash and subsequent rebound in markets over that time or maybe this time around it will be different?
[i] The Economist, February 12th -18th 2022