The two main components of most pension funds are stock market investments and government bonds. The stock market investments are seen as growth assets, and the government bonds are seen as more secure assets. How much of your money is in each will depend on your risk profile, but as a guide, a medium-risk fund could have 40% invested in each asset. The fund manager can increase and reduce the amount held in each.
The economic world is concerned that we are sliding into a recession. The war in Ukraine and subsequent increases in commodity prices such as wheat and oil have contributed to this turmoil. Add to this recent job cut announcements, and it’s clear to see why the profitability of companies is under scrutiny. This has led to an increase in the volatility of the large stock markets, with the Euro Stoxx index down 15% and the S&P500 down 17%, year to date.
With this type of volatility, most pension investors would prefer their fund manager to reduce the holding in the stock markets and increase the investment in more secure assets. And that’s what fund managers would typically do. But here is the real problem.
Government Bonds – not so secure!
Inflationary fears have forced central banks to increase interest rates very quickly. And at record-breaking levels. The ECB rate has gone from 0% to 2% in three months. In the last few years, governments have been borrowing money at next to zero interest rates. The increase in interest rates has reduced the market value of these existing government bonds. Subsequently, the bonds held in pension funds are seeing reductions in value of up to 20%! Remember, these are supposed to be the more secure assets.
The inclusion of other asset classes, such as property, infrastructure, and commodities, has helped lessen the impact. The average medium risk pension fund return is about -10%. The best performing funds have suffered losses of circa -4% to -6%. So clear evidence that diversification works.
It is understandable that people will worry about the economic impact on their pension savings. The important take aways from all this uncertainty is to make sure you know how much risk is being taken with your pension money and how well is it diversified. For more insight or advice on how to manage your pension, contact our Financial Planning team
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