Pension funds - irrational behaviour

OK, you are a pension fund. You have promised recently retired Mr Saver a lifetime annuity of £2,000 a year and to match this, you buy some long-dated UK gilts for £100,000 nominal at 2.5% nominal interest, i.e. you have guaranteed cash income of £2,500 until they mature, which hopefully covers Mr Saver for life. You trouser £500 as your mark-up and pay him the rest. You don’t really worry what the residual value of those gilts will be in two or three decades’ time – the market value will move back towards nominal value as they approach maturity.

(Or maybe you invested £80,000 nominal at 2.5% interest and pay him the whole £2,000 coming in, and trouser the residual value in two or three decades as your mark-up, same sort of thing.)

Because the fiscally reckless Tories* are in charge, the value of your gilts plummets to 70p in the £1 (giving a notional interest rate of 4% or whatever). So what? The £2,500 interest income (or £2,000 interest income) is fixed, Mr Saver’s annuity is covered and there is nothing to worry about. When Mr Saver dies, you sell or keep the gilts, or maybe they mature before he dies and you pay his last few years’ annuity out of the proceeds.

So why are pension funds selling off gilts like topsy? Did they invest current savers’ money into gilts? That’s a terrible idea, as they are not even going to keep pace with inflation, they should be investing in shares.

In the spirit of putting my money where my mouth is, I opened a Stocks and Shares ISA this morning and have chipped in £10,000 for some units in the Santander Sterling Gilt Fund at 211p per unit (or at least I hope I have done, it can take a while for this to go through). Let’s see what happens…

* The popular notion that the Tories are fiscally prudent and Labour are fiscally reckless is pure Indian Bicycle Marketing, actually the reverse is true (historically and to the present day). Which is one of the reasons why I have concluded that what this country needs is a Labour national government and Tory local councils, who seem to ignore most of the meddling crap from the national government (they are reluctant to employ Tobacco Control Officers or impose 20 mph speed limits on country lanes) and just run actual necessary public services.