This year, it’s been impossible to ignore the markets. Driven by inflation, war supply chain shortages, there have been significant declines in most markets, followed by a partial recovery over the summer, which itself is unwound in September and October. Many of us have seen significant declines in the value of our pension pots.
Whether it’s market ups and downs, new investment opportunities, or new attitudes to existing investments, having a grip on how your pension is invested can make a significant difference to your wealth.
Moneycube gathered an expert panel to look at how people should invest their pension money in 2022 and beyond.
We discussed such questions as:
– Which regions of the world are hot, and which are best avoided?
– Should you reallocate in or out of equities?
– What’s the outlook for commodities, bonds, and more speculative assets?
This is an edited transcript of a discussion recorded as part of Pensions Awareness Week 2022.
Hosted by Ralph Benson, Head of financial advice at Moneycube, the panel was made up of Gary Connolly, Ian Slattery and James Skehan.
Gary Connolly is Head of Investment Advisory at Davy, Ireland’s largest stockbroker. Gary set up and subsequently sold iCubed, an investment consulting business to Davy in 2014, and these days works with clients to make sense of investment markets and build out investment portfolios.
Ian Slattery is Head of Investment Solutions at Zurich Life, the major Irish pensions and life assurance provider. Ian’s responsibilities include producing Zurich’s investment commentary and insights in the Irish market. He is the current President of the Irish Institute for Pensions Management, and a CFA® Charterholder
James Skehan is former head of pensions at New Ireland. These days, James acts as an independent professional trustee and advises employers and trustees on pension matters, and is teaching a new generation of pension and investment experts, as lecturer at LIA for people working towards the Certified Financial Planner qualification.
Ralph Benson: The outlook at the beginning of 2022 looked very rosy. It’s hard to remember now, but the talk was of the roaring 20s, the great reopening of retail, of businesses able to reconnect with their global supply chain and all the pent-up saving that had been done during the long months of lockdown in the preceding two years.
There was a degree of optimism in the air. But the first signs that that wasn’t panning out were to be seen in the equities market, which has seen significant falls from start of January.
Ian Slattery: Yes, equities hit an all time high in the first week of January, on the back of a very strong 2020 recovery from COVID that continued through 2021. So there was a relatively optimistic view of markets at the start of the year, this idea of supply chain blockages and this pent-up demand was in the background. The general view was that inflation was transitory, not something to worry about from a fundamental perspective.
Obviously, towards the end of February, we had the Russian invasion of Ukraine. Looking at that through a purely economic lens that does accentuate inflationary powers in terms of the role Russia plays in commodity markets. If you bring it through from February, then we had inflation start to bite even further, and higher interest rates across the developed world from central banks. And higher interest rates start to get people to think we would see the brakes put on economic growth.
So you have inflation, interest rates, and economic growth, all working together to maybe bring a little bit of pessimism to market. So equities have had an up-and-down year, as we expect from one of the more volatile asset classes and did see a very strong recovery through the summer. But as you mentioned in some of your previous remarks, that’s come off again into August and September.
Currency is important in equities as well, we have seen the stronger US dollar versus the euro. That has softened the blow for global international equity investors, which most pension investors would be in the Ireland, via multi-asset funds. Equities are down year to date, a little bit less in Euro terms, but very much a volatile year so far. But I think some of the forces that we’ve mentioned there have really played out across a wide range of asset classes. And when we talk about multi-asset funds, that that plays into the likes of bonds and commodities and alternatives as well.
Ralph Benson: That’s right, isn’t it? You’ve mentioned interest rates there and banks being slow to act. Is it fair to say that inflation is the big news story of 2022 and bank reaction to that is what’s driven not just equities, but other asset classes, too?
Gary Connolly: I would say the inflation debate is the sole thing driving markets so far in 2022. It’s been an extraordinary year. In particular, bond markets in 2022 have seen an extraordinary sell off.
Emblematic of that is an example from Austria. In 2020 they issued a century bond. So the capital is not being returned until 2120, in 98 years’ time. It was issued at a paltry yield of 0.88%
That bond today is trading at about €0.45 in the euro. Now, it went up to about €1.30. So peak to trough that’s a loss which is just incredible.
Buying a government bond lending to a AAA-rated government like Austria should be like watching paint dry, it should be the most boring element of financial market investment. But it’s just been extraordinary.
Ralph Benson: So some people have lost two thirds of their money on that bond?
Gary Connolly: Certainly anybody who bought it at issue was down 55%, currently, anybody bought at a peak is down 65%. That’s the sort of loss you expect when you buy a speculative equity. Netflix would be down a similar amount.
So when I buy an equity, like Netflix, I buy into the potential for extraordinary returns, but also that downside risk. You don’t expect that when you buy a government bond lending to a AAA-rated government like Austria. It should be like watching paint dry, it should be the most boring element of financial market investment, but it’s just been extraordinary. As a lesson in duration risk it’s just been an extraordinary time. So that’s now reflected in bond market returns, which have been really, really poor this year. Unfortunately for more cautious investors that have diversified their portfolios out of equities into bonds, they’ve actually fared worse than those that have just been invested in equity.
Ralph Benson: I think that’s something we’ll come on to, ordinarily you would hope that there’s a degree of cushioning of risk if you’re split across those two primary asset classes, but it hasn’t panned out that way, certainly this year, so far.
James – it falls to you to inject a note of optimism in terms of what’s happened so far. One of the key things that’s happened in response to the inflationary pressure is that belatedly, arguably, central banks are pushing up interest rates. And because they’re a little late to the party, they’re doing it quite aggressively. So if we were to see a positive side to that, one option for pension savers, that’s been really off the table for years for many people is purchasing an annuity at retirement, a guaranteed income for life, but the interest rate changes are having an impact on that market.
James Skehan: Absolutely. Annuity rates are probably the one good story for the current year. In the first six months, annuity rates have improved by 25-26%. One of the problems is the whole concept of timing risk. If the same person with €100,000 bought an annuity on the 1st of January they would have bought 25% less than someone buying on the 1st July!
The other strange thing that happened during this year is that, to protect the purchasing power of an annuity, you should invest in long dated bonds. The problem is the long dated bonds dropped by 25% to 27% over the same six months. So you’re still able to purchase the same amount of pension, but trying to explain to an ordinary individual that their fund has dropped by that much, in what they thought was a safe fund, is a tough job.
Ralph Benson: Is there anything that one can do to protect against that timing risk and keep your the plan for your pension on track?
James Skehan: Yes, probably the way to do it, if you can get at an investment in an ARF, because the ARF, in turn, can buy an annuity at any stage, in part or in whole, and certainly as an individual gets older it is certainly something that enough investors should look at because you’re securing and guaranteeing a certain amount of income as you get older and perhaps have less tolerance of risk.
Ralph Benson: It’s a great point and it’s probably not for today’s session but we do have another discussion through the week on exactly that topic. That’s something that we haven’t seen play out in the post-retirement market quite yet because the generation that have been capable of buying those retirement solutions are only beginning to retire.
So if we return to this fact that both equities and bonds have been falling in tandem through the year, where’s the solution? You have mentioned multi asset funds…what is going through the fund manager’s head as that is happening? What are your colleagues at Zurich doing to kind of take account of that trend Ian?
There’s this classic idea, the 60:40 split (60 equity, 40 bonds), which has served people very well for decades.
But that model has suffered in 2022.
Ian Slattery: Multi-asset funds, which invest across equities, bonds, and sometimes other asset classes as well are a major repository of Irish pension wealth. There’s this classic idea, the 60:40 split (60 equity, 40 bonds), which has served people very well for decades. But you have this twin bear market with equities and bonds and that model, at least in the short term, has fallen apart a little bit, in 2022. That can be particularly hard for lower-risk investors to kind of get their head around because they thought they were in the safer assets and they’re seeing relatively larger falls.
I think there are always things you can do. We can always look at the asset classes in terms of their absolute valuations. What you’re doing as a fund manager in the multi asset fund is you’re choosing one asset over the other, rather than in isolation, so there is this idea of relative valuation.
So even if you think equities may still be in for a little bit of a tough time in 2022, you can still favour equities over bonds, if you think they’re going to do better than the bonds. Now, in terms of absolute returns for customers, that can be a bit of a tough one to deal with as well.
I think the duration risk, which we’ve kind of discussed already, is very important. Where you can actively reduce maturation risk, and you have to make that call correctly, you can do things to mitigate the effects of that interest rate environment as well. I think it is important though, that people stick with risk and even if you do see deposit rates start to shift up slowly as interest rates shift up, always try and look at real returns, which take into account the effect of inflation. So even if you see your headline deposit rate as a customer going up, your actual purchasing power still have been reduced by inflation. There’s always opportunities. Volatility always brings opportunities. But it’s a tough time to be to be managing in the market at the moment.
James Skehan: It also brings the old pound cost-averaging principle into the equation because if you’re paying regular contributions on a monthly basis, you’re going to be buying units at a cheap price. I think crucially, the age of the investor is all-important.
Ralph Benson: Tell me a bit more about that. How might it make a difference if one is five years away from retiring versus 25 years away?
James Skehan: Okay, I think 25 years away from retirement, I wouldn’t be bothered at all about the market downturn. You have time on your side and the contributions you’re paying on a monthly basis will be buying more units. Equity markets always recover. It’s a question of when, and how long will they stay in the doldrums. So if you’ve time on their side, you know, 5 to 10 years plus, I wouldn’t be worried about equity markets at the moment. The closer you get to retirement you should be running for cover. But a key part of that is matching the funds you’re invested in with the benefits that you’re likely to take after retirement.
Ralph Benson: So, are you talking about that in terms of the plan to drawdown funds, and remain invested in markets versus the annuity we spoke about?
James Skehan: Yeah, the benefits taken at retirement would still be driven by what tax-free lump sum you can take out and, unfortunately we have a slight conundrum here in that there are two options at retirement. Most people in group pension schemes will still get the better lump sum using the salary and service route and that, in turn, would mean that they would have to buy an annuity. So in that situation, they should be aiming to end up in a mixture of cash and long dated bonds, as they approach retirement.
On the other hand, the business owner, or those individuals with bigger funds would be looking towards the ARF and in that case there should be 25% of the fund in cash at retirement and the balance, you know, I think investors take two views really unrealistically they should be looking at a time horizon until they’re 90 but a lot of Irish people will look at the term up to their retirement date, take the lump sum, take stock, and then reinvest.
So again, it’s down to giving individual advice. And I think one of the key points in the current climate is people need advice.
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