Protecting your pension investments
Sunday Business Post: 15 July 2012
Brendan McGinn - Head of Goodbody Retirement Asset Services
Given the experience of the last four years, most people now recognise that pensions, like any other type of investment, carry investment risk. Pensions investors, rightly or wrongly, now instinctively wish to take a more conservative approach to their pensions, and seek out strategies to mitigate their exposure risk, usually involving a trade off between risk and return. Investors generally understand, and are alert to investment risk. While there has been an understandable trend over recent years to focus more on investing in cash deposits, bonds and capital protected products, it's worth considering the opportunity cost of this strategy particularly in an environment where growth and inflation move higher. The key lesson is not to be overly conservative in the investment strategy but to be flexible enough to choose a balanced strategy and adapt this in turn in response to changes in the market and personal circumstances.
But there is another more subtle and, until recently, largely unexplored risk when investing; the risk that someone along the line who holds or controls your investments will get into financial difficulty or, on very rare occasions, may misappropriate your assets, leading to a loss for you.
What lessons can pension investors learn from the Custom House Capital (CHC) debacle, where some €37m of pension investor funds were misapplied with a questionable chance of recovery?
What can you do to protect yourself as far as possible from this risk? The answer is simple; ask a lot of questions about how your pension arrangement will be structured, before you invest. In particular:
- Who will be the owner of your pension assets?
- How will your assets be held?
- Who will have control over the investment of your assets?
There are three main types of individual pension arrangements:
- Those structured as pension policies issued by life companies, such as Personal Retirement Savings Accounts, Approved Retirement Funds, Personal Retirement Bonds and Retirement Annuities. In this case you legally own the policy, but not the underlying investment assets which are owned by the life company.
- Those hosted by specialist pensions investment firms who are authorised under the Markets in Financial Instruments Directive (MIFID). A MIFID firm is authorised and regulated by the Central Bank and is subject to certain minimum capital adequacy requirements. Such firms must also provide regular reports including audited accounts to the Central Bank. Some MIFID firms offer pensions structures, such as PRSAs, ARFs and Personal Retirement Bonds. In these cases you are the beneficial owner of the investment assets, which may be legally held on your behalf by nominee companies and custodians, appointed by the firm. In this scenario, assets are held as client assets and are subject to the Central Bank's Client Asset Requirements which require firms to segregate client assets from their own, and to have their client assets audited regularly.
- Those held through trust arrangements, such as Small Self Administered Pension Schemes , where there are individual Trustees, and Executive Pension Plans issued by life companies which usually appoint the sponsoring Employer as Trustee.
In these cases the trustees legally own the underlying investments, be it a pension policy or securities, but you are the beneficiary of the trust. In the case of most Small Self Administered Schemes, you will generally be the sole beneficiary and a joint trustee.
Where pension policies are issued by an insurance company, you can choose the underlying investments or fund allocation, but these assets are always legally owned and controlled by the life company as policyholder assets.
In the case of pensions arrangements offered by MIFID firms , investment control can rest with you, under an advisor or execution only mandate, or you can give the firm a mandate to manage your portfolio on your behalf.
In the case of a trust, the trustees may retain control over the investments or, in the case of Small Self Administered Schemes, engage a MIFID investment firm or firms to manage the assets on a discretionary basis.
Some MIFID investment firms use exempt unit trusts or EUTs as they are known, to hold their clients' pension assets, rather than holding such assets directly as client assets. Some pension policies may invest in underlying assets through an EUT, so that you invest in a pension policy which in turn invests in an EUT, which in turn holds the underlying investments.
EUTs are open only to pension investors and have traditionally been used to hold geared property investments. They are an efficient and convenient structure to hold property. However some investment firms also hold non property assets for their pension investors in EUTs.
In this case, the pension investor legally owns the units in an EUT fund but NOT the underlying investments, which are legally owned by the trustees of the EUT, which may well be the company associated with the investment firm hosting the EUT.
So in the case of the EUT you are legally one step back from direct legal ownership of the underlying investments. If your pension is being invested in an EUT, there are some crucial questions that need to be answered:
- Who will be the trustee of the EUT, as the trustee will be the legal owner of the underlying investments.
- Who will be the investment manager to the EUT fund or funds in which your money will be invested and what is the investment policy of this fund, and
- What is the legal relationship of the EUT trustee with the investment firm managing the EUT fund.
Note that EUTs are not regulated by the Central Bank. In a Central Bank August 2011 review of the regulatory regime for safeguarding clients assets, the
review stated that "Exempt unit trusts are not subject to regulation and none of the assets placed therein are subject to the (Central Bank's) Client Asset Requirements."
Some €37m of pension investor funds which were improperly transferred in CHC were held in a CHC Destiny EUT structure, where the trustee company had common directors and shareholders with CHC itself.
committing yourself to any pension arrangement, check out who will own and control your pension investments.
Don't be afraid to ask questions.
Brendan McGinn - Head of Retirement Asset Services