Britain's budget benefits money managers

Changes to the way U.K. defined contribution plan participants access their retirement savings has given money managers a clean slate on which to design investment funds and strategies for retirement.

In his 2014 budget, delivered last month, Chancellor of the Exchequer George Osborne announced an end to the requirement for defined contribution plan participants to buy an annuity to fund retirement. The chancellor said the move gives participants “complete freedom” over how they access their retirement savings, removing a 55% tax charge on withdrawing the whole account at once and implementing instead a marginal rate of income tax, starting April 2015.

With about 350,000 people retiring in the U.K. each year, “the money managers could be the big winners,” said Andy Cheseldine, London-based partner at Lane, Clark & Peacock LLP. “Over 60% of annuities bought last year were for purchase prices of less than £30,000 ($50,000). We expect the vast majority of these to be taken as cash in the long-term — possibly spread over two or three years to keep the member below higher-rate tax thresholds. If managers can build scalable service propositions, offering good value for risk management expertise, then the opportunities are enormous.”

While U.K. insurers already have recognized that the move might signal a far smaller annuities market for them to play in than today's £12 billion market — with some putting all new sales and in-progress applications on hold — money managers are seeing the potential.

Annuities provider Legal & General issued a statement immediately following the budget announcement, detailing its confidence in other retirement offerings: “Legal & General is well-placed to continue to develop a product suite that includes good-value drawdown and protection against longevity risk as well as provision of investment income.”

Standard Life PLC is another annuity provider facing up to a smaller field in which to play.

“We have not put a number on it, but undoubtedly there will be a reduction (in annuity purchase),” said Jamie Jenkins, Edinburgh-based head of workplace strategy at Standard Life. “The question is what happens with the money people have — through automatic enrollment we will (continue to) see an increase in money put into pensions. That money is still there — it is just the compulsion to buy an annuity that is not.” Figures for the company's annuity business were not available.

Money managers could be fighting over £6 billion of new fund flows if just half of the current annuities market were to move to investment vehicles, according to a research note by Philip Middleton and Jonathan Richards, research analysts at Bank of America Merrill Lynch.

“In theory, investors could opt for a 100% equity allocation, although this strikes us as unlikely for the bulk of people,” they wrote March 20. “By and large, we suspect that people will be more tempted by more risk-managed products, such as multiasset or balanced funds ... this would reward providers who have high quality multiasset/risk managed/balanced products, as well as strong U.K. brands.”

“I'm excited by this — it is a big opportunity for us to be on the same stage as life (insurance) companies,” said Simon Chinnery, London-based managing director, head of U.K. defined contribution at J.P. Morgan Asset Management. “Where we ended (in terms of managing DC assets), they took up in terms of annuitization — we can now look at what people would need beyond retirement.” J.P. Morgan Asset Management runs about $110 billion in DC assets in the U.S. and U.K.

Managers believe the increased flexibility changes the investment focus for DC plans in general. “From an institutional standpoint, it is still all about pre-retirement rather than post-retirement, but we are moving from an investment strategy that is trying to hedge annuity conversion risk at retirement to one that is trying to preserve accumulated wealth, as members may want to invest beyond retirement,” said Stephen Bowles, London-based head of defined contribution at Schroders PLC. “Overall the changes have highlighted the need for better pre-retirement solutions, and in all probability created a more robust market for post-retirement options.”

That requires a change from the current lifestyle fund investment approach, and that represents an opportunity for target-date funds to really take hold in the U.K., in line with the U.S. and Australia where these funds are used as a default option. AllianceBernstein said it has already seen a spike in interest for target-date funds in the U.K., while Legal & General Investment Management could see immediate dividends from its February agreement to buy target-date funds specialist Global Index Advisors Inc.

“It is interesting to look at the strategies that U.S. target-date funds offer and how they could be applied to the U.K. ... and what's behind these funds in terms of asset allocation and how that changes over time. Pre-budget it was a bit harder to see how to translate a U.S. experience into the U.K. Post-budget there are more similarities than differences,” said Emma Douglas, head of defined contribution at Legal & General Investment Management in London. LGIM runs £31.1 billion in DC assets, with the majority accounted for by U.K. clients.

“In the old model we were fairly certain that the vast majority of members would be annuitizing, so putting about 75% of the fund into fixed income to coincide with the retirement age was straightforward,” said Steve Charlton, London-based defined contribution proposition manager for Europe at Vanguard Asset Management Ltd., a wholly owned subsidiary of Vanguard Group Inc. “The new unknown is the behavior of people in the U.K. now they have this flexibility.”

Vanguard hired Mr. Charlton at the end of last year as part of a push into the U.K. DC market in particular. “We (Vanguard) are developing our plan — at Vanguard that plan is not constrained by a legacy in the U.K. for DC, but it does benefit from the massive experience we have in the U.S. and Australia, where the markets are now similar.” He said there is also recognition that the DC team in the U.K. will need “additional resources” at some point, “but until we have that plan and know what that means and how we approach that market, the what, who, when, where and why isn't there.”

Standard Life is also considering its options. “The key is how you design investment solutions that can be adjusted and flexible, so if someone decides to stay in work for 10 years, (we can say) here are your options,” said Mr. Jenkins.

“Maintaining a reasonable growth rate from assets will be critical, in conjunction with keeping risk or volatility low,” said his colleague at Standard Life Investments, the group's £184.1 billion money management subsidiary, George Emmerson, investment director-U.K. institutional business. “Potentially, having assets that can create income will become a key consideration as individuals look to phase in retirement either through flexible working patterns or part-time employment, all of which will be used to create overall income requirement for the new retirement path.” The manager's DC assets under management was not available.

If DC participants choose to forgo a guaranteed lifetime annuity, managers have concerns people will simply take their cash and spend it, rather than saving for long-term care.

“There is a danger that we will see more older people in poverty,” said Ms. Douglas. “Suddenly we are forced to face what the U.S. has been facing for a while — that there is a very real possibility that pensioners could run out of money.”

That puts even more onus on the money managers to get it right.

“The budget basically means that lifestyle is dead,” said Tim Banks, London-based managing director and head of client relations in the pension strategies group at AllianceBernstein Ltd., which runs £1.3 billion in DC assets in the U.K, and about £21 billion globally. “The presumption that a member will stay in a scheme for 40 years to a specific day and then annuitize the day after is finished. Virtually all plan sponsors and trustees will have to review, and in all likelihood change, their investment default strategies. A number are also looking at retirement income solutions to help members take their money.

“On average, we believe members will draw their money faster — and we also think more members will invest through retirement rather than to retirement.”

Here's where managers can get smart, said Mr. Charlton. They can draw on experiences in the U.S. and Australia where there is no compulsion to purchase an annuity.

“In Australia we see more than two-thirds of people keep their money in a fund that gets them an income,” said Lesley-Ann Morgan, head of global strategic solutions at Schroders in London. “The other thing people worry about is that money will just be drawn and spent. But in Australia that has not been the case.”

Money managers specializing in real estate might also be in for a windfall. “The real clue is where the antipodean near- and at-retirees invest their money — and it's all about property,” said Amanda Frear, market lead of insurance at business consultancy Capco in London. “Property as an asset class has always been popular with consumers. Over time, most property markets worldwide continue to grow and outperform inflation. The biggest change could be the potential scale of money which could now flow from pension pots to property and property funds — especially (funds) as they have more advantageous tax implications when the drawdown is spread over a number of years, in a country which already has less supply than demand.” n