Is Your Pension at Risk From Bank Shares?

LONDON -- Another week, another banking scandal. Heads are rolling, inquiries are being launched, and lawsuits are doubtless being readied.

Indeed, as the rate-fixing scandal rumbles on, the ripples may even start to damage our pension savings. You see, shares in Barclays (ISE: BARC.L) collapsed 15% the other day as the LIBOR news broke, and retirement funds that hold bank shares could be hit further if more revelations come to light.

Should you be worried? Well, so far the news isn't good.

Let's look at the facts. In short, collapsing bank shares have almost certainly already damaged your pension, whether they're held through an employer or via a personal scheme stuffed with investment funds and index trackers. That's because the underlying investments will have had a big exposure to the banking sector that dominated the London stock market prior to the 2007 credit crunch and ensuing recession.

And that exposure will have hit pension savers hard.

Wiped out
Royal Bank of Scotland (ISE: RBS.L) , for instance, was briefly the second-largest bank in Europe after its ill-fated takeover of ABN Amro in 2007. No longer.

Today, the government owns 84% of the bank, and RBS shares have fallen by more than 95%, effectively wiping out shareholders.

It's a similar story at Lloyds Banking Group (ISE: LLOY.L) , of course. Trading for 5 pounds or so in the heady days before the crash, Lloyds shares today change hands for a paltry 30 pence.

Meanwhile, Northern Rock and Bradford and Bingley bombed completely, wiping out their shareholders 100%. Even shareholders in HSBC took a hefty hammering, thanks to a rights issue. What of shareholders in Halifax Bank of Scotland? Having taken a hefty loss, they're now shareholders in Lloyds.

The bottom line? Huge numbers of investment funds will have already taken a hit before the LIBOR scandal, as will the pension funds that held them -- yours included, most likely.

Warning signs
This is why the current economic and financial landscape is once again scary for pension savers. Even today, with share prices battered by the bad news of recent weeks, Britain's major banks represent a whopping 12% of the FTSE 100, the London stock market's benchmark index. That is an awful lot of exposure to an industry that at best seems accident-prone and due for profit-sapping regulation -- and at worst could be headed for another meltdown.

In short, banking reform looks more and more likely. That poses a huge set of unknowns both for bank shares and for us holding those shares through pension schemes and other funds.

What to do?
Historically, it's been easy to take a bullish stance on bank shares. At their present share prices, Lloyds and HSBC, for instance, just seem too darned cheap. But many people have thought that before, only to see the shares drop further.

In any event, now seems the right time to review your pension's exposure to bank shares. One option at hand could be to diversify. In particular, you may wish to consider an FTSE 250 index tracker that invests in the 250 shares below the FTSE 100 and so contains no exposure to British banks. Or perhaps you could consider funds that back a wide range of shares based outside the U.K., such as Vanguard's FTSE Developed World ex UK tracker.

Wise words
Of course, you'll have to make up your own mind as to what to do exactly with your pension savings.

But let me leave you with a thought: As the credit crunch loomed, sage voices counseled against bank shares, even as others were pointing to their rising share prices and attractive dividends. Chief among those voices was Neil Woodford, who looks after two of the country's largest investment funds and runs more money for private investors than any other City manager. More to the point, perhaps, his investment record is stellar. And even today, Woodford is giving banking shares a wide berth. As he explained to The Times newspaper: "I think that they will require a lot more capital to repair their balance sheets, even after all the billions that have already been poured into them."

Eight alternatives
So where is Neil Woodford investing instead? As it happens, this special free report from The Motley Fool -- "8 Shares Held By Britain's Super Investor" -- profiles eight of his favorite shares and explains the investing logic behind them.

Is Neil Woodford worth following? Well, on a dividend-reinvested basis over the 15 years to Dec. 31, 2011, he has delivered a 347% return, versus the wider stock market's distinctly modest 42% return. Avoiding bank shares helped him deliver such market-thumping gains.

In fact, Neil Woodford's investment funds may even be suitable for your pension if you, like him, have an aversion to bank shares and prefer to invest in more dependable sectors. You can download this free report today to find out more.

At the time thisarticle was published Malcolm owns shares in Lloyds Banking Group and has a beneficial interest in Vanguard index trackers. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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