Last Thursday, the Bank of England’s monetary policy committee raised rates for the seventh consecutive time – increasing the base rate by 0.5% to 2.25%. This is up from just 0.25% at the start of February this year – a two percentage point rise in nearly eight months.
The move came alongside the bank's announcement that it would sell £80bn of government bonds over the coming 12 months, cutting the stock amassed via quantitative easing to £758bn.
The government's Mini Budget on Friday added to expectations of significant increases in the supply of gilts. Indeed, on the same day, the UK Debt Management Office increased its planned bond sales for the 2022-23 fiscal year by £62.4bn to £193.9bn.
All of this led to what Barnett Waddingham called an "allergic reaction" in the gilt market.
According to data from Refinitiv IFR Markets, yields on benchmark 10-year gilts rose from 0.974% at the beginning of this year to 2.803% at the end of August. This month they had risen to 3.139% at the end of 16 September and 3.495 at the end of 22 September, the day before the chancellor's Mini Budget.
By the close of last Friday, yields had spiked to 3.827 and yesterday rose significantly further to 4.282% by the end of the day. And, while things steadied slightly this morning, with yields falling back down to nearly 4% during early trading, they have risen through the day and stood at 4.355% at 3:45pm this afternoon.
Yields on long-dated gilts saw an even more substantial rise - with the yield on 25 year paper increasing from 3.841% at the end of last Thursday to 4.833% as at 3:45pm today.
This is obviously great for defined benefit funding, but it is much be less good for those in defined contribution schemes that are approaching retirement, particularly if they are invested in funds with significant gilt holdings.
The scale of the issue
Well-diversified master trust default funds tended to fare better than some.
As an example, NEST's 2025 Retirement Fund - targeted at those looking to retire in 2025 - saw a fall in unit price from £2.2191 in the week ending 7 January to £2.1253 at 29 July, the latest numbers available, a fall of 4.23% during the period. Its 2023 Retirement Fund fell by 4.01% over the same period.
And, while measured on a different timescale, the £2.7bn B&CE Pre-Retirement Fund - targeted at "members who are approaching retirement and have not yet decided what they want to do with their investments at retirement" - saw a 9.4% fall in value from January to 27 September.
Commenting on the above, B&CE said it acted to reduce the interest rate sensitivity and credit risk of our bond allocation earlier in the year but noted the short-term market environment for both bonds and equities was "challenging and a clear headwind to performance"
Other providers, however, seem to do far worse.
One major insurer's £1.8bn pre-retirement fund - invested in a mixture of gilts and corporate bond funds and aimed at those targeting annuity purchase - posted a 19.51% loss in the six months to 30 June alone. The same insurer's option for those targeting drawdown saw an 8.2% fall in the year to the end of June, while its cash fund posted positive performance of 0.31% over the same period.
What members want
Being clear, I am not trying to pick on any single scheme or fund manager here - pretty much every pre-retirement fund strategy will be having similar issues and I would be surprised if many will end the year without double-digit falls in value.
Part of the issue here is what members actually want at retirement, but it is also about getting members to choose and understand what they want.
Some of these funds are targeting annuity purchase - and therefore the falls in fund values should mirror the rise in annuity prices so, if a perfect match, all will be well and good. Other pre-retirement funds target cash, drawdown or ‘those who are yet to make up their mind'.
My first concern is whether people are ending up in choices that are not suitable for the way in which they are likely to retire - either because they do not make the right choice (for whatever reason) or because their provider has defaulted them into a fund which is targeting something different than the outcome they want.
Many are still retiring with small pots so may well decide to take their benefits in cash - meaning protection against negative returns is vital. Others will look to drawdown, where some degree of protection is also important.
If people inadvertently end up in an annuity fund when they really want to cash out in six months' time, they are going to see horrendous losses on their pots.
Low-risk bonds?
The other issue I have is with the language we use to describe these sort of pre-retirement funds. So many are touted as ‘lower-risk', ‘cautious' or ‘protection' assets
Looking around a selection of pension documents, I can see sovereign debt being marked as ‘green' on volatility or ‘lower-risk', ‘cautious' investments. Regulators too have certainly been culpable of this as well.
There is a widespread view that bonds are a low-risk, low-volatility investment. This may have been true during some periods of history, but it clearly isn't true now.
What to do now?
Sadly, it is probably too late to do much for those expecting to retire within the next few months - if they have been invested in the wrong thing, they will have already suffered loss and feel they have received a poor outcome from their scheme.
For the future, we could, as an industry, redouble efforts to engage members and make sure all are choosing the right fund for them in the run-up to retirement.
Innovation may also help here - and things like capital guarantees might play a useful role in some pre-retirement strategies (although whether members will want to sacrifice returns for such guarantees is unclear).
How we label funds and communicate investment risk is clearly an area that also needs to change. Do bond funds still remain ‘protection' or ‘green on volatility' assets? If you judge the likely experience and outcomes of those who will retire in the coming year, the answer is likely to be ‘no'.
Jonathan Stapleton is editor of Professional Pensions
