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:
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.
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.
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.
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