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It would be a nice touch if Rachel Reeves were to stick some cotton wool in her mouth — à la Marlon Brando mumbling his way into the screen role of The Godfather — for next week’s Mansion House speech.
But even if she does not, it will be clear she is making the pensions industry “an offer it can’t refuse”.
Don Corleone underlined his point with a horse’s head in the bed of an unco-operative Hollywood producer. The chancellor is expected to demonstrate her own muscle to pensions companies with proposals for a “reserve power”. This could require default funds to invest 5 per cent or more of their money in UK private assets, such as private equity, if they have not done so voluntarily.
The “voluntarily” bit is a polite fiction, of course. The mere threat of duress — and the bad publicity that would result if it was exercised — will ensure that big pensions companies will all fall meekly into line.
When the government starts commandeering default funds as piggy banks to support its policies, pension investors should start paying attention. Otherwise, our money may wind up invested in ways that may not suit us.
Zoe Alexander, head of policy at Pensions UK, an industry body, says: “If investment targets are set and enforced by government, that may increase risk and damage trust.” Bank of England governor Andrew Bailey has also expressed grave doubts.
Politicians and businesses have always used the inertia of citizens and customers to their own advantage. The tactic has become omnipresent since organisations discovered they can bombard us with bumf over the internet. “Tick box if you do not want to receive marketing emails,” is one familiar wheeze.
Inertia-based persuasion was given intellectual heft by “nudge theory”, as formulated by US behavioural economists Richard Thaler and Cass Sunstein. They described how policymakers could build “choice architecture” biasing the public in favour of particular actions in their 2008 book Nudge. Converts included erstwhile Tory prime minister, David Cameron.
In 2012, his government implemented a law devised by Labour predecessors that smacked of nudge theory: auto-enrolment of UK employees into defined contribution workplace pension schemes.
Only one-tenth have exercised their right to opt out. Some £115bn was invested in the first 10 years of auto-enrolment and the total continues rising.
A second level of inertia — the disinclination of employees to choose investments — has channelled most of the money into default funds set up by savings and investment companies. These already sheltered hundreds of millions in DC assets.
“We have default funds to make it easy and frictionless for people to join pension schemes,” says Jesal Mistry, head of DC investment governance at Legal & General Investment Management. “They are designed to cater to as a broad a group of people as possible.”
Pensions companies usually switch money out of risky but potentially remunerative equities and into safe, but supposedly unexciting, bonds as default fund investors age. This trajectory is referred to as a “glide path”.
The coinage is more apt than I suspect its inventors knew. A glide path can end with a crash in a turnip field miles from the airfield unless a real glider has sufficient altitude. In gliding and retirement saving, it is always best to start high if you can.
Research by the Pensions Policy Institute (disclosure: I’m a trustee of this charity, my views are my own) found that the typical default fund investor has around two-thirds of their money in equities 20 years from retirement. By their selected retirement date, two-thirds of their pot will be in bonds and cash.
So far, so good. Auto-enrolment nudges people into putting aside more for their senior years. Default funds provide commonsense investments for folk too idle, uninformed or busy to pick their own.
The problem with default funds is that they are a one-size-fits-all solution. Most pensions businesses have tweaked glide paths to allow for the abolition of compulsory annuity purchase and the boom in drawdown products. Even so, a lot of equity risk is still liable to be taken off the table as we age.
This will not suit all of us. You might, for example, have substantial backup assets, such as an old defined benefit pension or a business you plan to sell. In such cases, you might prefer to remain exposed to equity risks and returns via a DC pot well into later life. Conversely, poor health and modest means might incline you to reduce investment volatility faster than peers, ahead of an early annuity purchase.
Overcome your own inertia and check the specification of any default funds you own. You may be able to extend or shorten your investment glide path by increasing or reducing the retirement age you specify to the pensions company. This need not coincide with when you actually stop working.
Equally, you can shift some or all of the money out of default funds and into investments you judge more suitable. That was my course of action with an old DC workplace scheme that was switching my pot into bonds faster than I liked.
The government is well on its way to providing a bloody-minded minority — me included — with an additional motive to pick our own pension investments.
I am sceptical whether UK private assets would generate value for me. Costs are high and I am not convinced historic performance figures are accurate. There are many other objections, including illiquidity and high exposure to a relatively small market.
And I am doubly suspicious when a politician with an economic agenda starts jostling me towards them. Unless I find a horse’s head at the end of my bed, courtesy of Rachel Reeves, I plan to opt out of default funds.
Jonathan Guthrie is a writer, an adviser and a former head of Lex; jonathanbuchananguthrie@gmail.com
