Adrian Shandley highlights the role equities should play in retirement planning portfolios
I am living in the hope that the events of the last eight months will represent a truly 'once in a lifetime' event in the financial world but whether or not this is the case, the fact that such a catastrophe will not occur again for decades is of no consolation whatsoever to somebody close to retirement.
One of the interesting things from a financial planning perspective is the fact that the basic bedrock fundamentals have been blown away and, with the second largest economy in the world now having a stock market at a twenty seven year low, how can we now define 'the long term'!
What role should equities play in retirement planning? Is it time to redefine how we use equities? Are dividends still relevant?
Before any of these questions can be answered, I really do think we have to set aside the situation in which we currently find ourselves, the fact is that equities are a major investment class, of which there are only a few, and they have to play some role in the retirement planning process.
Focus on dividends
One of the biggest crimes committed by this government was the attack on equity dividends within pension plans, and in a small way this may well have fuelled the recent bubbles in property and equity markets. If long term investing in a pursuit of dividends is no longer as attractive as it was, fund managers and pension investors will increasingly seek returns from short term growth markets rather than long term profitability.
However, if equities are to be used properly in the retirement planning market, then we have to see a return to traditional dividend focus, this in itself reduces volatility because normally only stable profit making companies declare dividends. The long term effect of dividends for pension funds is to produce more steady growth, through investment addition rather than fund expansion.
Historically, equities have been seen as an early to mid stage vehicle in the life of a pension plan, with lifestyle phasing to bonds and property normally taking place in the latter stages. In the future, one of two things will happen, either investors will remain weighted to equities for longer, perhaps even into retirement, simply because property and bonds are perceived as offering almost as much risk as equities themselves. Or, secondly, investors will phase out of equities earlier, opting for cash rather than property or bond funds, again because the investor perceives the risk to be similar, yet may not wish to accept the volatility.
Another issue that will almost certainly emerge from the current crisis is the fact that active fund management needs to be given much greater priority in the future. Shares are cyclical, and if investors are to make the most of equity markets, then they need to have an active and reliable fund manager who will hopefully spot trends. For example, the banks have recently created a polarisation of opinions among the investment manager community, some have stuck with the banking shares or increased their holdings, while others sold out some time ago. While you would obviously be a much happier person if you had appointed a fund manager in the latter category, the important message for the equity investor to take away, is the fact that active fund management is vitally important, as is the ability to change your appointed fund manager as necessary.
Equities will definitely continue to have an important role to play in pension investing, but I am certain that we will see exposure reduced in percentage terms over the next few years, which is a shame because this is exactly when exposure in percentage terms should probably be increased. Equities that produce a high level of dividend will be hard to find over the next couple of years, simply because of the recession, and I think it is important for fund managers and investors alike to realise that the quality shares producing high levels of dividend may well become over priced as a result of under supply and over demand. There will inevitably be a risk of high volatility in these shares simply as a result of fluctuating market confidence.
Whatever happens, the long term viability and suitability of equities within pension funds will inevitably undergo a fundamental rethink and it is incumbent on the adviser not to allow an investor's short term emotion to drive long term investment decisions.
In the aftermath of the 2001 tech bubble, there was a flight back to the more traditional shares, which was appropriate at the time, but there was also a strong desire by many investors to acquire some sort of underpin or guarantee. Structured products became a very popular holding for pension funds, and we may well see the same situation this time. Ironically, in the years that followed the stock market crash of 2001, these structured products actually performed worse than straightforward equity investment in the main. But with the severity of the most recent falls, pension investors can be forgiven for wanting some form of guarantee, after all your pension fund is the asset you can least afford to lose.
Only time will tell whether or not we are seeing the dawn of a new financial world, but if we are, it cannot be a world without equity investment as part of retirement planning. Equities are such a fundamental part of the global economy and at their most basic level, they actually represent the health of the global economy. I would argue that all other asset classes are driven by equities, and that the confidence in many other asset classes depends on the share markets. It is therefore so vitally important that we, as investment advisers, do not allow our clients to abandon quality dividend producing equities in the long term.
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