On Wednesday September 10 2008, Lehman Brothers posted a loss of $3.9bn for the three months to August. Confidence in the firm evaporated and, in the absence of a US Government bail-out and unable to find a buyer, it filed for bankruptcy protection on Monday September 15.
It was a thunderbolt that left the world in no doubt that the financial crisis was real and that no institution was safe. Only weeks earlier the great and the good in the City had been confident that no British bank would go under – Lehman’s changed that notion overnight and panic ensued.
Markets crashed and the FTSE All Share lost a third of its value by the spring of 2009, falling from 2,653 on September 15 in 2008 to 1,789 on March 6 2009. The financials component of the FTSE All Share fell even harder, losing about two-thirds of their value.
The loss of confidence also led to a borrowing freeze and credit markets reacted as never before. Sterling credit spreads, a key measure of the fear corporate bond investors feel that their investments will not pay out, were already unusually high, but they shot up from 3.6 to 4.4 per cent in a week and then just kept on rising to an unprecedented 10 per cent.
Investors poured money into gilts, sending prices upwards and yields crashing down. The yield on the two-year gilt fell from 4.3 per cent on September 15 to 1 per cent on December 23.
Two years on and markets have recovered. Central banks initiated quantitative easing (QE) to keep economies afloat and banks have returned to profit. And in the UK all the major banks, including those that had been bailed out have just announced bumper figures.
But what of the pensions landscape? Did trustees make knee jerk reaction to the market upheaval, or did they sit tight and keep strategies intact?
According to the NAPF, the level of contributions weathered the storm: In its latest annual survey the average contribution rate to DC pensions remained stable with the average employer contributions standing at 7.5 per cent and employee contributions at 4 per cent. However, assets have fallen.
Total defined contribution schemes assets in the survey amount to £7.6 billion. The average asset value for schemes was £53m, although a handful of typically large defined contribution schemes drove this average value up. The median value was £12m in 2009, compared to £11m in 2008. The average fund value per member is £15,940, compared to £18,500 in 2008.
Pension experts reckon that the employees that would have suffered the most would have been those close to retirement and had a significant exposure to equities.
Members a long way from retirement who were still invested 100 per cent in the accumulation phase may have seen their funds fall by 40 per cent but they should have sufficient time to recoup their losses. On the other hand, most members very close to retirement won’t have suffered much as they would have been in fixed interest and cash.
Lee Smythe at Killik, says: “Looking at the most commonly held funds in group pension schemes – balanced managed funds – most investors would have been lucky to see a 5 per cent return over the last two years, despite the funds not being entirely invested in equities and over three years, the majority are probably slightly below water.”
Given the severity of the crisis, many schemes have looked at ways of protecting members’ funds.
Patrick Bloomfield, partner and actuary at Hymans Robertson says the most enduring impact of the credit crunch has been to put risk at the centre of pension fund trustees’ minds. In the NICE decade (non-inflationary consistent expansion) prior to Lehman’s collapse, volatility and downside were becoming a hazy memory and weren’t given sufficient weight in strategic or tactical investment decisions.
“The messages that advisers have put forward haven’t really changed, but downside considerations have resonated with pension fund trustees much more than before Lehman’s collapse,” he says.
“Lehman’s collapse restored a certain amount of common sense which was missing at the peak of the credit bubble. Pension fund trustees are much more wary of heavily engineered financial products and have returned to the mantra of ’if you don’t understand it, don’t buy it’.”
Pension experts admit that the crisis has forced trustees and consultants to re-examine the asset mix of schemes.
“Within the balanced and multi-asset fund space, there has been a gradual shift from more UK equity biased funds to a more global equity biased asset allocation. Historically the typical default fund has been a 70/30 split between UK/Global equities,” says Julian Webb, head of DC pensions, at Fidelity. “A 60/40 split is now typical and in some cases schemes favour a higher weighting to global equities compared with UK.
he events of 2008 did not affect the pace of this move from UK equities to global equities – rather they have stressed the importance of having a mix of asset classes and variety of market exposure to reduce volatility.”
Diversified growth funds had already been starting to emerge but the market falls gave fund providers the perfect excuse to promote them, as schemes looked for ways to produce steadier less volatile returns.
Emma Douglas, head of DC sales at Blackrock says that Lehmans has accelerated the trends that were emerging before it collapsed. She argues that schemes were already questioning whether 100 per cent exposure to equities was the correct strategy for most members and they were constructing lifestyle strategies based on a 70:30 split of equities and bonds.
“I have done a lot of member presentation and questions coming from the audience have been along the lines of ’you at Blackrock don’t have a positive view on equities at the moment, so why are we 100 per cent in equities?’ Members are starting to want fund managers to do more and make decisions on their behalf by looking for the best place to invest money.
“People like products that limit the downside – it’s why they liked with-profits. Diversified growth products meet members’ needs more than 100 per cent equities. We have 22 schemes that are using our diversified fund, either as their default or as part of their default fund. Prior to Lehman’s they would have been using global equity funds.”
The appeal of diversified growth funds to employers and trustees was that they purport to offer a “safer” default to their members. The adage of these funds is that in theory they shouldn’t fall as far as a fund with 100 per cent investment in equities but they can, and do, still fall significantly.
Helen Dowsey at Aon Consulting says: “My worry is that the message to members can be misleading as they often have a target of inflation plus 2, 3 or even 5 per cent a year and the fact that these targets may be over rolling five-year periods is not always understood by members who may expect to see positive growth at all times.”
The aftermath of the Lehmans collapse has also cast doubt on the efficacy of the popular lifestyling approach. While there is no doubt that some people would have benefited from the move out of equities, the turbulence that hit the fixed interest markets meant that few assets escaped the fallout. When equities hit rock bottom and gilt prices soared as a result of QE, some members’ funds would have been switched out of equities into gilts at exactly the wrong time as a result of lifestyling. Laith Khalaf at Hargreaves Lansdown says: “The problem is that is a clunky approach, but there is no real alternative to lifestyling unless GPP members are willing to take investment decisions into their own hands and de-risk their portfolio themselves.
Dowsey adds: “Members with a very few years to retirement were the hardest hit: often with high exposure to equities and in the process of monthly switching to fixed interest and cash thereby consolidating their losses. Many members I spoke to over the last couple of years were miserable about the possibility of having to put their retirement plans on hold.
Consultants say that there is a more positive mood towards alternatives such as target date funds and so-called glide path funds, but studies have yet to dispel the notion that lifestyling works.
Last month, the Staple Inn Actuarial Society paper Economic Rationales for Defined Contribution Investment Solutions: All We Need To Know concluded that traditional lifestyling strategies “still makes sense” – and the report covered the post-Lehman era.
It said that historical data from 31 December 1985 to 31 March 2010 suggests that lifestyling strategy with nine-year switching periods had the best average absolute performance compared with other lifestyling strategies with different switching period. On risk adjusted basis, lifestyling strategy with a switching period of around 12 to 14 years have been the best performing lifestyling strategies, it said.
The financial and economic turmoil and market volatility heightened the need to review investments, funds and asset allocation. Governance became an issue. The likes of Aegon and Scottish Widows announced that they were revamping their GPP ranges so they take a more hands-on approach to asset allocation while Scottish Life made a lot of noise about its Governed Range.
The NAPF got in on the act with the launch of its Quality Mark. Its judging panel recognises trustees, management committees and stand-alone annual reviews as proof of good governance, while employees must be provided with clear and engaging communications. So far 62 schemes have met the required standard.
Joanne Segars, chief executive at the NAPF, says: “The market jitters caused by Lehman’s has put more responsibility on trustees – governance is an issue. It is why the NAPF introduced its quality mark and we think the industry has upped its game. It has also improved communications to members.”
That said, the NAPF annual survey doesn’t show a marked improvement. In 2008 just 22 per cent said they reviewed their schemes at least annually, and this number was just under a third in 2009. The key is whether this upward trend accelerates or stabilizes in the years ahead.
The crisis has caused untold misery and sparked a global recession of gigantic proportions but most pension experts agree that one positive that has emerged is that members are more interested in their pension than they were two years ago.
As Douglas admits: “You have seen more people turn up to a seminar even though it will not be on the top of your wish list on how to spend an hour. Yet post-Lehman’s far more get the fact that pensions are an important issue.”
The pension industry will be hoping it’s a legacy that remains.
What the crunch did to retirement
Members of DC and GPP schemes have the added concern of dealing with annuity rates and annuity choices when they retire. And if one thing is for sure, annuity rates have nose-dived over the past couple of years. This is due to bond and gilt yields, which have fallen as a result of QE and the perceived reduction in default risk since the collapse of Lehmans.
According to Burrows Cummins, two years ago a £100,000 purchase, joint life 2/3rds, man 65, women 60, level annuity would have paid out more than £6,700 a year. Today, falling annuity rates mean that the annuity would pay just £5,700.