Pension Savers and Speculative Technology Investments

The growing influence of passive investment strategies means that savers can gain exposure to fast-growing technology companies without making an active decision to invest in them. While this can provide access to significant long-term growth opportunities, it also raises questions about valuation, timing and the level of risk investors may unknowingly be taking.

How passive investing can create unexpected exposure

Artur Vorobyev, Director, said:

Some pension savers may have become indirect investors in high value speculative technology assets through their workplace pension, Self-Invested Personal Pension (SIPP), ISA or diversified global equity fund, even if they never made a direct investment decision

Many pension savers are invested in passive funds that track broad US, global or technology-heavy indexes. A fund is a collective investment, looked after by a fund manager who will pool money with other investors and use it to invest in a range of assets. If high value speculative technology assets are included in those indexes, funds tracking them may be required to buy the shares, not because the fund manager has made an active judgement that the valuation is attractive, but because the index rules require it.

This distinction matters. Investors may believe they are simply holding a diversified pension or investment fund, while the underlying portfolio can change as companies enter or leave major indexes.

Index inclusion can drive demand

Index inclusion can create mechanical buying pressure – which are market price increases created by automated rules-based triggers rather than human demand driven. Passive funds are designed to replicate an index. If a company is added to an index, the funds tracking that index need to gain exposure. In the case of a large and widely followed company, that can bring significant demand from institutional investors, pension funds and retail index products.

For investors, the issue is not necessarily that passive investment is inappropriate. Rather, it is that index inclusion can create additional demand at a particular point in a company’s development, potentially affecting the price at which funds gain exposure.

Valuation and timing are key risks

This comes with risks. The first risk of index-based investment is valuation – if a technology asset comes to market at a very significant valuation, perhaps reflecting expectations about future growth in space infrastructure, satellite communications, defence, AI, data and connectivity, the opportunities may be substantial, but the valuation still relies heavily on future delivery. If market expectations change, the share price could be volatile. For pension savers, this means the value of the part of their pension invested in speculative technology assets could rise or fall sharply if the company’s share price is volatile.

The second risk is index timing. Passive funds may be required to buy once a speculative technology asset is included in a relevant index. That buying may happen after the Initial Public Offering (IPO), when market excitement is high and available public float is still limited. If demand is strong and the number of freely tradable shares is relatively small, the share price can be pushed higher in the short term. The risk for pension savers is that their pension fund may buy speculative technology shares after the initial excitement has already pushed the price up, meaning they could be exposed if the share price later falls.

Another risk is that pension savers, through passive index funds, may be buying immediately because index rules require it, while early investors may later be selling because their lock-up restrictions have expired. And pension funds may be buying the shares automatically at the same time as early investors are preparing to sell. This could increase the risk of savers being exposed to short-term price falls.

Passive investment still has significant benefits

The risks should not obscure the wider advantages of index investing. Passive funds generally offer diversification and relatively low costs, while giving ordinary savers access to businesses and markets that might previously have been difficult to access.

Artur concluded:

The positive side to index funds is that they allow ordinary pension savers to access the growth of major listed companies at relatively low cost. If a speculative technology asset continues to grow and becomes a successful long-term listed business, pension savers may participate in that upside. In that sense, public market access can democratise investment opportunities that were previously available mainly to founders, employees, venture capital investors and private market funds

The key issue, therefore, is not whether pension savers should avoid technology investments altogether. It is whether they understand the exposure they have, how their funds are constructed and whether the level of risk remains appropriate for their circumstances.

What should you consider or do next?

Pension and investment decisions should be based on an individual’s circumstances, objectives and attitude to risk. However, savers may benefit from:

• Reviewing what your pension actually invests in: Look beyond the name of the fund and check its underlying holdings, asset allocation and benchmark
• Understanding your exposure to technology: Consider how much of your portfolio is indirectly invested in technology-heavy indexes or individual high-growth companies
• Considering diversification: A diversified portfolio can help reduce the impact of a sharp fall in any one company, sector or market
• Checking whether your investment strategy still fits your objectives: Your tolerance for volatility may change nearer to retirement or as your financial circumstances evolve
• Taking advice where appropriate: If you are unsure about the risks within your pension or investment portfolio, consider seeking professional financial advice

Ultimately, passive investing can be a highly effective way to build long-term wealth. But “passive” does not mean “risk-free”. Understanding what sits beneath the fund can help investors make more informed decisions about the risks and opportunities they are taking.

Would you like to know more?

If you would like to discuss any of the above and how it impacts you, please get in touch with your usual Blick Rothenberg contact or Artur Vorobyev.