Every client is different, but when looking at those in decumulation, the main priority for many will be sustainability of income, rather than capital growth.
Advisers will need to consider different risks to those faced by clients still in the accumulation phase.
In accumulation, we’re looking to provide the best level of return within the accepted risk budget. A key goal will be to beat inflation and, while interest rate risk is also an important factor because of the impact on bonds, sequencing risk and longevity are less of a consideration.
In decumulation, however, sequencing risk is hugely significant, as falling markets can have a detrimental effect on the amount of income someone in retirement can take and how long it will last.
The longevity risk of outliving your assets is also a key consideration – and with current investment into research to eradicate numerous life-limiting diseases, this risk is only likely to increase.
When investment markets are rising, many of these risks are less of an issue, but falling markets can have a devastating effect on traditional portfolios, impacting particularly those in decumulation.
In the last couple of years, we’ve seen significant volatility and the correlation of equities and bonds causing some conventional accumulation-style portfolios to fall by as much as 20%. While an accumulation portfolio will typically have a longer-term investment horizon, for investors who need to draw an income now it’s a different story.
There are also other factors to consider, like the Financial Conduct Authority’s Consumer Duty requirement to deliver appropriate client segmentation and value for money in supporting investors to pursue their financial objectives. Although no one can predict the future, potentially exposing a retirement savings pot to an adverse event from which it has little time to recover is arguably not avoiding foreseeable harm.
There’s also the FCA’s thematic review of retirement advice, which is currently underway, with a focus on the quality of outcomes in retirement. We expect this will recommend a different approach to managing risks and a re-think on constructing portfolios for decumulation versus accumulation.
Consumer needs are also evolving as retirement norms change, so clients themselves increasingly want flexibility, low cost and some certainty of outcome.
So, what’s the answer?
Investing for decumulation requires purpose-built solutions that balance maximising investment returns while limiting average drawdowns. This can be achieved by using alternative sources of risk and return with low correlation to traditional asset classes like equities and bonds. These alternatives should also provide downside protection and generate absolute returns during periods of stress.
In the past, these alternative assets have included hedge funds, infrastructure, real estate and commodities. Clearly, there can be higher risk in these products, but the lack of equity/bond correlation could prove useful.
More recently, on platform guaranteed income producing assets have offered another option uncorrelated to mainstream asset classes. Guaranteed income producing assets are a modern take on traditional annuities, offering the same certainty of income but now as an integrated asset on platform.
The advantage of these guaranteed income producing assets is that they provide a guaranteed income for life, personalised to the client based on their age, health, lifestyle and where they live, mitigating longevity risk.
Using a guaranteed income producing asset inside a Sipp, as part of the asset allocation strategy to create a highly diversified managed portfolio, generates an income stream that isn’t volatile and is uncorrelated to the rest of the portfolio, offering some protection against sequencing risk.
The remainder of the portfolio can then be weighted slightly more towards equity and alternatives, and slightly less towards bonds. This offers more opportunity for growth, potentially enhancing outcomes for a legacy pot, without increasing the overall risk for the investor.
In addition, as the need to sell assets in unfavourable markets to generate income is reduced, more of the other assets stay invested for longer. This again increases the opportunity to outperform and leave a legacy, while remaining within the same overall risk profile.
As the guaranteed income producing asset sits within the Sipp alongside the investment portfolio, any income not paid out to the client can easily be retained in the Sipp wrapper and deployed to help manage tax liabilities, retained for future use, or reallocated back into the portfolio, enhancing the client’s legacy pot.
The presence of guaranteed income producing assets on platforms is fairly limited at the moment. However, we expect availability to grow considerably over the next few months, giving advisers greater access to purpose-built decumulation solutions that meet the value for money and foreseeable harms requirements of Consumer Duty.
These alternative assets allow investment managers to take a more innovative, blended approach to retirement income generation that addresses the specific risks faced in decumulation, while still delivering an optimised investment portfolio that provides greater opportunity for performance.
Tony Hicks is head of sales at Copia Capital and Yannis Katsis is SLI business development director at Just Group
