Abraham Okusanya: Why providers are getting CRPs wrong

Centralised retirement proposition is the latest lingo being bandied about by asset managers and consultants. Many use it to imply that you need a different set of portfolios for clients in drawdown than those in accumulation.

If you ask any of these folks how decumulation portfolios should be different, they have the same tired approaches that have been discredited by extensive academic research. These include:

Bucketing approach

This involves creating multiple buckets to fund withdrawals over different time horizons. The typical approach involves three buckets: a short-term bucket largely comprising cash and near-cash assets to fund withdrawals for up to five years, a medium-term, medium-risk bucket to fund expenses in the fifth to 10th year of retirement, and a more aggressive long-term bucket.

Bucketing doesn’t really work. You end up with an overall asset allocation skewed heavily towards cash and bonds compared to a single pot with a total return portfolio.

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Cash buffers to fund withdrawals

This is essentially a version of bucketing, except the adviser keeps two buckets – one in cash and the other in investments. During periods of market declines, you can draw on the cash without having to dip into your portfolios. It suffers all the same ailments as bucketing: if you wish to withdraw 4 per cent of the initial portfolio and want five years in a short-term bucket, that’s 20 per cent of it not doing much.

Natural yield portfolio

The assumption here is that you can rely on natural yield in your portfolio and leave the capital untouched. But there is no reason why living on the yield alone should fare better than the total return on the portfolio. You could tilt the equity allocation towards firms producing dividends, but you’re merely betting on the value-premium. You could chase return up the yield, but you’ll only set yourselves up for horror in bear markets.

Cover story: Are centralised retirement propositions the future of pension planning?

Volatility-managed portfolio

In a misguided attempt to manage sequence risk in retirement income portfolios, a great deal of effort is devoted to managing volatility. The reason this is unlikely to work is that sequence risk is amplified by withdrawals. Managing the volatility of the portfolio won’t necessarily manage order of return.

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So, what is a CRP if it’s not about the portfolio? I suggest it’s more about codifying a firm’s decumulation advice process. It must involve:

  • How you assess risk capacity and evidence-consistent decision-making on annuity versus drawdown;
  • A rigorous model of investment, inflation and longevity risks in a way that is meaningful to the client;
  • A robust demonstration of sustainable withdrawal strategy.

Without these, tinkering with the portfolio is a waste of everybody’s time.

Abraham Okusanya is director of FinalytiQ

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Comments

There are 5 comments at the moment, we would love to hear your opinion too.

  1. A broad brush article naming ‘issues’ with provider CRP’s without acknowledging that most of them are designed / have features to mitigate them.

    Poorly Researched.

  2. I don’t think you can call Abraham’s views as poorly researched (I think he will fall off his chair reading that and upset his very high stack of academic research).

    However, I think all approaches have advantages and disadvantages and can be suitable for some clients. The disadvantages of the ones he dismisses are that they don’t result in the highest £s. But it’s not all about achieving the highest £s. It is also, for many clients, about what they can understand, feel comfortable with and give them peace of mind.

  3. Clearly the appropriate risk for the Accumulation and Drawdown periods are different.

    This affects the decision of what is the appropriate asset mix.

    The decision to allow the customer to take pension benefits solely as cash from age 55 has muddied the water.

    It means that from age 50, that failing to hold adequate cash can be risky as risk based investments could take a down turn shortly before the customer decides to take his/her benefits.

    • For many of us as advisers, those clients we work with, pensions are now the asset of last resort and are unlikely to be seen as a source of income in the early period of retirement.

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