Investors approaching retirement should look closely at their pension plans, AJ Bell has warned, after a type of fund popular with pension holders saw its value crash in recent months.

An estimated 850,000 pension savers are invested in Lifestyling funds, which have lost 13 per cent in two months, according to the firm.

Most of these people will have been automatically invested in a default strategy which they signed up to many years ago, resulting in many of those invested in these plans not knowing about it.

“Many investors probably won’t be aware this is going on, but they could be sleepwalking into a bond market nightmare,” said Laith Khalaf, head of investment analysis at AJ Bell.

Lifestyle funds

Lifestyle funds are invested in long-dated bonds, known as annuity-hedging funds, which invest with the aim of hedging annuity rate movements.

Switching into one of these funds as you approach retirement makes sense if you are going to buy an annuity with your pension, as any falls in annuity rates are made up for by rises in the value of the lifestyle fund.

However, since the pension freedoms were introduced in 2015, those of a pension age have the options to draw their pension in cash, or invest it to provide income.

Data from the FCA shows that in 2020 to 2021, 10 per cent of retiring investors bought an annuity.

AJ Bell estimated the number of pension investors holding the funds by looking at the amount of money held in these funds (£15bn, according to Morningstar) and the average defined contribution pension pot of 55 to 64-year-olds, which is £35,000, as well as the “simplifying assumption” that the typical pension saver in one of these funds will have 50 per cent of their pension pot invested.

Khalaf said: “That number doesn’t include people who might have a lifestyling programme sitting patiently in the background, waiting for them to hit 55, or 60 years of age, and then starting to shift them into annuity-hedging funds.”

Poor performance

The funds’ performance is determined by bond prices, which have enjoyed the rising tide of low interest rates since the pension freedoms were introduced in 2015.

However, since inflation began to rise and interest rates were hiked up by the Bank of England, bond prices have fallen, driving the value of lifestyle funds down.

Khalaf said: “The logic behind Lifestyling funds is that if they are falling in value, annuity rates will be rising to compensate. But that’s little comfort if you’re not going to buy an annuity with your pension.”

He recommended investors approaching retirement should take a look “under the bonnet” of their pensions plans to ensure they’re making an informed judgement on whether an automatic switching is appropriate for them.

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This article by Sally Hickey first appeared on FT.COM