As pensions freedom begins to embed, advisers may be finding that a growing proportion of clients are looking to use drawdown as the primary source of income in retirement.
Established investment solutions and processes, designed originally for accumulation, now need to be adapted to cater for and align with the cashflow requirements of clients in retirement. The factors to consider when designing decumulation portfolios are different to that in accumulation, and there’s a lot more to think about.
In a recent study, the langcat1 found that over 70% of adviser firms don’t change their investment models to suit clients drawing income in retirement. MiFID might have something to do with that, making it more difficult than ever to manage and transition between portfolios, but it’s a problem that’s only going to get bigger over time, so a solution is needed now.
There are already a range of drawdown-focused portfolios available to choose from, or you could opt to design and manage your own. Before deciding which route to take, you’re going to need to understand what makes a well-designed drawdown portfolio different from an accumulation portfolio. Here are some things to consider.
Accumulation – it’s about volatility and return
The principles of investing in accumulation are relatively well established. At this stage volatility is generally a good thing, subject to your clients’ attitude to risk. A good accumulation portfolio will be designed to maximise capital growth for a given level of volatility. The ongoing management and monitoring of a good accumulation portfolio will focus on these risk factors – the volatility of the portfolio, and the level of capital growth achieved for that level of volatility.
Decumulation – it’s about income sustainability
In decumulation, this is where it gets tricky. Firstly, volatility becomes more of an issue – particularly in early retirement where the pounds and pence losses can be much bigger. But there’s a tension here, because not taking enough risk in decumulation can also have negative impact on someone’s retirement outcome. So, rather than focussing on volatility, a good decumulation portfolio will be designed to maximise the sustainability of an income plan, aligned to client cashflow requirements.
Measuring the sustainability of an income plan requires sophisticated modelling techniques. Firstly, you need to work out a wide range of good, bad, and average economic and investment market scenarios. You then need to use these scenarios to stress test what might happen to a given retirement plan. From that investigation, the output will be an idea of how achievable that retirement plan is – ie the probability that the plan won’t end up in your client running out of money earlier than they wanted to. Now, repeat all that with different asset allocation options until you find the option which maximises income sustainability, and you have yourself a good multi-asset decumulation portfolio.
As you can see designing and managing a decumulation portfolio which meets a broad range of your clients’ needs is not a straightforward exercise. However it is becoming an increasingly essential part of an investment proposition and will be a core part of your clients’ overall financial plan.