OK, you are a pension fund. You have promised recently retired Mr Saver a lifetime annuity of £2,000 a year and to match this, you have just bought some long-dated UK gilts for £100,000 nominal at 2.5% nominal interest, i.e. you have guaranteed cash income of £2,500 until they mature, which hopefully covers Mr Saver for life. You trouser £500 as your mark-up and pay him the rest. You don't really worry what the residual value of those gilts will be in two or three decades' time - the market value will move back towards nominal value as they approach maturity.
(Or maybe you invested £80,000 nominal at 2.5% interest and pay him the whole £2,000 coming in, and trouser the residual value in two or three decades as your mark-up, same sort of thing.)
Because the fiscally reckless Tories* are in charge, the value of your gilts plummets to 70p in the £1 (giving a notional interest rate of 4% or whatever). So what? The £2,500 interest income (or £2,000 interest income) is fixed, Mr Saver's annuity is covered and there is nothing to worry about. When Mr Saver dies, you sell or keep the gilts, or maybe they mature before he dies and you pay his last few years' annuity out of the proceeds.
So why are pension funds selling off gilts like topsy? Did they invest current savers' money into gilts? That's a terrible idea, as they are not even going to keep pace with inflation, they should be investing in shares.
In the spirit of putting my money where my mouth is, I opened a Stocks and Shares ISA this morning and have chipped in £10,000 for some units in the Santander Sterling Gilt Fund at 211p per unit (or at least I hope I have done, it can take a while for this to go through). Let's see what happens...
* The popular notion that the Tories are fiscally prudent and Labour are fiscally reckless is pure Indian Bicycle Marketing, actually the reverse is true (historically and to the present day). Which is one of the reasons why I have concluded that what this country needs is a Labour national government and Tory local councils, who seem to ignore most of the meddling crap from the national government (they are reluctant to employ Tobacco Control Officers or impose 20 mph speed limits on country lanes) and just run actual necessary public services.
Thursday, 13 October 2022
Pension funds - irrational behaviour
My latest blogpost: Pension funds - irrational behaviourTweet this! Posted by Mark Wadsworth at 13:43
Labels: government bonds, Indian bicycle market, Investing, Pensions
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14 comments:
Nearly, but not quite.
The issue with pension funds (not money purchase pension schemes like your ISA) is that the annuity fund (a) does not hold all gilts (b) the pension funds have had a shed load of regulatory interventionism by largely ignorant bureaucrats... (c) ...part of which is being forced to make their investments 'liability driven' - whatever that really means (d) subject to bizarre accounting rules that mandate that they need sufficient funds to buy every member at any time an annuity for their accumulated benefits (e) for schemes with indexation they need to hold enough for index linked annuities, i.e. very costly, (f) that some investments have to be sold of gilt prices fall to maintain their solvency requirements, (g) the ZIRP / QE stupidity has made all this very difficult. That is it's not Trusses fault. It's all Chancellors and governments since 1990 and really becoming an issue from 1997 and the Blair Brown Ball terror. BTW did you know that about some part of Aviva's equity release business is funded by their annuity fund?
If the pension funds had been left alone they (mostly insurers) would have run these funds in a realistic way and only really resorted to buying Gilts to secure the final pension.
But where you control your own pension moneys you can take your own views in what to invest and when, remembering that there are only two reasons to invest; (1) for income now and (2) for income in the future.
Lola
As I understand it, Gordon Broon made the pension funds stock up on gilts, but then every government since the GFC forced interest rates into the basement using QE, so pension funds struggled to get enough future income to match future liabilities. Some bright spark in the City said 'Hey Mr Pension Fund Manager, sign up to our super-wizzo financial product, just lend us your gilts, we'll give you loads of cash and you can invest that in other things that pay better income rates than gilts. You can't lose. Well you could if interest rates ever went up again, but hey thats not going to happen is it?' And before you could say 'Andrew Bailey is a incompetent tw@t' pension funds had signed up to £1.6tn (yes Trillion with a T) of these deals. Fast forward to Oct 2022, interest rates start going north at a rate of knots, pension fund managers franticly selling their grannies (and loads of gilts) to meet collateral calls, and City wide boys quietly sneaking out of the country with suitcases full of loot........
S. Yup. But not Brown directly, but via his 'regulatory' structures post the FSMA2000. The likes of the Financial Shambles Authority. As I understand it.
Whatever, these things are always the fall out from an a priori incompetent intervention by an unaccountable and ignorant bureaucrat into the market and often the sanctity of private contract.
L and S, aha, so it is, in market terms, irrational behaviour. But this course of action is the unintended consequence of what regulators force them to do. Ta!
MW. Yup. Exactly. In nay event , IMPO, this whole thing around the Quasi (sic) non-budget is confected. TPTB really do not want a low tax small government (and hopefully sound money) UK government. It's a deliberate attempt to create a run on Sterling and unseat Truss and Co. The moment she pre-announced in her hustings for leadership that she would reverse Sunaks tax rises this was being planned.
But, the pension funds are just unwilling fellow travellers in that conspiracy but at the same time victims of a priori gov't and bureaucratic failure.
As a side note, we have not knowingly held any Gilts, especially long dated Gilts, in the bond component of our client investment portfolios for years. We have stuck to short dated high quality corporate bonds although, we cannot know for sure, that some of those holdings are Sovereigns which may include Gilts, but even if they are they will be short dated and therefore not as volatile in price/yield.
* The popular notion that the Tories are fiscally prudent and Labour are fiscally reckless is pure Indian Bicycle Marketing, actually the reverse is true (historically and to the present day).
Trying to improve the economy by simply cutting back on public expenditure is like trying to get fit by eating less and nothing else.
Which is one of the reasons why I have concluded that what this country needs is a Labour national government
Unfortunately, all that is now on offer is a slightly different flavour of Tory. Many of the current Conservative MPs would be right at home in Starmer's "Labour" party. Some of the ones who went in Boris's purge would probably be considered too left wing. Starmer's socialism is, as feared, turning out to be very national.
B, I'm not bothered about left-right. I'm bothered about managerial competence, not being too corrupt etc.
Mark, the question is, that now that Labour under Starmer has gone full Red Tory, will they be any more fiscally competent than the Blue Tories (obviously not this current bunch, my cat could be more fiscally competent than them).
MW. Labour has never ever been managerially competent. They cannot be as they always substitute bureaucratic rationing for market prices and they put the collective above the individual. They are the true dogmatists. Yet the denounce liberty loving personally responsible blokes like me as 'free market dogmatists.
The problem is we are offered a voting choice between two sets of incompetence.
That's why absolutely miniscule government is the best outcome. The least possible resources to do any more damage with.
If luxury pensions were not a thing, this problem would be much smaller. A modest but decent citizen's pension for all, anything above that can be saved for on a non subsidised basis. Also need to look at the extra 10 years holiday that people can get on the public's dime by taking early retirement on a 'private' pension at age 57 instead of 67.
Another hypocritical position from me, tucking into hundreds of thousands of pounds of tax relief into my pension over the years :-)
Mombers. Agreed mostly.
The 'early retirement' available to personal pension savers comes about only if they can save enough to be able to afford that. And, do not forget, a pension annuity or drawdown scheme withdrawals are taxed as pay. Whereas a life annuity is taxed only on the interest components. yes, early retirers will have had good tax relief (probably) on contributions, but the quid pro quo is they then pay income tax throughout retirement.
@Lola, I get tax relief of ~67% ('lucky' enough to be a 60% taxpayer and subject to NI) whereas my resulting pension will most likely be taxed at 20%. Not something that the government should be spending money on when they are nicking the private property from working age people on much lower incomes. With an ageing population it makes no sense to tax working age people double what retired people get whacked. Many countries now are doing the opposite, giving young people who immigrate to them a LOWER tax rate
As far as I can see, the lifetime allowance for defined benefit pensions is 20x the annual amount, regardless of whether you take it at 57 or 77 - correct me if I'm wrong. Goodness knows how much an inflation linked annuity for an income of £53,655 from age 57 is but it's definitely much more than the current lifetime allowance of £1,073,100
M: "whereas my resulting pension will most likely be taxed at 20%"
15% actually - a quarter tax-free and dribble out the rest at 20%.
MW/Mom
MW yes.
My personal preference is to restrict any tax relief on contributions to the basic income tax rate and do away with the lifetime allowance. Mind you I'd also scrap all final salary schemes for all government employees. Making them use investment savings schemes would encourage them to not trash the economy. Incentives matter.
It used to be that a lot of the pensions tax relief went straight to the insurers. That's not really the case to day. As you can get very low cost schemes. And the bulk of the 'subsidy' goes back to the government in taxes on the profits of scheme operators.
In truth the whole thing is a n absolute mess and needs radical - and genuine simplification.
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