WHEN looking glumly at the size of your pension and the prospective shortfall in retirement, it can be tempting to dream of putting the lot on a horse, the lottery or a spread bet, and doubling it overnight.
For most of us, that is precisely where the dream should safely remain: in our heads. But it is possible to invest in derivatives, such as contracts for difference (CFDs), within a pension, which if successful could provide just the shot of adrenalin
you are hoping for.
These may have attractions for certain individuals, although extreme caution must be exercised.
Only a small number of companies providing tax-free Sipp wrappers (Self-Invested Personal Pensions) will accept CFDs, and those that do have strict scrutiny and monitoring requirements before allowing an investor to proceed.
These include Standard Life, Killik Capital (part of Killik & Co), Fidelity via its FundsNetwork Sipp (but not its personal pension), Allianz Trust, stockbroker Brewin Dolphin and its sister company Bell Lawrie.
Most of these are extremely cautious. Standard Life, for example, will only accept CFDs in its Sipp on the advice of a suitably qualified discretionary fund manager.
Standard Life's John Lawson said: "This is essentially a form of gambling, rather than investing. You are betting that the share price will rise or fall, and you could lose a great deal of money if you bet the wrong way."
Bryan Johnston, a director of Bell Lawrie, part of Brewin Dolphin added: "I don't believe a Sipp should be treated as a tax-free punting fund. Punting your pension is not a good habit to get into. We will allow them in a Sipp both at Bell Lawrie and Brewin Dolphin, but they require specific clearance."
Allianz Trust spokesman Steve Latto said that the Sipp is held in the name of the Sipp provider, which acts as trustee. As such, if the deal turns sour, the company itself could end up liable for any losses.
"We will want to be confident at the outset that the risks of a contract are limited. We can't allow the client to fall into a negative balance, because ultimately we could be held liable."
Nevertheless, CFDs can have sensible applications, not least as a hedge against falling prices for certain kinds of pension funds, particularly large ones.
And while punting your pension may not be a good idea, if you are intent on CFD trading, wrapping the transactions in a tax-free Sipp may appeal.
CFDs are essentially a form of margin trading. If you think a share is going to rise, and you have £1,000 to invest, you could buy stock to that amount. If you guess right, and the shares rise by, say, 20%, you have made £200, minus dealing charges.
However, if, instead of buying shares with that £1,000, you open a contract for difference, you could gain 20 or 30 times greater exposure to the upside, giving profits of £4,000 to £6,000, depending on the margin set by the CFD provider.
You also risk magnifying losses twenty or thirty-fold if you guess wrong, which could cost you dear, or, at worst, wipe out your entire pension.
Many FTSE 100 shares trade at a 5% margin. Therefore, rather than using your investment to buy 100% of a block of stock, you effectively "put down" 5%, and buy a contract to buy or sell a further 95% worth of a much larger holding.
If you are buying long, in the expectation that shares will rise, you will also have to pay interest at Libor plus 3% (currently around 9%) on the stock, which you are effectively borrowing.
Alternatively, if you are selling short, and buying the right to sell a falling share, the market maker pays you interest at Libor minus 3% (currently around 3%).
There are two critical hazards if you are trying to trade these contracts within your pension. Firstly, if you gamble the wrong way, you could in theory lose the lot and more.
Furthermore, Sipp regulations prohibit trading account deficits. Should you lose badly, and be forced to inject further cash into the Sipp to meet a margin call, this is subject to a 40% HM Revenue and Customs unauthorised payment charge, which will cost you even more.
But some market makers, such as CMC Markets, require those investing via a pension to impose a stop/loss on the account, so the maximum that can be lost is the down payment.
CMC spokesman Tony Cross said: "We don't want people to lose all their pension, so we put in place a guarantee that the shares will be sold once they reach a certain level.
"We charge a slightly higher dealing charge of 0.15% rather than 0.08% for this guarantee."
Concern about the various risks led major Sipp provider Hargreaves Lansdown to prohibit CFDs from its wrapper, but it accepts that, for those intent on this kind of 'gambling', a Sipp could provide 'free money' to fund their punt.
HL investment manager Ben Yearsley said: "We do trade CFDs but not within a pension. But if higher rate taxpayers put, say, £8,000 into a Sipp, the taxman tops that up with £2,000.
"Some people may like to look on that £2,000 as free money with which to play. They will get a further £2,000 through their tax return and they could invest this as well."
But when it comes to hedging an existing sizeable pension, Kareem Khouri, managing director of Killik Capital, believes CFDs come into their own.
"If you have a large portfolio invested in equities and you think the market is going to fall, rather than sell everything at huge cost, and then face another bill for buying back in, you can buy a CFD to hedge your position.
"If you are right and the market does fall, although the value of your portfolio will suffer, you will make money on the CFD to offset all this.
"If you are wrong, and the market rises, although you will lose on your CFD, your portfolio will have increased in value."
Hedging in this way is attractive because of the lower charges associated with CFDs. There are no additional Sipp charges, and the contracts would only be subject to the normal advisory fee levied by discretionary managers. However, dealing can be as low as 0.08%, and there is no stamp duty.
