To mark the fourth anniversary of pension freedoms on April 6th, we consider how investing at income drawdown is evolving today given Brexit and other growing uncertainties affecting the markets. Over the years we have discussed the following: move from growth to income funds since the latter offers higher yields that can be taken as income and with potential growth on top; invest in low risk in the beginning since it offers a potentially smoother ride with a lower chance of having the pot hit at an early stage; and last but not least consider allocating to some higher risk assets to help add potential for better returns.
While these are all sensible moves, the most common strategy for income drawdown has been to invest in a balanced fund; for example, the ‘4’s’ and ‘5’s’ of risk profiling which spreads the retirement money across a diversified portfolio of stocks and bonds. This solution allows allocations in both lower and higher risk assets and provides ways for selling off units in order to cover the clients’ retirement income.
Centralised Investment Propositions (CIPs) have become commonplace for financial advisers since the Retail Distribution Review was introduced at the end of 2012, but Centralised Retirement Propositions (CRPs) strategies have yet to take off since the majority of advisers tend to carry over their CIPs for investment selection at retirement. The key difference (and what could be the most costly) is that certain risks are associated with retirement investing which although present at the accumulation stage do not have the same impact. The two prime examples of these are sequencing risk and pound cost ravaging.
Now a few strategies to help better manage these risks are starting to take hold for current CRPs: investing in natural income-producing funds; using the safe withdrawal rate method to basically segregate a client’s investment pot based on when they need it; and lastly the part-guaranteed income strategy where the client can invest the rest as per accumulation. All three provide good starting points, as they are designed to help better manage drawdown risks. For example, a balanced fund route still might not suit everyone’s income requirements at retirement. This is something the Financial Conduct Authority (FCA) would naturally be concerned about since the ability to manage the sequencing risk and pound cost ravaging are ultimately determined by that one fund. Take the ABI mixed 20-60 shares sector, for example. It contains a broad mix of both lower and higher risk assets as well as alternatives for better diversification. As the 20-60 shares sector is naturally more volatile than the 0-35 one, the sequencing risk increases and even though the fund rebalances as units are actively sold off for income, during times of negative performance the entire investment is affected by the selling of units and those losses are further increased.
Being able to develop a separate strategy for clients’ investment at retirement is crucial to better manage these risks – which a client at accumulation would not necessarily encounter but having something completely different to their existing CIP could not only be a challenge but also potentially end up costing the end client more due to the level of work involved.
The CRP obstacle course:
- What the client needs
- Risk profile
- Overall longevity and sustainability risk
- Sequencing risk
- Pound cost ravaging
If an investor’s current CIP covers all of the above bullet points apart from the last two, could there still be a way to manage them without having to create something from scratch? One example could be a variation to the investment pots strategy. Similar to a traditional investment strategy where you would select a fund or range of funds that match the clients’ level of risk, taking the essence of an investment’s pot strategy and instead of just one level of risk you construct a portfolio of multi-asset risk mapped funds to equal their risk profile. So, for example, instead of buying a balanced fund, buy an equal amount of cautious, balanced and adventurous funds to equal out a balanced portfolio.
To start, more can be done with a range of different risk level funds. Clients could start taking income from the lowest risk fund, for example. This way also gives better control of sequencing risk since the lowest risk fund is in theory the most unlikely to fall. This would allow the rest of the pot to grow continuously and potentially provide a steadier income. Last but not least investing in a range of funds instead of one could also create opportunities for putting pound cost averaging back in. This allows clients to benefit from market volatility over the long term by investing small amounts regularly and paying the average price for the total over time. This technique can be particularly beneficial during a time of turbulence and uncertainty.
By rebalancing the other pots within the drawdown, clients could be selling gains in the funds which have made money and buying back into the funds which have possibly lost. As the likelihood of topping up a drawdown pot is slim, being able to take gains and buy into funds when they are low helps manage overall pound cost ravaging more effectively. Rebalancing also allows advisers to realign with the intended level of risk, while at the same time providing more flexibility to match their clients’ needs at the time of review. This could help justify management fees as well, which was another important concern that the FCA has raised.
From an adviser’s point of view, this type of strategy is aligned with their existing CIP and the added management of drawdown risks. With the right product and underlying funds this approach can streamline the process of adding in an appropriate retirement investment strategy into their overall CIP.
The Retirement Account from Canada Life is a flexible drawdown product which is capable of running multiple drawdown strategies in an efficient way. Like the example above, The Retirement Account is able to invest in a range of funds, giving advisers the ability to choose where income is taken and, with a simple request, rebalance when needed. This is only one example of what the Retirement Account can do. For the underlying fund selection, Canada Life Investments manage a suite of risk-targeted multi asset funds each with a defined risk band. Together these funds offer a diversified actively managed approach that is focused on risk. As the asset allocation is reviewed daily and rebalanced when needed, the funds stay fully aligned to the defined bands of risk. When purchasing within the Retirement Account, the client gains access to a flexible product, an actively managed range of risk mapped funds, all at a competitive price.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
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CLI01394 Expiry 31/10/2020