Here's how to weather your SIPP from stockmarket storms
February's market wobble was a timely reminder that stockmarkets can go down as well as up. For almost a decade, there has been little apparent risk in stock or bond market investment. With only a few exceptions, investors could have chucked a dart at the Financial Times, invested where it landed and probably have made money.
This was largely the effect of the loose monetary policy employed by central banks to deal with the fallout from the global financial crisis. It has been a generally happy time for investors with or without a dart, who haven't had to do very much to see their savings pots grow.
This was always likely to change as interest rates started to rise - as they have in the US and, more tentatively, in the UK - and central bankers reined back on quantitative easing. The question is how, or whether, long-term SIPP investors need to adapt their portfolios for this new, probably more volatile environment.
First is a philosophical question: should longterm investors adjust their portfolios at all? Many would argue that investors should set their asset allocation according to their long-term goals, review it periodically, but largely forget about market noise in the interim.
Tim Cockerill, investment director at Rowan Dartington, says: "There is a danger for investors in focusing on short-term noise. They have knee-jerk reactions and may make mistakes. The ideal is to have a SIPP that is already well-diversified. In this case, a sell-off doesn't matter too much."
All risk assets carry the risk of loss and the key is to look through these short-term movements to the long term.
Certainly, few investment experts would recommend trying to time the right point to get in and out of the market.
George Houston, technical director at Mattioli Woods, says: "There is little doubt that there is an element of fear in clients' minds at the moment about a possible market correction - and recent volatility has only added to this - but no-one can call the markets, not even those who cry "I told you so!" after the event."
However, the current changes in the wider economic environment - from loose monetary policy to tighter monetary policy, from deflation to inflation, from weaker to stronger economic growth - are more than just noise.
They are likely to have an enduring impact on bond and equity prices and it is worth making sure a long-term portfolio can withstand these shifts, for a number of reasons.
Perhaps most importantly, the environment for bonds may be about to change dramatically. Higher interest rates do not favour bonds and yields have already started to rise (and prices to fall).
Bonds tend to be used as the ballast for a portfolio, particularly for those nearing retirement, and historically this has worked very well.
However, the average UK gilt fund is down 3.2% for the year to date: that's a significant drop in two months for a 'safe-as-houses' investment. Index-linked gilts have lost even more (and that is at a time when inflation is strong).
Assets in a new environment
In other words, traditional assumptions about the role of equities and bonds in a portfolio may not work in the new environment. Bonds may not work to protect capital, or to provide diversification.
At the same time, no-one can say with any certainty how long this new climate will last. If it were just going to last a few months, investors could sit it out and wait for the previous conditions to return.
However, estimates vary wildly - anything from 12 months to a decade. As such, it would seem sensible to reappraise for a new environment.
The extent to which investors need to be concerned about the changing economic backdrop will also depend on how close they are to retirement.
Those in their 40s, with 20 years to wait until they draw on their retirement pot, probably don't need to worry too much about a couple of years of troublesome markets.
However, those who have five years or less until they move into partial or full retirement should perhaps be paying attention.
Steve Patterson, managing director at Intelligent Pensions, highlights a phenomenon called 'sequence risk', which is an important consideration for those nearing or at retirement.
This means that there are times in the investment lifecycle when an investor needs to pay particular attention to preserving capital.
Patterson says: "The sequence of returns can have a major impact on the longer-term value of your retirement pot. Someone who enjoys strong growth in the early years of retirement will do much better in the longer term than someone who suffers negative returns in the early years."
Research from Aegon put some figures around this issue. It looked at a retiree with a drawdown pot of £225,000 taking a theoretical drawdown income of £13,600 each year, and calculated how the stockmarket would impact their money over the next decade.
It found that if that person had invested in January 1995, ahead of the giddy stockmarket returns of the late 1990s, they would have a pension worth £269,219 at the end of the period.
Someone who invested five years later, at the start of January 2000 when the technology bubble was about to burst, would have ended up with just £114,303 after 10 years.
Patterson says investors need to have an investment strategy that mitigates sequence risk. To his mind, there is no magic to the right solution - it is simply to draw income from a diversified portfolio of funds.
"This approach means that income withdrawals are captured from whichever asset class is showing most profit at that time, avoiding the problem of being forced to sell when prices are low."
Cockerill agrees that a blend of assets is particularly important in the current environment, where it is difficult to judge the direction of travel in markets.
He says: "Investors need a blend of property, equity, bonds and alternatives, each with low levels of correlation and volatility. Another recommendation would be to focus on incomegenerative assets. If you have a portfolio of income assets, there may be a wobble, but the income will provide some consistency, and for many people that is important."
Mark Taylor, chief customer officer at Selftrade from Equiniti, says true diversification should consider all types of equities, including developed and emerging markets as well as small to large-cap companies, fixed income (both sovereign and corporate, diversified across different regions) and, importantly, uncorrelated asset classes such as infrastructure, property and commodities.
Dialling up these 'safer' assets is another option for SIPP investors looking to protect their portfolio against a more difficult environment. For this to be an effective strategy, investors need to seek out those assets where returns tend to bear little relationship to classic stock or bond markets.
SIPP portfolios for different stages
Source: interactive investor Past performance is not a guide to future performance
In addition to property or infrastructure, this may involve assets such as gold or absolute return funds.
Crucially, it probably shouldn't include cash. Cash is a 'crisis' asset class, and investors will often retreat into it at times of maximum fear.
Taylor suggests it is worth holding some of a SIPP portfolio in cash to avoid being a forced seller in a declining market.
However, holding too much in cash is likely to interfere with longer-term goals, given that almost all investment goals - a comfortable retirement, extensive holidays, the ability to help younger family members - necessitate beating inflation.
While savings rates are likely to rise as interest rates rise, they continue to lag inflation. Short-term preservation of capital should not trump long-term preservation of real wealth.
Gold strengthens on the back of dollar weakness
Gold has much of the liquidity of cash, but a higher potential upside. It has shown a strong run since the start of December, largely on the back of a weakening dollar.
It is relatively easy to access, either via gold ETFs or, for the traditionalists, by buying gold bars.
That said, it has not always been a good store of wealth, losing around 30% of its value between 2013 and 2016, and should only ever form a relatively small part of a SIPP portfolio; but it has tended to perform well at times of market turbulence.
As such, investors worried about turbulent times ahead or difficulties in the bond market may find it provides some protection.
Targeted absolute return funds are another potential solution, though investors need to select carefully as many of the funds in this sector have struggled to maintain a positive performance over recent years.
Patterson says: "Absolute return as a concept might have a strong appeal, but these funds are not likely to be appropriate on their own. Funds in this sector are unlikely to match equity fund performance over the medium to long term."
Investors need to look for funds with low maximum drawdown (level of investment loss in difficult times), high consistency and low volatility for them to have the intended effect in a portfolio.
Another way to protect your SIPP in the current climate is to back away from those areas that have done extremely well, redirecting capital into those areas that have done less well. This sounds counter-intuitive, but should help move a portfolio away from the most expensive areas.
Stephen Peters, portfolio manager at Barclays Wealth and Investment Management, says: "In simple terms, low and falling bond yields and interest rates have made "bond proxy" sectors very attractive, and have driven strong performance for fund managers such as Terry Smith of FundSmith and Nick Train of Lindsell Train.
Technology investment has had similar drivers - it's a producer of growth in a world where growth is scarce - and the likes of Baillie Gifford have benefited from that. In contrast, areas such as banks and utilities have suffered."
Peters believes that the recent rise in bond yields will start to have more and more influence on equity markets.
In this environment, he would gravitate more to managers such as Richard Buxton of OMGI and Ben Whitmore of Jupiter, "who both have long-term, contrarian styles with a value angle to much of what they do, and would stand to perform well in a value-driven market, particularly in the UK".
The same is true for bond markets. While bond yields have spiked higher, they remain expensive. Credit spreads are also at historically low levels over government bonds. This suggests that where investors have fixed-income exposure, it needs to be well-considered, active and flexible. There are no easy wins in the bond market at these levels.
One final question that may govern an investor's allocation is the extent to which they are concerned about an imminent crisis, rather than simply fretting over valuations.
Cockerill says: "When we look at the economic indicators - the purchasing managers indices (PMIs), both services and manufacturing - they are pretty strong globally. That tells us that the global economy is doing very well. We know employment is high and inflation is generally low. There is still economic stimulus from the ECB and Bank of Japan, plus the US tax cuts. I can't see any indicators that say a recession is on its way, looking 12-18 months ahead.
"Certainly, valuations are elevated, but there has been so much money pumped into the system over the past decade that of course asset prices are going up. All that money is still in the system and has to go somewhere. I can't see why there would be any great change in the performance of asset classes."
Mixed asset approach is best
It is also worth bearing long-term goals in mind. Houston adds: "Our approach - and not just with SIPPs - is to stay close to our clients and understand their goals and objectives, their attitude to risk and capacity for loss, and create a mixed portfolio of assets that can balance out any volatility over time."
He concludes: "There is probably no such thing as a bullet-proof SIPP. However, a well-researched and informed approach to this area, in the context of an overall financial planning exercise, can help clients achieve their longerterm goals. Longerterm statistics show that putting your money under the mattress doesn't result in a better return than in other investments, given that inflation will erode cash value over time."
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