Fiona Murphy takes a closer look at how drawdown investment risk and reward is changing
We all know about the downsides of income drawdown with its toxic mix of falling gilt yields, the maximum GAD rate which has since been re-instated and underperforming investment markets.
While many pensioners faced massive drops in income, it was clear they had few alternatives. The annuity market has also continued on its downward trajectory, creating a Catch 22 situation for retirees.
With such changing circumstances, on the advice of advisers and fund managers, retirees are adapting the investments they are putting into drawdown portfolios.
Income for life
Blackrock head of retail Tony Stenning explains the change: "Historically, once in drawdown, people's portfolios have tended to be less risky. There is less chance they will contribute into it as they stop working.
They do not want to lose that pot; that is their income for life. However, a number of those traditional perceived safe havens [such as cash or bonds] are not giving the returns.
He continues: "Keeping it in a very low risk investment, which does not return very much; is an issue [with] the ravaging effects of inflation. For example, if you have a pot of £100,000 and inflation is at 3% for 25 years, that would have reduced the purchasing power of your pot by half."
Brewin Dolphin divisional director and investment manager Rob Burgeman says: "The biggest issue is in an ideal world you would have tried to secure the kind of income drawdown income you wanted by using corporate bonds or government bonds. "
Stenning adds: "You are getting less than 2% from government bonds for instance, virtually nothing from cash. You have got this real paradox. People want to preserve cash because they are very scared, we have had the lost decade in equities, so they are not doing anything. It is not going to help for the longer term.
"The norm has been people in retirement keep invested in low-risk assets. That is where we start getting into a world of investments, and it won't come overnight.
"In the run up to retirement and post retirement, there are better ways to glide you in - minimising volatility, defining an outcome after the effects of inflation or there is an enhanced income element to it from considering other investments, such as high quality equities.
"People think that is a risky asset but if you are looking at a five- to ten-year time horizon, buying things that will yield near 5% but have an exposure to the market of 0.7 [with compounding], you would still come out net-net, if the market halved. These risky assets are no longer risky if they are used in the right way."
It is clear that the traditional strongholds are losing their dominance on income drawdown portfolios with newer favourites gaining ground.
Burgeman agrees: "What you are seeing is people increasingly looking at equities to produce income in the hope they will get a little capital growth as well. Primarily, it is as much for the income as it is for the capital growth.
"Equities have always formed a part of drawdown strategy but perhaps bond weightings are a little lighter than they have been in the past simply because the returns aren't there. There has been a lot of press comment about the bond bubble about to burst.
"I do not think there is a lot of scope to see the kind of return on bonds you have seen over the last year but I do not think the bubble is about to pop. That is certainly not our core view. It is not going to happen until you start seeing interest rates moving up significantly."
Fiducia Wealth Management head of wealth management Simon Bonnett says the search is on for more diverse funds.
"People are starting to draw or supplement funds from their ISA portfolios [for income] and making income drawdown funds slightly more aggressive.
"They are starting to up the risk portfolio within their drawdown funds. People are looking for more diverse investments. There is less gilts. People tend to replace these with more strategic bond funds. People appreciate we are no longer stockbroker driven or UK centric.
"We have got to take more of a view to the global economy. Gilts are shot to pieces at the moment; let's look elsewhere for lower volatility growth.
"They are also starting to look more at established alternative investments such as absolute return style funds, or infrastructure. Infrastructure funds have good yields and absolute return funds are looking to reduce volatility but give you a certain increase depending on the make-up of these funds.
"They are also looking at more overseas equity - it is the emerging markets where the growth part of the portfolio is going to lie. In addition, private equity funds are a good way of reducing overall risk but looking for the upswing."
Last year, Old Mutual Global Investors released a range of four multi-manager, multi-asset income funds. The investment group has said these funds will be particularly attractive to people in income drawdown as these funds give regular income with more clarity over how this will affect the capital value of their investment.
John Ventre, the company's head of multi-manager explains: "What the funds are trying to do is deliver a targeted income yield, year in year out. [The funds have] targets of 4% and 6%. I think this is ideal for someone beginning to live off their assets. That is what [the funds] have been designed to do, as a partner for our existing, Spectrum line which we designed for the accumulation stage.
"The second issue is longevity risk, the risk you outlive your capital. The traditional way of dealing with that risk has been an annuity but rates have fallen so low."
With retirees traditionally taking a cautious stance, telling people to take a bit more risk in challenging markets can be a difficult conversation to broach.
Bonnett says: "It is a long education process. It used to be a case of annuity only and that was it. We prepare [clients] by saying just because you're going to retire officially at 68 does not mean we are converting your [entire] pension fund into cash. You will take out your pension commencement lump sum if that is right for you.
"Think about going forward. What is the longevity in your family? What is your health like? How long do you want it to last for? You have [to say]: ‘You will need an amount of growth in your portfolio because you want flexibility and with flexibility are downsides such as investment risk.'
"It is helping them understand that a pension fund in drawdown is continual. You have got to help them evaluate it all the time. It is a psychological change on the investment front."
It is clear this brave new world of pension investment, with a heavy focus on risk, reward and global opportunities, will be here to stay.
Three years at Wells Fargo
Effective from 9 December 2019
One firm with permission suspensions left
Continuing the Architas education series for clients.
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