Franklin’s rallying call ‘Those who surrender freedom for security will not have, nor do they deserve, either one’ does not extend to annuities – surrendering a little freedom creates a great deal of security and often makes financial sense.

July 2015






Summer is here and suddenly everything becomes a little more relaxed. Ties are discarded and lunches longer. Here in our new home at the UEA Enterprise Centre we’re enjoying our new-found freedom to wander down to the river or sit in the sun on the roof terrace. I had forgotten how invigorating escaping the tyranny of the desk for even a short while could be.

There’s been a lot of talk about freedom lately. The Charleston shootings yet again brought into stark relief the balance between freedom and responsibility – and how many too often pay the price of freedom for one.

John Stuart Mill took the view that it was not government’s role to restrict freedoms as long as exercising them did not harm others. This seems like a reasonable starting point but in the century and a half since Mill pulled his thoughts together we have developed a greater appreciation of the interconnectedness of the world we share.

We don’t need to go to the extremes of worrying whether the hurricane we’re seeing on the news was a result of our startling a butterfly into unexpected flight to understand that, for example, our freedom to use a car creates pollution that impacts drivers and pedestrians alike, even though the latter receive no compensation from the former. Or the consequences of exercising my Second Amendment right to bear arms are not reflected in the price I pay for the Uzi machine pistol I need to protect myself because anything capable of firing less than around a thousand rounds a minute would leave me vulnerable and exposed.

Economists refer to consequences not reflected in market prices as externalities. They don’t have to be negative – a farmer benefits from the pollinating activities of his honey producing neighbour’s bees – although most tend to be. There is growing evidence that institutional investors are adopting non-financial social impact measures to recognise externalities and guide their decisions.

Tomás Carruthers, CEO of the Social Stock Exchange presenting at a conference earlier this week, impressed me. He spoke about BP. The received wisdom is that the Deepwater Horizon catastrophe was unforeseeable. Certainly, if you had examined the company’s financials there was little to suggest any problems. However, a social impact audit would have revealed that in the period before the oil spill BP had more environmental breaches in North America than all other oil companies put together – a piece of information that, while not exactly predicting a blow-out, would have at least given cause for caution.

It is all too easy to adopt a narrow focus and miss the bigger picture. In the self-obsessed world of financial services for the last year or so wider notions of freedom have been lost; mention the New Freedoms and everyone knows you are talking about pension reform.

Writing in March, Chancellor Osborne said ‘In a couple of weeks we will see the biggest and most exciting change to our pensions system for a century. People will no longer be effectively forced to buy an annuity on retirement.’

‘Instead, from April 6, under reforms I introduced in last year’s Budget, people who have worked hard and saved all their lives will have the freedom to make their own informed choice about what to do with their pension in retirement.’

Ignoring the fact that no-one has been forced to buy an annuity for many years, the debate here is not whether Osborne is willing to stretch the truth to make political capital but about freedom and responsibility, with responsibility extending beyond that each of us has to ourselves and our families to questions of where the government’s responsibility starts and finishes. Is it responsible government or unwarranted interference to say to a generally financially illiterate population ‘we’d rather you didn’t end up destitute in retirement so we’ve set out some ground rules to try to make sure that happens less often’?

Australia has had pretty similar pension freedoms for a number of years and it is interesting to look at their experience. There retirees have fallen into four broad categories, of which the first group is depressingly small:

  • Those who get it right, who draw down at a sustainable rate and enjoy a stable retirement income
  • Those who take all their fund and spend it as quickly as possible
  • Those who think they’re doing it right but are actually drawing down at an unsustainable rate
  • And finally, the most poignant, those who don’t spend enough because they are worried about running out of money.

Although they have had a bad press it is important to understand the role annuities play in sharing longevity risk. We know that the average person will live into their mid-eighties, which implies half of us will live longer but also that half will not make it that far. Few of us know which side of the average we will sit. It is simply inefficient for all of us to make provision for a longer than average retirement when only half of us will need it – annuities address these inefficiencies by sharing the risk that some of us will live ‘too long’. Franklin’s rallying call ‘Those who surrender freedom for security will not have, nor do they deserve, either one’ does not extend to annuities – surrendering a little freedom creates a great deal of security and often makes financial sense.

Which is more than can be said for cashing in your pension to buy a buy-to-let property – probably the subject I have been asked most about since the pension reforms were announced.

There are parallels to be drawn between the development of the private rental market and the gold market over the last decade. Go back to the last millennium and gold was used primarily for two purposes; by central banks to support their currencies and by consumers to wear around their necks and wrists. Private holdings for investment tended to be in the form of a few Krugerand, often as part of a tax-evasion strategy.

The market changed rapidly with the launch of gold ETFs (Exchange Traded Funds) around a decade ago. By early 2013 the SPDR gold fund, one of the earlier offerings, held over 1300 tonnes of gold, making it the sixth largest holder worldwide behind the US, Germany, the IMF, Italy and France; ahead of China, Russia, Switzerland and over four times the UK’s holdings. This influx of new gold investors fundamentally changed the dynamics of the market and markedly increased risk.

The money we use every day is fiat currency, based on little more than a series of promises – every banknote is an IOU signed by the Chief Cashier of the Bank of England, promising to pay the bearer twenty pounds or whatever. Of course it won’t get you very far if you call in his promise, long gone are the days when you could have expected him to give you twenty pounds worth of gold, now he’ll just give you a crisp new £20 note in return for your tatty old one.

A fair number of gold investors base their faith in the yellow metal on a near religious belief that the world is rushing headlong toward a currency meltdown which will cause the fiat house of cards to come crashing down. In this they could yet be proved right – it is the next stage of their argument that I find less convincing. In the post-apocalyptic world they envisage only those with physical gold will survive. It strikes me that in that scenario I’d be keener to trade with someone who had something I could eat rather than fiddling about with fractions of an ounce of gold. Pretty soon I’d resort to giving IOUs and before you knew it I’d be back to a fiat currency.

Of course not all gold investors are closet survivalists with cellars stacked high with tinned goods; most are simply speculators who were drawn to the market by ten years of steady (and heady) returns. These are important new market participants. Their objective is not to support a currency or to protect against a financial holocaust – it is simply to make money. They are more active, and therefore have a greater influence on price, and they are more likely to sell if there appear to be better opportunities elsewhere. And in 2012 that is precisely what they did – in the space of a few months ETF investors almost halved their holdings, selling into a falling market and driving the price down to around $1200 from its $1800 high earlier in the year.

OK, all very interesting, but what has this got to do with the UK property market? In its latest Financial Stability Report (July 2015) the Bank of England highlights the risks represented by the growing Buy-to-let sector. The private rental sector now accounts for 18% of new mortgage lending and, as with gold, many of these investors have a similarly unrealistic view of the market. ‘You know where you are with bricks and mortar; it’s always going to be there.’ The same could be said of gold, although property has an important advantage – it generates an income.

The buy-to-let market is supported by housing benefits payments and most buy-to-let mortgages are advanced on a floating rate, interest only basis. This makes the sector vulnerable to political risk. The perfect storm of rising interest rates and a squeeze on achievable rents is a real and present threat. Once speculative investors see things are starting to turn pear-shaped they will bolt for the exit and we are likely to see a similar outcome to that experienced in the gold market. This brings the potential for first-time buyers, encouraged into the market with government subsidised loans, to find themselves deep in negative equity. It would be profoundly unfair if these people paid the price for pension freedoms.

The Bank of England recognises this risk and intends to consult on tools to address the problem later in the year. In the meantime they propose to monitor the sector closely – doubtless from the roof garden across the road at No.1 Poultry. From up there they should get an excellent view of the collapsing property market.


Richard Ross

July 2015


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