Sam Liddle: Shielding the pension pot in a ‘perfect storm’

Retirees should remind themselves of the goals of their pension pot – i.e. to provide a stable income throughout their twilight years – and ensure they are as protected as possible during these turbulent economic times, writes Sam Liddle

Although we are by no means out of the woods, we have seen something of a return to normality in Britain.

Shops have reopened, we can eat in restaurants, and just prior to the news that the UK is facing the worst recession since records began, the Bank of England noted that the UK economy had “clawed back” about half of the output it had lost in April 2020.

While this hasn’t seemed to have dented investor confidence as yet with the FTSE continuing to climb (at the time of writing), investors would be forgiven for feeling a little bemused with markets right now.

Against this backdrop, the natural temptation for many retirees and pension savers may be to put more risk on the table in a bid to recover the hefty drawdowns their pensions have suffered this year. However, with huge economic uncertainties remaining, investors must be mindful of walking before they can run.

Anything from a second coronavirus wave and the wider effects of a potential global recession all the way to the UK’s uncertain future relationship with the EU (remember Brexit?) could once again catch out those caught in risk assets.

Today, we feel that retirees should remind themselves of the goals of their pension pot – i.e. to provide a stable income throughout their twilight years – and ensure they are as protected as possible.

A perfect storm?

Recent research from Moneyfacts estimates that the investments of as many as nine in 10 Britons saving for their retirement suffered heavy losses in Q1 2020. And that’s just pension savers.

Ironically, the very purpose of a retirement fund means those who are actually in retirement can end up the worst affected when markets crash.

It comes down to a nasty phenomenon called “pound-cost ravaging”; the process by which retirees are forced to sell larger and larger portions of their pension pot to maintain their preferred level of consistent income as the underlying value of that pot falls.

As mentioned, markets are, for now, in better shape in spite of recession news, than they were during the throes of coronavirus. The recovery officially got underway in May when the economy grew by 1.8% month-on-month, although even this fell well short of analysts’ 5% expectations.

Today, with the economy remaining 24.5% below its pre-Covid-19 level, optimistic investors may be betting on a sharp recovery of lost ground over the coming months – especially given the recent easing of restrictions.

This, however, could prove to be short-sighted.

Investments like equities and property can be a great way of recovering value lost in a portfolio when timing and allocation are correct. However, this is something that even the experts struggle with over the long-term.

They are called risk assets for a reason – when markets turn, they tend to be the worst hit. Today, there is a very real risk of conditions once again turning due to any number of causes.

Whispers of a “second wave” of coronavirus have been circulating since the beginning of the first wave. With cases of the virus surging in July, this risk is becoming more and more real with every passing day. Given many experts expect a second wave to be even more deadly than the first, the World Bank’s repeated risks of the worst global recession since World War Two loom large.

This would affect holdings globally but another concern closer to home for British retirees who are likely to have significant allocations to UK and European assets is Brexit. It may have fallen off the news agenda for now, but it still presents a very real risk for both domestic businesses and those on the continent.

Just this month, more than 100 UK company chiefs, entrepreneurs and business groups wrote to the PM to warn that Britain leaving the EU without a deal at the end of 2020 would be “hugely damaging” to the economy.

Businesses “simply do not have time or capacity to prepare for big changes in trading rules by the end of the year, especially given that we are already grappling with the upheaval caused by coronavirus”, they said.

The importance of capital preservation

With these risks in mind, we believe that retirees should be less concerned with recovering what has been lost, and more focused on ensuring they can preserve what’s left. After all, capital preservation is the key to ensuring a consistent income for an indefinite retirement period.

In this respect, cash (or near cash) is king. This may be a cliché, but this asset class proves its mettle when times are tough. According to Morningstar, the average investment ISA was down 13.3% year-to-date at the end of April 2020, while a cash ISA would have grown an investor’s money by an average of 1.2%

When a large cash allocation is combined with a low-risk approach to asset allocation that can provide “cash plus”, and, in the case of FRNs (floating rate notes), to which we have a healthy allocation, “inflation plus” returns, investors can regularly draw down small amounts that are subsequently recovered. In other words, the impact of pound-cost ravaging is reduced enormously when markets turn.

The multi-award-winning Church House Tenax Absolute Return Strategies Fund has been designed specifically to meet this requirement. Alongside a core 50% allocation to money market instruments, this Fund is spread across many asset classes to provide returns in any macro condition.

By keeping volatility to a minimum throughout the entire market cycle, a much greater emphasis is placed on overall capital preservation.

Because they take risk off the table, multi-asset absolute return funds like Tenax tend not to participate in all the upside on offer when the wider equity and bond markets are booming. But that doesn’t matter. When the tide changes, their stable performance will look a whole lot more appealing to retirement investors whose goal is to ensure smooth returns over an indefinite period.

No-one likes to lose money – especially when that money is a major lifeline for the remainder of one’s retired life. In certain circumstances, adding risk to the table in a bid to recoup lost capital may make sense. However, with so much uncertainty in the air, today may not be one of those times.

For retirees, an approach that focuses on capital preservation by delivering cash plus returns holds the key to navigating stormy waters in 2020 and beyond with a stable income and sustainable pension pot intact.

Sam Liddle is a director at Church House Investment Management