Scotsman article: Choices available if your pension faces a serious shortfall

31 January 2009

THOUSANDS of people who have seen the value of their pension eroded in recent months face a tricky dilemma if they're approaching retirement.

Let's take 58-year old Margaret Shaw as an example. She saw the value of her personal pension fall by 20 per cent in 2008, but intends to retire from work and to start taking her pension benefits in July 2010.

Should she "take the hit" and switch into something safer to avoid the possibility of further losses, stay put in her existing fund (a balanced managed fund currently invested 70 per cent in shares) or switch into other funds or sectors?

Sadly, I don't have a crystal ball – only with the benefit of hindsight will we know which is the correct choice.

Most investment commentators are of the view that the world's developed economies will remain in recession throughout 2009 and possibly beyond.

At the same time, valuations in some sectors are attractive and some economies are better placed than others for recovery.

But while history shows that stock markets recover before economies, the recovery may occur too late to make a difference, making equity investments over the 18 month timeframe being considered a risky prospect.

Recent base rate cuts have rendered cash returns singularly unattractive for most of the 18 month period under consideration. So, cash isn't necessarily the answer.

Meanwhile, yields on short dated government bonds (often used as a proxy for cash in portfolios) have fallen to extremely low levels and may yet fall further, but exceptional demand for this safe-haven has arguably over-valued the sector.

UK Corporate Bond funds look attractive as the market has priced in overly pessimistic assumptions about levels of defaults and there would appear to be a good chance of some capital appreciation once confidence in the UK economy begins to return.

Although many commercial property fund values have suffered drops of around 40 per cent since mid 2007, many analysts believe the recession will further depress prices, with any sustained recovery being some way off. So, that isn't the answer.

Similarly, commodity prices have taken a battering and are likely to remain depressed until demand and confidence recovers, although they are likely to turn quickly when sentiment changes.

So, for Margaret we can adopt the following investment strategy for the remaining 18 months of her working life.

An immediate switch of 50 per cent of current holdings, investing across a range of UK corporate bond funds holding mostly investment grade debt.
15 per cent of the portfolio into a six-month cash deal paying a fixed rate of 3.75 per cent.
The remaining 35 per cent gradually switched over the next six months into a selection of equity funds, including US, Europe, Natural Resources and Emerging Markets. This is known as "pound cost averaging" and hedges against prices falling further during the phasing-in period.

Given that her existing pension investments included 70 per cent in shares (albeit mostly UK) the above represents a significant de-risking, but at the same time positioning her portfolio to catch the upside of a recovery.

Let's hope hindsight speaks well of our decisions.

Paul Lothian is a director of Verus Chartered Financial Planners in Dundee.

WHAT NEXT

Understand your existing pension funds – find out where your money is invested by asking your adviser or pension provider or checking fund websites such as www.trustnet.co.uk.
Are you happy with the levels of risk? The longer you have until retirement, the more risk you can take
Optimise returns by re-positioning investments for recovery. We don't know when it will occur, but it will come, so don't miss out.
Review your investments at least every year.
Start "de-risking" the investments from around five years to retirement by moving to cash, or near cash investments.
Understand costs and charges. Could you get better value elsewhere? Is an adviser receiving commission out of your pension fund?
Do you know what your pension is likely to provide as a percentage of your pre-retirement income? If not, obtain projections.
Get a joined-up financial plan from a highly qualified and experienced planner whose remuneration basis is transparent and is agreed with you up front.

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