Warning re Stakeholders/Personal Pension vs SIPPS

Pal

I agree with most of your comments Chris: risk is almost entirely misunderstood, and the way that Ed bands around high yield stocks as being low risk is extremely misguided in my humble opinion.

However, this being the pensions board, you have perhaps missed the point about bonds and gilts, particularly when considering bond or gilt indicies. It is possible through tracker funds to track these indicies fairly closely, removing much of the risk of underperforming the index itself. Most importantly however, the movement of these indicies is almost entirely negatively correlated to the cost of purchasing a pension annuity. So by investing in a mixture of bond and Gilt indicies, the investor can remove the risk that the amount of pension they can buy with their final pot of money on retirement might fall.

As a result, while holding bonds in the longer term might prove to be misguided if alternative assets could offer outperformance, holding them in the short term when approaching retirement might be beneficial as a risk reduction mechanism. An investor might take the entirely reasonable view that it doesn't matter if the face value of bonds fall by 2.3% p.a. over the next 1,2,3+ years, as long as the cost of purchasing an annuity is falling by the same percentage, leaving the total pension at retirement the same.

Obviously the investor might prefer to invest in cash instead if bonds are expected to fall in value, thus increasing their retirement income. But that, obviously, is taking an investment "risk".

In a pensions context, linking investments to bond and gilt indicies can be about as low risk as you can get. Cash is more "risky".

The fact that BGI are forecasting bond returns of -2.3% over any future time period does not make -2.3% the return "expected" by anyone except BGI's marketing department and whatever resources they used to come up with that made up figure. I am also bearish on Corporate bonds and gilts in the long term, but that doesn't mean that bond prices are going to fall over any future long or short time periods.

I am also bearish on house prices, but they don't seem to be falling either...

Chrismaths

Ah, the old liability matching chestnut. Fair point - I think you've illustrated my multidimensional risk very well. But again you have used risk in 2 slightly different manners - index risk (also called tracking error) and liability risk. If you do match your liability (that required to buy an annuity) then essentially you are fixing your annuity rate at today's level. Not entirely sure why you'd do that but it's definitely another kind of risk.

I'm intrigued as to how you'd use the bond indices to match the liability though - how would you manage the duration? I haven't seen too many retail trackers of sections of the market (only really a couple of long gilt funds). Annuities depend on the gilt yields between date of commencement of benefits and the date the life company expects you to die. So you'd have to manage your duration reasonably accurately to match the liablities.

Given the removal of compulsory annuity purchase, I don't think I have missed the points. A pension can now be treated just as any other wrapper - ie focus on investments. Making money is making money - to construct a proper portfolio for someone's needs you need to take into account a) income requirements, b) attitude to risk/return c) for how long they intend to invest. Obviously this is a simplification, but how does that differ with pension investments?

It also wasn't the face value of bonds that would fall, it was the total real return expected from bonds. Given that 2.3% is pretty similar to inflation currently, That means a total nominal return of 0.

As a final caveat, a favourite quote from JM Keynes - "The market can stay irrational longer than you can remain solvent". Just because something should fall, doesn't mean it will... Quite appropriate in these liquidity influenced times...

EdInvestor

I agree with most of your comments Chris: risk is almost entirely misunderstood, and the way that Ed bands around high yield stocks as being low risk is extremely misguided in my humble opinion.

I assume you are referring to the High Yield Portfolio concept which I have mentioned to a few posters whom it might suit in the past.

This concept does not include just any old high yield share. It has specific rules on size of portfolio and of market cap of the constituent shares, on dividend history and cover, on gearing and on sector diversification.These guideliness seek to remove as much risk as possible while retaining good performance. This makes the HYP a comparatively low risk way of investing in equities, similar to Equity Income funds but without the drag of high charges.

Nowhere have I ever said that "high yield shares are low risk."

Anyone who invests in an HYP needs to be happy to take equity risk, of course. However since that includes anyone with a pension, endowment or investment bond - ie virtually all "clients" of advisors, I wouldn't have thought it was a problem.

Here's what's behind this problem:

Fear of regulator stops IFAs recommending equities for income

Chrismaths

So a pretty similar concept to the FTSE UK Div + ETF, or the DJ Euro Stoxx Dividend ETF. Shame both of those have been significantly outperformed by most funds despite the 'drag' of high charges. Even an equity income fund with a performance fee has outperformed the FTSE UK Div+ by 8% since launch with less volatility! I don't know how these high charging fund managers can live with themselves...

PS. You've got it spot on with why people are scared of equities though. A regulator - someone who prevents the problems that occurred in the past from occuring in the future whilst ignoring current problems...

[Deleted User]

Anyone considering running their own sipp needs to be comfortable in working out their risk profile and also an asset allocation chart. I have done this via a pie chart. It includes a hyp portfolio of my own choosing with regard to various criteria to include diversification and gearing etc. I also include five funds based on fund and manager performance. Cash is included. Any more details re asset allocation for various risk profiles can be easily found on the net. For the funds I pay an initial charge of 0.25% or nothing and an annual management charge of 1.25% for 3 funds and 1.5% for 2 funds. For the hyp stocks only the initial dealing charge capped at £30 plus stamp duty

My sipp is starting to shape up into a vessel that I can leave alone. It willl be providing income and growth

I regard my sipp allocation as safer than the three funds I had in my sw stakeholder. It is not rocket science to set one up but it does take planning in which risk assessment plus asset allocation are paramount

EdInvestor

So a pretty similar concept to the FTSE UK Div + ETF

No, quite different.The ETF has no risk filters.

Chrismaths

Yes it does. It is one year forecast dividend yield it is weighted by.

The DJ Euro Stoxx Select Dividend requires non-negative earnings growth, a well covered dividend and some other stuff I can't remember.

EdInvestor

The Euro one sounds as though it has some risk filters but

It is one year forecast dividend yield it is weighted by.

How is this a risk filter?

Surely it's quite the opposite?I mean some shares have a high yield because they are duff shares. These shares needed to be weeded out for safety.You don't just run down the list and pick the top 15 listed shares by divi yield for an HYP, that's not how it works at all.

Note also that outperformance is not the point. Rising income is the point.

moneytroll

kittie wrote:

For the funds I pay an initial charge of 0.25% or nothing and an annual management charge of 1.25% for 3 funds and 1.5% for 2 funds.

Just to pick up on something regarding camparisons of fund charges (of the same funds - like for like) in a SIPP and in a pp. When looking at funds in a SIPP (eg from HL), there's often a rather significant difference between AMCs and the actual annual TERs, because of "other expenses" that would put an extra drag on the fund. The way charges are presented in Sipps is more or less transparent (because amc and TERs are published seperately).
So for example, the Aberdeen Emerging Markets fund has an "innocent" amc of 1.5% of which 0.25% is rebated (from HL). So far so good. But if you look at the annual TER of this fund, it is as high as 2.35%! (because of "other expenses", which are NOT included in the 1.5% amc). For some funds (especially fund of funds) the annual TERs are even higher still!
My question is, (so that I and other people can understand the somewhat less transparent charging structure of Personal Pnesions), would those "other expenses" be included in the amc of a personal pension? Or is it added somewhere within the funds of a particular Personal Pension on top of the amc? If latter is the case, then the 1-ish% amc from some personal pensions providers is really not that attractive at all if the funds within this plan will be added with these mysterious "other expenses" which can go well above 1%!

Anybody knows "the truth" behind this? I have attempted to asking this in other threads but haven't managed to get an answer.

moneytroll

Does nobody know then if these "other expenses" are included in the AMCs of PPPs?

To explain why I am still confused about the way PPs present their charges:
I received a quote from a PP provider and it says that the amc is 1.25%. (Is this fairly typical btw?)
However, it also says that the effect of deductions would bring the investment down from 7% to 5.2% pa. So there must be somewhere another expense of 0.55% incorporated which would bring the total annual deductions to 1.8% (which would be the TER I guess) which is suddenly much steeper for no apparent reason than the 1.25% originally quoted. (Putting it another way, the final sum of all deductions will amount to 37% of the final value of the investment after 30 years.)
Why are the TERs not published by PP companies? (or is it just mine) The SIPP companies do and it is so much clearer to see exactly how much you are charged etc.

That means that if PPs do quote their amc at 1-is% but the actual TER is higher in reality, that doesnt' make their plans more attractive at all when compared to SIPP products. Just because the charge isn't presented visibly, doesn't mean it's not there.