The following lesson is one of IML’s ‘20 lessons for 20 years of quality and value investing’, which were recently published by Anton Tagliaferro and the IML investment team to mark 20 years since IML was founded.

We chose this lesson for Lonsec Retire, as it highlights the need for growth assets in retirement, particularly for early retirees who typically have investment timeframes of 20+ years.

The lesson illustrates the benefits of compounding by showing how companies that reinvest back into their businesses can reward investors with increasing dividends and appreciating share prices over the long-term. Increasing dividends is vital for retirees facing significantly lower returns from popular retirement income streams such as term deposits and traditional fixed income funds.


#6 The Power and Benefits of Compounding Over Time in Equity Portfolios

Most people are familiar with the concept of compound interest when it comes to term deposits, where one can earn interest on interest by continuing to roll over a term deposit. However, many investors do not relate the concept of compounding to their investments in the sharemarket.
Compounding occurs in the sharemarket when income from an investment is reinvested back into the business, and investors are rewarded with the benefits of increasing profits and appreciating share price growth over the long-term.
For investors in the sharemarket, there are two ways compounding can work in their favour to enhance their long-term returns.

These lessons are available both in hard copy and e-book format. For a copy of the book please register your interest here or email iml@iml.com.au

**IML and Lonsec  Investment Consulting will be holding a webinar as part of Lonsec Retire Program on Wednesday, February 12th, find out more.

In our first paper: “Balancing the Needs, Challenges and Dilemmas of Retirement Investing”, we noted that Income generation isn’t as easy as it once was. The fact retirees require income needs no explanation.

How should we think about generating income in retirement? In August 1991 the Budget address, by then Treasurer John Kerin, proposed the introduction of compulsory superannuation in
1992. At the time a 90 Day Bank Term Deposit was paying 9.75% p.a.

Bank Term Deposits are one of the reasons Australia is the ‘lucky country’ as today these are guaranteed, or true ‘risk free’ investments. Unfortunately, while the ‘risk free’ aspect
remains attractive, the investment returns compared to 30 years ago are not.

While cash remains ‘risk free’ relying on it as your only source of income risks quality of life in retirement. Therefore, to generate sufficient income to sustain a comfortable retirement, we are forced to accept some level of investment risk. In simple terms, the more risk we accept, the higher income we should expect to generate. While acknowledging this,
acceptance of risk increases the probability that the asset base we’ve spent 40+ years working to build is at some risk of diminishing.

How Much is Enough?
The Australian Financial Security Authority “AFSA” advises that a comfortable retirement for a retiree with the ATO Median superannuation balance 5 eligible for the Government Pension needs to generate 7.6% per annum. Once upon a time, generating this level of income was achievable using “risk free” approaches. This is an exceedingly lofty ambition today with cash rates closer to 1%. As we’ve noted investing for the specific needs of retirement is incredibly complex, while much of the commentary proposes solutions that only work for those with adequate assets to be self-sufficient in retirement.

There are various proposals surrounding the use of draw-downs to supplement income generation, such as the concept of a constant draw-down policy in retirement, which we’re supportive of. However, we are concerned that their applicability is limited to only those with Asset Bases sufficiently adequate to provide for a self-funded retirement, therefore risking overlooking the
issues facing a majority of retirees.

The following commentary attempts to investigate the issues facing those with Asset Bases around the level of the ATO Median 2016-17, where the issue is more stark. For these retirees drawing down their asset base guarantees a retirement well below comfortable.

For Retirees with asset bases at or below the level of the ATO Median their Asset Base is sacrosanct.

 

Many retirees struggle to have enough income to fund a comfortable retirement because of an over-reliance on so-called “low risk” asset allocations, a problem that requires innovative solutions to overcome according to the team at Legg Mason’s Martin Currie.

Access the full article here.

 

Balancing the Needs, Challenges and Dilemmas of Retirement Investing

Retirement investing is necessarily complex.

The median super balance when entering retirement can’t support a comfortable lifestyle in the years ahead. In the first part of this series we outline the major investment building blocks and how they’re used to deliver better lifestyle outcomes for retirees.

Australians spend 40 years of their working life building an asset base to retire. For the majority1 this asset base on Day 1 of retirement is insufficient to pay for their remaining life costs should they wish to live comfortably2.

Specialised approaches to investing are the only way to breach this shortfall for retirees. Conceptually, growing our asset base in the accumulation phase is easy, we engage the growth investment engine and our risk is defined as opportunity cost.

In retirement, the engine of accumulation is still required.

Throughout the accumulation phase the investment engine was set to asset growth. For retirees, that engine must engage new gears, set for the unique combination of investment goals specific to retirement needs.

We spend 40+ years working to build an asset base to support us in retirement and in retirement we need that asset base to deliver 3 outcomes:

  • Income generation, but not at the expense of capital loss;
  • Growth of assets, but not risk losing all our savings;
  • Certainty of outcomes…

…and do all this for an unknown number of years.

The investment engine now requires three components to successfully drive retirement outcomes:

Income, growth and certainty are important individual investment components but paradoxically are not always complementary to each other. However, it is only by combining them that retirees can meet their overall retirement needs – this makes retirement investing complex.

Whilst the sub-components of retirement investing may be complex, the investment framework and discussion of its rationale need not be. Simply put:

  • Retirement investing has three core standalone objectives: Income, Growth, and Certainty which in combination are hard to balance. Each objective solves a specific Need, each Need presents a Challenge, and each Challenge has its own Dilemma

Based on the guidance provided by the ASFA Retirement Standards3, it’s clear that the Median Superannuation Balance4 isn’t enough to support a comfortable retirement.

We also know that the longer we live, the longer we’re expected to live. Thus, increasing the stress / responsibility on our savings to provide for retirement:

Life Expectancy At Age:

Age At Birth 65 75 80 85 90 95 100
Males 80.5 84.7 87.1 88.9 89.3 94.3 98.1 102.1
Females 84.6 87.3 89.1 90.4 89.9 94.9 98.3 102.3

Source: ABS 3302.0.55.001 – Life Tables, States, Territories and Australia, 2015-2017

With these data points in mind, aligning the investment engine to an investment strategy that meets client needs while engaging them in why and how this will help solve their problem isn’t easy, but it doesn’t need to be incomprehensible. Below we present each of the required retirement investment outcomes with their individual Need, Challenge and Dilemma concluding with a robust framework for delivering improved retiree lifestyles in retirement.

Income

Need: Income generation, accounting for inflation, avoiding the risk of capital loss.

Challenge: To generate enough income from retirees’ existing asset base.

Footnote: Yield required from asset base based on ATO Median 64-69 year old superannuation balance, accounting for pension payment for homeowning couple (Male and Female), using ASFA Comfortable spending requirement, ASFA Inflation assumption of 2.75% p.a.

Dilemma: Income generation isn’t as easy as it once was. Today, with income levels either too low (for our needs) or too risky (as standalone investments), focusing solely on generating enough income from our asset base introduces significant risks that our asset base may be eroded while not adequately rewarding for the risk of running out of money and diminishing quality of lifestyle in retirement. Alone, investing for income is not an adequate solution for this unique challenge.

1990 2000 2010 2019
RBA Cash Rate 17.5% 5.0% 3.75% 1.25%
Inflation 7.8% 1.9% 2.1% 1.3%
Real return on cash 9.7% 3.1% 1.65% -0.05%

Source: ABS, Inflation – Consumer price index; All groups, March 2019 (Series ID: GCPIAG)

Growth

Need: Growth of assets, but not at the expense of losing my asset base.

Challenge: Investing for growth is the only way to extend the duration of a comfortable retirement. However it can significantly increase the risk of reducing the extent of a comfortable retirement by eroding retirees’ asset base through poor returns. The ultimate measure of risk in retirement is “will this investment increase my risk of running out of money earlier?”, or in other words “what does this investment do to the range of outcomes for when I’ll run out of money?” To test what this risk is we add equities5 to cash, to build some simplistic scenarios to assess the impact of investing to achieve an expected 6% p.a. return6. This provides a picture of what the real risk of investing for growth to a retiree looks like.

Dilemma: Investing for growth is a prerequisite, but achieving growth and increasing the duration of a comfortable retirement isn’t risk free. Growth investing isn’t a straight-line reward, we all remember the GFC and the impact on invested savings. The risk to our asset base is real, finding the appropriate balance of this risk and appropriate growth assets can only come with a genuine understanding of the possible investments and how each may impact on retiree lifestyles.

Certainty

Need: With only our asset base to support our living standards, providing certainty is critical to maintaining those standards.

Challenge: Investing is uncertain. Retirement requires a level of certainty that traditional approaches may not facilitate. Certainty has an opportunity cost: lower risk necessitates lower expected peak returns.

There’s also a client engagement necessity of certainty. Australians are under-advised, so presenting them with comprehensible solutions and building trust as their partner is critical. It’s not hard to imagine that this trust would never eventuate if we were to introduce too much uncertainty, ultimately losing retirees through the diminished perception of the value of advice.

Being a genuine source of value to retirees throughout the most important part of their financial lives is of significant mutual benefit. This trust is facilitated through the use of solutions that provide increased certainty to investment outcomes.

Investment certainty and growth aren’t positively associated so approaches to retirement investing need to take certainty into account far more than in the accumulation phase. As a retiree knowing that my asset base will support a comfortable retirement for as long as possible is, arguably the most important goal to achieve.

Source: Bloomberg, based on calendar year total returns

Dilemma: People need advice to navigate the most complex of investment problems any of us face. Building trust in what we provide as fiduciaries is critical. The marriage of “complexity of challenge” and “simplicity of solution” isn’t straight forward or always self-evident, but is necessary to earn the trust of retirees.

Conclusion

In retirement, the investment engine of accumulation is still required. The task we set our engine is very different as finding the right mix of strategies providing Income, Growth and Certainty is imperative. Simply put, we have different needs as retirement investors.

Different needs require a different approach. The same strategies we employed in accumulation won’t work in retirement. We know this balance is imperative but equally important is the balance of the message for clients.

What remains constant, if not more important, is the trust we must maintain with retirees. We believe an understanding of the three key pillars of retirement investing, along with the challenges in achieving each and the dilemmas presented is essential. Having retirees’ needs at the centre of this understanding provides the best position to engage in the successful pursuit of a longer, more comfortable retirement.

Life is full of certainties, in retirement it’s no different: doing nothing leads to having nothing.

The solution isn’t easy, it requires; forgetting our investment approach in accumulation, different actions in the consideration of building investment structures and the adoption of unique investment approaches to truly ensure the retirement investment engine is working for retirees.

Specialised approaches to investing are the only way to breach this shortfall for retirees. Growing our asset base through a mix of growth, income and certainty increases the likelihood improving retirees’ retirement lifestyle for longer.

1 ATO Taxation Statistics 2016–17, Median super account balance, by ages 65 – 69, 2016–17 financial year
2 The Association of Superannuation Funds of Australia Limited, Retirement Standard for retirees, March Quarter 2019, Comfortable Lifestyle
3 The Association of Superannuation Funds of Australia Limited, Retirement Standard for retirees, March Quarter 2019, Comfortable Lifestyle
4 ATO Taxation Statistics 2016–17, Median super account balance, by ages 65 – 69, 2016–17 financial year
5 Lonsec Risk Profiles 2018, Step 3: Long term asset class return and risk assumptions, October 2018
6 ASFA, Retirement Standard March 2019, assumed investment earning rate
7 Calculated using Lonsec Risk Profiles, Long Term Asset Class Return and Risk assumptions to generate 6% p.a. expected return and using +/- 1 standard deviation to determine range of outcomes with c.66% confidence

Important Information

This document is intended for licensed financial advisers and institutional clients only and is not intended for use by retail clients. The information in this document is general information only and is not based on the objectives, financial situation or needs of any particular investor. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document. Financial conclusions are reasonably held at the time of completion but subject to change without notice.

Talaria Asset Management Pty Ltd ABN 67 130 534 342, AFS Licence No, 333732 assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, Talaria, its directors, officers, employees and agents disclaim all liability for any error or inaccuracy in, misstatement or omission from this document or any loss or damage suffered by the reader or any other person as a consequence of relying upon it.

As it continues to grapple with the challenges facing retirees, the Australian retirement industry in some ways resembles a research institution―continually coming up with ideas for solutions to those challenges, testing them, then implementing them and reviewing the results.

For those involved in such an enterprise, it’s always interesting to see how well (or badly) those solutions work in practice, and the extent to which they’ve validated their research hypotheses.

At AllianceBernstein, we’ve been running the numbers on an investment strategy we launched five years ago, primarily for investors saving for retirement.

The strategy was developed in collaboration with a major Australian superannuation fund which had asked us to look for ways to “smooth the ride” for its members―that is, to help them earn meaningful investment returns while reducing the downside risk in their portfolios.

Reducing downside risk is, of course, important for investors who are in retirement or approaching it: the less their portfolios lose, the more money they have left over to deal with future market drawdowns, and the risk that they might live longer than expected.

There are several aspects to the strategy but, at its heart, is a portfolio of low-volatility stocks and a focus on aiming to limit downside risk to 50% of what the market experiences, while seeking to capture 80% of the upside when the market recovers.

Our research indicated that this might be achievable by combining careful stock selection (about which more later) with the so-called low-volatility paradox (the well-attested fact that a portfolio of low-volatility stocks can outperform the market over time on a risk-adjusted basis).

It’s been an eventful five years with several market ups and downs and our research hypothesis has been well tested. What have we learned?

SMOOTHER, BUT STILL THE OCCASIONAL BUMP

Pleasingly, the strategy has performed well, outperforming the market over the period (Display) and providing investors with a smoother ride, particularly when the market fell.

Downside Protection Generated Outperformance

April 1, 2014 to March 31, 2019

Source: S&P Dow Jones and AB; see Performance Disclosure.

As of March 31, 2019

Past performance does not guarantee future results.

Based on a representative Managed Volatility Equities account vs. S&P/ASX 300 Franking Credit Adjusted Daily Total Return (Tax-Exempt)

The returns presented above are gross of fees. The results do not reflect the deduction of investment-management fees or Fund costs. Performance figures include the value of any franking (or imputation) credits received. Numbers may not sum due to rounding. Periods of more than one year are annualised.

*For determining months when index is up or down, performance of S&P/ASX 300 (i.e., excluding franking credits) is used.

In fact, the strategy’s buffer on the downside contributed most to outperformance: the portfolio’s mean monthly return was 1.4% higher than the index when the market dipped and 0.3% lower when the market rose.

It’s interesting to note, too, that the strategy exceeded our aims in terms of upside/downside performance, with the portfolio suffering only 47% of the downside when the market fell (compared to our 50% target) and capturing 90% of the upside (our target was 80%).

There is a compounding effect at work here: limited downside means that the portfolio has less ground to make up when the market recovers, and this can contribute to outperformance over time.

It turns out, however, that even a strategy carefully designed to withstand volatility can experience the occasional bump, as happened when banks and mining companies performed very strongly after Donald Trump was elected US President in November 2016.

Bank and mining stocks tend to be volatile and, because they don’t figure highly in our low-volatility strategy, they were underweighted by our portfolio at the time. Financials and materials, of course, are the Australian share market’s biggest sectors. As they drove the market up, our portfolio lagged.

But the effect was short-lived and had relatively little impact on overall performance, appearing to validate one part of our hypothesis, that a low-volatility portfolio can outperform over time. What about the other part, regarding stock selection and portfolio management?

THE BIGGEST LESSON OF ALL

This consisted of five basic principles:

  • choose low-volatility stocks where the underlying businesses are high quality, with good cash flows and strong balance sheets, and the shares are reasonably valued
  • use fundamental research to avoid ‘volatility traps’, or the risk that idiosyncratic factors―such as a takeover bid―can make a normally stable stock suddenly volatile
  • ignore market benchmarks when constructing the portfolio: this makes it easier to focus on low-volatility stocks, and to avoid the volatility inherent in Australian equity indices
  • invest up to 20% of the portfolio in global stocks as a way of reducing risk, and making up for the necessity of limiting the portfolio’s access to the Australian market
  • manage macroeconomic risk―such as the potential impact on the portfolio of Brexit or the US-China trade wars―thoughtfully, so that the removal of one risk doesn’t inadvertently create exposure to another

Applying these principles consistently contributed positively to performance over the period.

Perhaps the biggest lesson we learned, however, is that it’s possible to deliver investors above-market returns with below-market volatility.

We’re happy to share that knowledge, and the benefits it delivers, with our colleagues in the industry who are seeking to create a better retirement future for Australians.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time.

INFORMATION ABOUT THE AB MANAGED VOLATILITY EQUITIES FUND AllianceBernstein Investment Management Australia Limited (ABN 58 007 212 606, AFSL 230 683) (“ABIMAL”) is the responsible entity of the AllianceBernstein Managed Volatility Equities Fund (ARSN 099 739 447) (“Fund” or “AB Managed Volatility Equities Fund”) and is the issuer of units in the Fund. AllianceBernstein Australia Limited (“ABAL”) ABN 53 095 022 718, AFSL 230 698 is the investment manager of the Fund. ABAL in turn has delegated a portion of the investment manager function to AllianceBernstein L.P.(“AB”). The Fund’s Product Disclosure Statement (“PDS”) is available at the following link https://web.alliancebernstein.com/funds/au/equity/managed-volatility-equities.htm

or by contacting the client services team at AllianceBernstein Australia Limited at (02) 9255 1299.

Neither this document nor the information contained in it are intended to take the place of professional advice. Please note that past performance is not indicative of future performance and projections, although based on current information, may not be realised. Information, forecasts and opinions can change without notice and neither ABIMAL or ABAL guarantees the accuracy of the information at any particular time. Although care has been exercised in compiling the information contained in this report, neither ABIMAL or ABAL warrants that this document is free from errors, inaccuracies or omissions.

This document is released by AllianceBernstein Australia Limited ABN 53 095 022 718, AFSL 230 698.

DISCLAIMER

This document is provided solely for informational purposes and is not an offer to buy or sell securities. The information, forecasts and opinions set out in this document have not been prepared for any recipient’s specific investment objectives, financial situation or particular needs. Neither this document nor the information contained in it are intended to take the place of professional advice. You should not take action on specific issues based on the information contained in the attached without first obtaining professional advice. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Current analysis does not guarantee future results.

INFORMATION ABOUT ALLIANCEBERNSTEIN

AllianceBernstein (AB) is a leading global investment management and research firm. We bring together a wide range of insights, expertise and innovations to advance the interests of our institutional investors, individuals and private clients in major world markets. AB offers a comprehensive range of research, portfolio management, wealth management and client-service offices around the world, reflecting our global capabilities and the needs of our clients. As at March 31, 2019, our firm managed US$555 billion in assets, including US$257 billion on behalf of institutions. These include pension plans, superannuation schemes, charities, insurance companies, central banks, and governments in more than 45 countries. This document is released by AllianceBernstein Australia Limited (“ABAL”) ABN 53 095 022 718, AFSL 230 698. AllianceBernstein Australia Limited (ABAL) is a wholly owned subsidiary of the AllianceBernstein, L.P. Group (AB).

To access the insights, please click here.

An in-depth analysis of the new social security means test assessment of lifetime income streams and the significant opportunities it presents for retirement income advice.

To access the insights, please click here.

Imagine a baby is born in Europe at the very moment you finish this article. That child can expect to live for two minutes longer than one born as you finish this sentence. Increasing lifespans threaten to topple the current pensions model. But, then again, maybe it’s time for a change.

To access the insights, please click here.

 

What are the real underlying structural forces bewildering the RBA? Is cash the king once again? Find out more about these and other interesting topics in Pendal’s latest review of fixed interest markets.

To access the insights, please click here.

 

 

AB’s latest insights update shows that markets have snapped back from a tough 4Q18.

Click here to view the article.

Important information: Any express or implied rating or advice is limited to general advice, it doesn’t consider any personal needs, goals or objectives.  Before making any decision about financial products, consider whether it is personally appropriate for you in light of your personal circumstances. Obtain and consider the Product Disclosure Statement for each financial product and seek professional personal advice before making any decisions regarding a financial product.