The Link Between The Financial Markets And Pension Fund Value

Why should those with a pension really care what happens in the financial markets? In the past, most pension holders trusted their pension provider to manage the investment, and its growth, on their behalf so the financial markets (although vitally important to that growth and ultimate pension fund value) were somewhat remote.

The situation changed with the pension reforms (2015) and the growing trend to Pension Drawdown arrangements instead of an annuity. It is now more important than ever for pension holders to have some grasp of what is happening in the financial markets and the potential impact on their final pension fund value.

Pension funds have always been invested in Property, Commodities (including gold), Equities (shares), Gilts, Corporate bonds and a range of other investments. Fund managers have traditionally managed risk, diversity, volatility and liquidity while attempting to maximise growth. For those in pension drawdown that responsibility falls to the individual pension holder and/or their advisers.

It is therefore important to have a grasp of what is happening in each of the investment markets and, with the main enemy of pension growth, inflation. It is also important to understand the relationship between risk and return. To minimise risk it is important to have a portfolio with a suitable balance across a wide range of investments. It is also wise to have a portfolio and balance within each investment type.

COMMODITIES

Typical examples include oil and precious metals. Over the long term, the growth in commodity values tends to track inflation but there is a high degree of volatility (movement up / down). There is, therefore, a risk an unwary investor may be panicked into a sale when the market is down realising less for their investment than if they had waited for the market to bounce back up.

As a simple example, the price of crude oil (WTI) was $57 a barrel in September 2015, falling to around $33 per barrel on January 16 and recovering to approximately $50 a barrel in June 2016. Selling in January 2016 would have been a costly mistake.

EQUITIES

Shares in companies traded on the FTSE (and others). A long-term (110 years) average shows returns of around 7% (before inflation is accounted for) but the short term shows a high degree of volatility and, like commodities, it is important to avoid sale when the market is down. If relying on cash reserves to ride out a period when equities are at a low point it is important to have a medium term view on when markets may turn.

GILTS & BONDS

The return from bonds is typically at around the rate of inflation but the risk is minimal and the volatility lower than commodities and equities. Provided the bonds are held until they mature, the only realistic risk that investors face is that inflation erodes the value of their money and that the interest rates they have locked into at the point of purchase fail to keep up with inflation.

So why is it important for an investor to track the financial markets? Any decision should be based on a long-term view and making minor adjustments to a balanced investment portfolio but to maximise pension fund value it is worth monitoring movements in the FTSE, key commodities and the bond markets on at least a quarterly basis while taking a view on future trends.

The information in this article does not constitute financial or other professional advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances.

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