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Take an active role in passive resistance

Rewind the clock to 1985. At the time, most of the adult population was more likely to as sociate equities with the union for the darlings of stage and screen than with pension funds.

Since then, we have seen privatisations, demutualisations, Peps, Isas, technology sector booms and the odd stockmarket crash.

Stakeholder pensions will have low, transparent char ges, so the question now facing pension investors is not so much “How much money will they take off me?” as “How much money can they make for me?”

Get this one right and you deserve to sell a lot of pension business.

A recent survey of the pot en tial major players in the stakeholder market looked at their views on a variety of stakeholder-related issues, including their preferred choice of default investment fund. Managed funds and lifestyle risk management dominated the responses, with a smattering of with-profits, tracker and guaranteed funds making up the numbers.

This would suggest the pension industry is waking up to the demands of a more inf ormed and discerning market, in which it is no longer relevant to tell the client: “Come back in 30 years and we will tell what income you can have.”

What about with-profits? Well, the ABI and its more vociferous members have argued that with-profits should be included in stakeholder. They seem to be suggesting many stakeholder investors will be relatively unsophisticated lower earners who cannot understand the subtle art of investment risk management and that, for these people, the cosy security of a nice, safe with-profits fund should be just the ticket.

To my mind, this is a backward-looking approach which should be consigned to history, along with other arcane practices such as capital units, reduced allocation periods and policy fees.

How can you describe an investment that can deliver in excess of 50 per cent of its total return on the last day of investment as low risk? With-profits funds are prey to myriad potential banana skins, from actuarial misjudgement to over-enthusiastic promises made by marketing departments. If markets fall far enough, market value adjustments can take away even the reversionary bonuses.

The investment strategy of the fund is tailored to meet the requirements of the insurance company and the average needs of its pool of policyholders. No account is taken of an individual investor&#39s personal requirements.

Comparing historical inv estment returns of with-profits funds is an uncertain business. No realistic assessment of an institution&#39s future inv estment prospects can be made without factoring in its financial strength, market position, present and future liabilities (including the ones it has not yet budgeted for) and the overall asset mix of the fund.

Any way you cut it, with-profits funds are incompatible with the fundamental principles of stakeholder. In investment terms, they have all the transparency of a brick wall.

Tracker funds have made a virtue out of buying stocks after their price has risen and selling them again when their price falls. Bizarrely, this strategy actually works some of the time and, for much of the last few years, tracker funds have shown creditable performance relative to the average actively managed fund.

It is important not to get carried away by the latest fashion trend and recent res earch from Standard and Poor&#39s tells a very different story for the last 12 months of turbulent stockmarket activity. Over a 12-month review period, the average total ret urn from an actively managed fund is 11.1 per cent compa red with a 7.6 per cent rise in the FTSE All-Share index and a modest 4.4 per cent increase in the FTSE 100.

This appears to bear out the theory that a tracker fund will perform well in a stable, rising market but will display all the self-preservation ins tincts of a depressed lemming when times are hard. For the long haul of pension fund man agement, the case for tracker funds remains unproven.

A managed fund (as opp osed to an actively managed equity fund) will invest across a range of asset classes, inc luding bonds, property and cash as well as equities, using the skill and judgement of the fund manager to deliver the best returns in a range of economic conditions.

In fact, the asset mix of the typical managed fund often bears an uncanny resemb lance to that of a with-profits fund. However, while managed funds are at least more transparent than with-profits funds, they still suffer from the one-size-fits-all approach. An acceptance that they are suitable for the entire life of a 30-year-plus investment is tantamount to suggesting that investors&#39 risk/return requirements are uniform throughout the same period. This is daft.

Lifestyling delivers equity exposure through the majority of the life of the contract, accepting market fluctuations and volatility as the necessary price to be paid for overall ret urns in the long term. Young investors can and should take risks. In the majority of cases, stakeholder investors will be making regular contributions and, given the effects of pound-cost averaging, market falls will not necessarily be a bad thing – they may actually be a good thing.

Consistently selecting the best sector funds will und ou btedly produce the very best returns but this may well be an unrealistic ambition for a target market that can, in some cases, still regard a managed fund as a little bit risqué. Nevertheless, the use of act ively managed international or UK equity funds for the bulk of an investment term should make a substantial and positive difference to the value of an investment.

Lifestyling will also reduce the investor&#39s risk exposure in the later years. By moving money from highto low-risk funds over a period of several years in the run-up to retirement, an investor can accept a gradual loss of potential gain. This is the trade-off for inc rea sed security at a time in their lives when volatility is no lon ger acceptable.

It is important to remember that, for all the funny tax treatments that they enjoy, defined-contribution pensions are still investment vehicles. The removal of much of the charges complexity that has for so long obscured the mech anics of pension fund investment to anyone without a degree in rocket science – or at least a three-week training course from a direct-sales company – will open up the pension market to investor control.

Individual pension acc ounts will accelerate this pro cess as the big fund management houses cast covetous eyes at a massive market that has hitherto been the comfor table preserve of insurance com panies. The fun has only just begun.

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