Distressed investments in pensions

The implications of not being able to sell investments when required has been brought to the forefront of investors’ minds by a number of high-profile issues involving funds and fund managers in the last year.

The most noteworthy was the closure of Woodford Investment Management. The first casualty was the Woodford Equity Income fund, which ceased redemptions in June 2019 and is being wound down from January 2020. Investors have been left in limbo, with a wait of over eight months for their money.

And in December 2019, M&G’s £2.5 billion property funds were suspended until further notice. The decision was made “in the interests of protecting the fund’s investors” but will again mean investors may have to wait months to realise their investment.

In each case, a wave of withdrawals led to fund managers having to review their liquidity positions. With the issue remaining firmly in the news, I’ve set out in this article how investments can become distressed, how this could impact your client’s pension options and potential solutions.

How can investments become distressed?

The main risk with open-ended funds is that the investments held within the fund cannot be sold quickly enough to keep up with redemption requests. In recent examples, the issue has been exacerbated by the funds being invest primarily in less liquid areas such as property or unlisted shares.

Where equities are held directly in a listed company, the main risks with a company are that it delists or becomes insolvent due to financial difficulties.

In the event that the company becomes delisted, it can become significantly more difficult to value and, even if a value can be obtained, to find a buyer for any shares.

When companies become insolvent, there is an order of priority in which the creditors are paid. Ordinary shareholders are at the back of the queue, so are the last to be repaid. In many cases, this means waiting the longest amount of time to be paid, and then only if there is any money left over.

What problems does this cause?

At a basic level, a distressed investment can complicate the process of changing investment strategy and making further investments.

Where the distressed shares are held within a pension, there are a number of actions that would be restricted as a result. These include:

  • making further investments;

  • transferring pension funds; and

  • taking benefits.

  • While the funds held within the distressed investment are tied up, they cannot be sold or used to purchase alternative investments. This could result in having to sell better alternative investments at inopportune times when cash is needed for further investments or payments.

    Looking at transfers, it may not be possible for the investment to be re-registered between nominees. This would prevent the asset from being transferred between pension schemes.

    If the pension fund only contains a drawdown arrangement, then rules require it to be transferred in full. Therefore, if the pension is fully crystallised, the funds could not be transferred if one of the assets couldn’t be sold or re-registered.

    Another common issue is a difficultly in valuing distressed investments. A scheme administrator may be unable to process a benefit application if they are unable to obtain an accurate and up-to-date value of all holdings. The values are needed to ensure the tax-free cash is calculated correctly. Overpayments of tax-free cash due to the use of an incorrect valuation would result in significant tax charges.

    Solutions

    Where the scheme is fully in drawdown – and the intention is to transfer to another provider – depending on how the scheme is structured, it may be possible for a contribution to be paid to the scheme which is equal to or greater than the value of the distressed holding. If investments are not allocated to specific parts of the SIPP, this could allow the drawdown funds to be transferred out of the scheme, leaving the value of the contribution in the existing scheme in the form of the distressed fund. Ongoing fees would need to be considered but the bulk of the funds would be released.

    Where a client is looking to take benefits from some of an uncrystallised fund, an option could be to transfer part of the uncrystallised pension fund, not including the problem investment, to a separate scheme. The new scheme could then be valued and therefore pension benefits could be withdrawn from it in the usual fashion.

    Another option, depending on precisely what was wrong with the distressed investment, may be to purchase it from the pension into a dealing account. A market valuation would be required as this would be a connected-party transaction. This removes the holding from the pension and removes the aforementioned restrictions.

    It may also be possible to write off investments or gift them to charity. This can only be done if the broker has the ability to gift and is confident the holding is worthless.

    There is much more to come on this topic as the FCA and Bank of England announced in December 2019 that they have teamed up to review open-ended funds and the risks posed by their liquidity mismatch.

    In the meantime, though, planning may be needed to help clients to achieve their desired outcomes.

    This article was previously published by Professional Paraplanner.

    Technical Consultant

    Before starting at AJ Bell Grant studied Forensic Science, Analytical Science and Law in Sheffield, graduating in 2013. Prior to University he studied Chemistry, Physics, Maths and Design Technology at A-level. Grant started working at AJ Bell in the Benefits Department, progressing to be a Senior Administrator before moving to the Technical Resources Team in 2017. He is currently working towards a Diploma in Regulated Financial Planning and is part of the GETsmart Training Team, which involves conducting and scheduling internal technical training.

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