The advantages of investment trusts for decumulation

Pension savers withdrew more than £52 billion from their retirement pots in the 2023-24 tax year, new data from the Financial Conduct Authority reveals – a 20% increase on the previous year. The figures are likely related to the cost-of-living crisis, with over-55s dipping into their pensions to make ends meet. But the data also underlines the challenges facing financial advisers when it comes to working with clients on long-term savings strategies.

Next April will mark the 10^th anniversary of the pension freedom reforms, which have transformed the pensions landscape. Before these changes, when most people turned pensions savings into income by buying an annuity, advisers’ main role was to help people accumulate as large a pension pot as possible. Today, with most savers opting to take income directly from their pension funds, rather than via an annuity, the need for professional advice is just as pressing during the decumulation phase of retirement planning – if not more so.

The problem for advisers is that their clients have two different objectives when thinking about strategies for managing income drawdown – worse, there is a potential conflict between these goals.

On the one hand, savers need to withdraw cash from their pension pots to live on – and most of us want to live as comfortably as possible. On the other, they also need their savings to sustain them for an extended period – potentially until the end of their lives, but at least until they decide the time has come to buy an annuity, which could be decades into the future.

How, then, to build an investment portfolio for a pension saver looking for reliable income and long-term growth to protect them from the possibility of their savings running out? Well, there are a number of possibilities, but investment trusts have a good claim to stake for sitting at the centre of this type of portfolio planning.

On the income side, the fact that investment trusts are able to retain some of the dividend income they earn each year – a practice that other funds are barred from – enables them to smooth out income distributions over time. The so-called “Dividend Heroes” have gone further, using their dividend reserves, where necessary, to support annual dividend increases that have been delivered year-in, year-out, for several decades.

What investors get here is not necessarily the highest yield currently available from a fund; rather, they get a stream of income they feel they can depend on, which is crucial for pension savers.
As for growth, the long-term performance record of investment trusts is widely acknowledged – their track record of beating comparable open-ended funds is well-documented. This reflects multiple factors, including the unique ability of investment trusts to take on gearing, which automatically boosts returns when asset prices are rising, and certain structural advantages.

A related point is that investment trusts are better-suited to investing in illiquid assets –  private equity, property, and infrastructure, for example. This can be useful for pension savers looking to protect against risk by ensuring they have exposure to a diversified portfolio of assets rather than just stock markets.

That’s not to suggest pension savers have to bet the house. For more risk-averse savers, investment trusts primarily focused on capital preservation could offer strong foundations at least for their pension funds in retirement. Examples include Personal Assets Trust and Ruffer Investment Company, which invest across a range of asset classes with mandates to avoid losses.

None of which is to say that investment trusts are the only vehicles through which advisers can confront the conflicting priorities of their clients during retirement. But closed-ended funds do feel particularly well-equipped to deal with many of the challenges that come up as savers decumulate.