“Sell them the dream.” I first heard this phrase used more than 30 years ago, during one of the many ‘get-to-know-you’ visits to advisers across the country while working at Money Marketing.
I was reminded of the need to “sell the dream” a few weeks ago after hearing chancellor Jeremy Hunt’s Autumn Statement, in which he claimed his plans to increase the amount pension funds invest in unlisted shares could “provide an additional £1,000 a year in pension income for the average earner”.
The claim originates from Hunt’s Mansion House speech in July this year, when he announced up to £75bn of people’s pension funds will be invested into higher-risk investments by 2030. Hunt has since gone on to make the same claim numerous times, the latest occasion being his Autumn Statement.
You don’t have to be a genius to realise this extra £16,000 is doing some incredibly heavy lifting as to the additional pension income it might deliver
This headline figure is now treated as gospel. It certainly sounds wonderful: who wouldn’t want an extra grand a year to spend if it cost them nothing in return?
But where does the £1,000 number come from? It is contained in a set of financial assumptions published by the Department for Work and Pensions (DWP) at the same time as Hunt’s Mansion House speech.
The DWP document looks at a pension pot built up over 30 years by someone on earnings of £30,000 a year who contributes 8% into their pension each year. It states: “Assessing gross returns (before charges) in the median case, pots could be around 5% higher after 30 years with a 5% private equity allocation to replace bonds.”
All this assumes, of course, a metronomic set of annual pension contributions over the course of someone’s working life
So, a fund with no private equity in its asset mix and median returns might grow to £273,300. A fund with a 55/40/5 mix of equities, bonds and private equities could grow to £283,000. A fund with a 60/35/5 ratio might grow to £288,200. That extra £16,000 is what buys us the additional £1,000 in annual income, apparently.
You don’t have to be a genius to realise that this extra £16,000 assumed increase in the value of a pension fund is doing some incredibly heavy lifting as to the additional pension income it might deliver, not least in terms of what annuity generates a 6.25% income from a lump sum.
Moreover, the additional median growth in the value of a fund is predicated on the assumption management charges levied on private equity investments would be the same as for listed equities or bonds.
Returns will barely change for most of us, although the risks taken with our pension pots will increase
Using a 2/20 fee structure – 2% per annum charge with a further 20% performance fee on returns above 8% (not an unusual figure) – returns on that 55/40/5 mix would actually be lower than with no private equity held in the fund.
Even assuming a 1/10 fee structure – an unusually low fee for private equity investments – returns are barely £4,500 better in a 55/40/5 mix and just £9,000 better in a fund with a 60/35/5 ratio.
All this assumes, of course, a metronomic set of annual pension contributions over the course of someone’s working life. Uninterrupted by anything such as losing one’s job, divorce, paying for kids’ education or the many other financial crises that regularly affect real life human beings.
I was reminded of the need to “sell the dream” a few weeks ago after hearing chancellor Jeremy Hunt’s Autumn Statement
Unbothered by the lack of any rigour in these calculations – and generously committing our own pension pots to Hunt’s pet project – the UK’s largest defined contribution pension schemes are now saying they will direct 5% of their default funds into unlisted equities within the next seven years.
Aviva, Scottish Widows, L&G, Aegon, Phoenix, Nest, Smart Pension, M&G and Mercer all signed a so-called Mansion House Compact to this effect in July. Other providers, including Aon and Cushon, have since climbed on board.
These companies will invest in illiquid private equity vehicles, perhaps even create a few themselves, that allow them to charge us higher fees to “manage” our money. Returns will barely change for most of us, although the risks taken with our pension pots will increase.
Still, it’s always good to follow the dream, isn’t it?
Nic Cicutti can be contacted at nic@inspiredmoney.co.uk
I have some vague recollection that some part of the parliamentary pension schemes, amongst a few others, actually have some real investment rather than just taxpayer funded.
I sugest it would be beholden upon Hunt to ensure that all of these public sector schemes invest in his pet projects and leave the private sector alone.
This is pretty damning information by Nick.
Yes Nic, quite so. But also please don’t forget the strictures from the regulator about risk. Woodford’s fund had oodles of Private Equity and look what happened to that. Fine for the experienced investor who actually has the option to choose, but those in AE or DB schemes have little or no say where their hard earned money is invested. Thank heavens those who have PPs or SIPPS can make up their own minds.