Around 850,000 pension savers in the UK risk sleepwalking into a bond market ‘nightmare’, according to AJ Bell, due to being invested in ‘lifestyling’ funds.

These funds, which invest in long-dated bonds with the objective of hedging annuity rate movements, have fallen in value by 13 per cent in the past two months due to high inflation and rising interest rates.

AJ Bell noted that the logic behind lifestyling funds, also known as annuity-hedging funds, is that if they are falling in value, annuity rates will be increasing to compensate.

However, since pension freedoms were introduced, only around 10 per cent of pension investors now purchase an annuity, compared to approximately 90 per cent when some pension default strategies were set up “decades ago”.

AJ Bell said that the funds were often used in old workplace pension schemes run by insurers and individual stakeholder pensions, which are now starting to automatically switch some pension investors in their 50s and 60s into lifestyling funds.

“Many of these pension providers have now updated their current investment strategies to reflect the fact that few people are buying an annuity in today’s retirement market,” commented AJ Bell head of investment analysis, Laith Khalaf.

“But older pension plans are still ploughing on ahead with their default investment strategy of automatically shifting investors out of equities, and into these lifestyling funds which hedge annuity rate movements.

“For most pension investors, who aren’t going to buy an annuity, these funds are now totally unfit for purpose.”

AJ Bell estimated that around 850,000 pension investors currently hold a lifestyling fund.

The firm noted that lifestyling strategies usually automatically shift out of equities into annuity hedging funds over a period of 5 to 10 years, urging urged pension savers approaching retirement to take stock of their position and retirement plans, and adjust their investment strategy accordingly.

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