Cherry Reynard shows investors how to make the most effective use of the flexibility of SIPPs.

Pension planning has certainly moved on from the traditional bonds/ equities/cash model, particularly over the past two years as markets have plummeted.

However, despite the fact that a much more sophisticated appraoch is demanded, many investors lack a coherent investment strategy for their self-invested personal pension (SIPP). So what should you do to make the most of the flexibility proffered from SIPPs?

Flexing your muscles
While the investment flexibility varies from SIPP to SIPP, some basic principles hold true: even the most straightforward products will usually allow investors to incorporate shares into their portfolios. This means investors can get access to the broad range of investment strategies provided by investment trusts and low-cost tracking products such as exchange-traded funds (ETFs).

Although traditional pension products from the major insurers have moved on from the days when investors were restricted to the group’s with-profits fund and nothing else, the range of collective funds offered by SIPPs is broader, incorporating smaller fund management groups and less mainstream investments. Put simply, this means that SIPP investors will usually have access to a greater diversity of investments and can nuance their portfolios accordingly.

Depending on the sophistication of the SIPP, it may also offer the flexibility to invest in futures and options, venture capital trusts (VCTs) and commercial property. The ability to include commercial property can be beneficial to small business owners. For example, Murray Smith at pensions consultancy Mattioli Woods says that a number of its clients have ‘sold’ business assets to the SIPP, thereby raising capital for their business at a time when banks are reluctant to lend. Octopus Investments has  been encouraging its clients to shelter maturing VCT investments in a SIPP and benefit from additional tax advantages.

Big decisions
The first decision will be how much investment flexibility you need in choosing a SIPP. John Moret, director of sales and marketing at Suffolk Life, says, ‘If you need to use a SIPP for commercial property or other specialist purposes, you would need to go to a SIPP provider with a track record. The biggest decision on the investment side is whether you are going to use collective funds – unit trusts, OEICs, investment trusts, ETFs – or if you are looking to discretionary management or to build a portfolio of equities on a direct basis.’

Ultimately, the amount of investment flexibility will affect the cost. Bruce Ely-Johnston, head of adviser solutions at London & Capital, believes that investors need around £250,000 in their portfolio to make the most flexible SIPPs cost-effective. However, this doesn’t apply across the board. Moret explains, ‘There is no doubt that SIPPs cost more
than stakeholder pensions. But they needn’t cost hugely more. Platform-based SIPPs, such as those provided by Hargreaves Lansdown, can compete with a standard personal pension.’

Strengthening the core
The next decision is whether the SIPP is the core pension provision or whether it will sit alongside, say, a work-based pension. A typical defined-contribution pension – now the norm for many employers – will comprise a selection of core global equities and bonds. Some choice may be offered, but the plan will not be tailored to an investor’s specific requirements. A SIPP can be used to bring in diversification, alternatives and to shape an overall pension pot to suit individual needs.

Ely-Johnston is finding that SIPP portfolios are increasingly diversified as investors wake up to the benefits of including alternatives. ‘The downturn, in particular, has culminated in people looking across all investments and moving away from the traditional investment model on which they previously relied.’

From there, any investment strategy must start with an appraisal of risk, expectations and ambitions. Philip Pearson, partner at Southampton-based adviser P&P Invest, comments, ‘The first thing is always to set objectives. How long will you be invested? What do you want to achieve with your capital? Is your existing funding adequate? These things drive all the other decision-making along the way.’

Pearson suggests that the timing of an annuity purchase is key. If a retiree plans to buy an annuity the moment he retires, then for the previous five to ten years, he will have to adjust his portfolio accordingly, ensuring he is not vulnerable to a sudden shift in market conditions. Capital preservation should be the main priority and with it a focus on corporate bonds, government bonds and cash or near-cash investments. If he plans to move to a drawdown portfolio, and therefore could be invested for another 20 to 30 years, then he may retain a higher weighting in ‘growth’ assets such as equities.

Age and risk appetite
Only once all these building blocks are in place can a proper decision be made about asset allocation. Most do-it-yourself SIPP providers will have model allocations based on age and risk appetite.

These asset allocation models are usually based on ‘stochastic modelling’, which looks at past risk and returns for different asset classes and aims to draw conclusions about their potential future performance and risk. That way, investors can combine asset classes to maximum effect. This has some limitations – traditional diversification strategies did not work well in 2008, when all asset classes fell simultaneously, and it necessarily works on the premise that history repeats itself, which it may not.

For those who would prefer to outsourcethe asset allocation decision, discretionary managers will tailor the portfolio specifically to the individual. Gavin Haynes of Whitechurch Securities says, ‘If people come to us, it is because they want a multi-asset portfolio picked from different managers based on their own objectives, risk profile
and timescale to retirement.’

A good discretionary manager should also ensure that the asset allocation remains appropriate, given an investor’s changing risk profile over time and shifting market conditions. Haynes adds, ‘We don’t believe you should hold any asset class if it’s not doing better than cash. It has to be attractive on a risk-reward basis.’

This ongoing monitoring is a much neglected part of an investment strategy. Rupert Curtis, managing director at Curtis Banks, says there is a danger that people end up with a mixed bag of poorly thought-out investments. ‘The investment strategy needs to change over time, but many people don’t review it and therefore don’t make the right investments.’

Any investment strategy should also incorporate diversification. The beauty of SIPPs is that they offer investors the chance to include asset classes that do not correlate with traditional equity and bond markets. Matt Pitcher, an adviser with Towry Law, suggests, ‘A lot of people just stick to a standard mixed portfolio of corporate bonds, equities and gilts. We believe there should be a lot more to it, and investors should consider incorporating gold, hedge funds and overseas equities to ensure a broad asset allocation.’

The bulk of the matter
Of course, beneath all this is the thorny issue of investment selection. If investors have not chosen to entrust this to an adviser or a discretionary manager, most SIPPs will have research tools and recommendations. Hargreaves Lansdown, for example, provides a review of each fund on its platform from its fund research team, plus new ideas. Alternatively, large data providers, such as Morningstar, will have their own publicly available ratings.

Ultimately, investors need to ensure they are using the right SIPP for their needs and are not paying extra for investment flexibility they will not use. They need to ask whether the product will be for core pension provision or for diversification and/or investing in alternatives. They then need an honest appraisal of their appetite for risk, expected returns and when they are likely to buy an annuity. Only then should they move on to asset allocation and, finally, investment selection. One of the biggest mistakes is to start at the end.