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Cantillon: Irish pension savers cautiously watch bond markets

Bond prices are predicted to fall, but an ‘intense and large’ drop may be some way away

Tue Nov 15 2016 - 08:53

In August Paul Singer, manager of the $28 billion (€26 billion) Elliott Management fund, said investors are facing "the biggest bond bubble in world history". When prices start to drop, he warned, it will be "surprising, sudden, intense, and large".

The last few days trading suggest he may have been, at least, half-right . Fears of inflation are driving the bond sell-off, amid expectations that Mr Trump’s proposed increase in infrastructure spending will see inflation rise. However an “intense and large” drop in bond prices has still not happened - bond rates are still very low by historical standards.

Nonetheless, Irish pension savers, particularly those who have just retired or are coming close to that day, should be aware of what exactly their bond holdings are, and what risks market events might pose for them.

So what do pension savers need to be aware of?

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If you’re an impending retiree with a large proportion of your pension savings in bonds, you’re more at risk than most of getting hit by this market move, with a swing in interest rates likely to hit holders of long-dated bonds sharpest. Put simply, the value of your pension fund could fall, at precisely the wrong time.

However there may be a balancing factor. The risk of being overweight in bonds as you approach retirement is less keenly felt if you intend getting an annuity. Annuities are typically purchased by pensioners from life companies with the proceeds of their pension policy, in return for a fixed rate of income until they die.

Under an annuity, how much a person gets typically depends on interest rates when they retire , and given the recent slump in interest rates, many retirees have opted to invest in an approved retirement fund (ARF) instead. With long-term rates rising, those heading to retirement may find their choices changing.

Irish-based insurance companies price annuities off European government bonds – and the yields on these are starting to rise, albeit off very low bases. The Irish cost of funding, for example, has jumped to more than 1 per cent from 0.32 per cent in late September. If this trend was to continue, annuity rates could start to look a little bit more attractive for retirees.