Oh no, I hear you cry. Not another decumulation article.
Well yes, and for good reason. I am starting to lose count of the number of advisers telling me how frustrated they are when it comes to managing income needy clients in retirement.
Advisers often cite the lack of innovation from providers on the at retirement products currently available on the market, with the following coming in for particular criticism:
- Annuities – Many advisers admit annuities are still very useful, and particularly good value for money for those beyond age 80 where the mortality pooling kicks in to good effect. Yet they don’t provide the flexibility and shape of income that many clients now want.
- Third way products – There isn't a great supply of these and what's more, these have proven to be expensive.
- Clever funds – As it turns out, these are not always that clever. In reality they are often opaque, expensive and difficult to explain to clients, and returns have been somewhat mixed if not disappointing.
- Multi-asset funds – While there are some good funds out there, a fund is not a service. Investors in multi-aseet funds all get the same journey, and nor can they flex with clients over time.
Advisers also tell me the at retirement administrative burden is getting too heavy due to the increasing proportion of their client bank in retirement, and the fact that income clients require more administrative support.
Add to that, the truth is rebalancing advisory portfolios is a pain in the neck, and Mifid II only looks set to add to the workload.
The frustration about provision from providers is curious when the market for income seems bigger now than ever and is set to increase.
This set me off to do a lot of research and analysis over the last two years. For advisers already knee deep in the literature around safe withdrawal rates and decumulation investment strategies, there is no lack of words already written. The focus has been on how much to take out and not so much on what to invest in.
To paraphrase the old saying, I know: it's equities stupid. That’s true of course. But show me an adviser that will advise a client to put 100 per cent of their portfolio in equities, on the basis that nine times out of 10 that will be ok, given historical analysis of investment markets?
We don’t do that of course, because markets have a nasty habit of making a mockery of these statistics.
Managing the risks
I've been out to see lots of advisers and asked them what they do when putting together an investment strategy that manages decumulation risks.
They tended to fall into one of four camps:
1) Firms that said they needed to know more about decumulation risks, that is, they haven’t done anything.
(I doubt there are many Illuminate readers in this camp, but for the uninitiated, it's worth reading up on sequencing risk, volatility drag, pound cost ravaging, longevity and inflation and their combined impact on retirement portfolios)
2) Firms that are concerned about decumulation risks and are actively reviewing how to tackle these
3) Firms that have developed an approach and defined a centralised retirement proposition (CRP) that is distinct from the investment proposition used with accumulation clients
4) Firms that have a CRP and are also working on the next iteration. They are also looking for ways of implementing their CRP more efficiently
What I discovered is sometimes even advisers that fall into the first camp do have a distinct approach for at retirement clients, it just isn’t written down as a thing in itself.
Typically advisers use the multi-pots approach: that is, cash on deposit, cash or cash like assets in low risk portfolio and a third pot of growth assets for the medium to long term.
Advisers then draw off the second pot on a wrap from low volatility assets to provide regular income. They then fiddle about with the pots at least annually to rebalance one way or the other.
This raises some questions. Does this pots approach work? Is it better than other strategies? If the pots approach is the right way to go, how much do you put in each pot, and for how long?
You might say "it depends". That's true, but for a given set of circumstances for a client there must be some good and less good ways of optimising the pots approach and deciding how much of each main asset type to hold.
We have published research on this approach, looking at why advisers need a mechanised service for their at retirement proposition. Helpfully, Finalytiq has also put out its own findings which put forward an approach that combines different assets mixed with a range of investment strategies and different approaches to rebalancing. For the detail, read Beyond the 4% Rule.
The essential message of our research and those of others is:
- Volatility is not your enemy
- Longevity and inflation are nasty long-term risks which need the antidote of equities
- Eat cash first, then bonds, then equities
- The impact of significant market falls and the wrong sequence of returns is most harmful in the early years of retirement
- Too much in cash or bonds is bad, and won’t deliver the long-term value needed
Having considered all of the above, there needs to be a concerted effort to help remove the burden from the adviser and allow them to make more effective asset allocation decisions.
A systemisation of the pots approach will smooth asset allocation from a large allocation to cash and bonds in the early years in favour of equities for the medium to long term. This still needs to reflect different risk profiles, different income requirements, different product wrappers and provide for different smoothing paths.
There's no fund that provides that level of service. That's where advisers come in.