With central bankers around the world committing to keep interest rates low for many years to come, this creates an issue for retirees looking for income. Traditional defensive assets such as cash and fixed income which typically form a large percentage of retiree portfolios are producing levels of income significantly below historical averages.

In Australia, the RBA is keeping the 3-year yield for government bonds at 0.25%, in what is known as yield curve control. Interest rates have been suppressed for the last decade, however what is unique about the current economic climate, is that with inflation yet to emerge and central bankers focused on generating growth and employment, their signalling to the market has moved further out. Lower for much longer!

 

SuperRatings Executive Director Kirby Rappell shares the latest performance results for superannuation funds and the future outlook for the industry.

Members should be prepared for more ups and downs. However, a patient approach has paid off for members over the long term with the median balanced style fund returning 7.0% per annum since the introduction of superannuation in 1992.

 

 

 


Any advice that SuperRatings provides is of a general nature and does not take into account an individual’s financial situation, objectives or needs. Because the information that SuperRatings receives about superannuation and pension financial products is from a number of sources, it is not guaranteed to be completely accurate. Because of this, individuals should, before acting on the information, consider its appropriateness having regard to their own financial objectives, situation and needs and if appropriate, obtain personal financial advice on the matter from a financial adviser. Before making a decision regarding any financial product, individuals should obtain and consider a copy of the relevant Product Disclosure Statement from the financial product issue.

Although the secrets of a long life remain a mystery, there are now over 300,000 centenarians across the globe and the numbers are rising. Most of us will not survive to 100 no matter how many green vegetables we eat, but there is no doubt life expectancy is increasing. In Japan, 2.5 times more adult than baby diapers are sold. Australian life expectancy from birth is among the highest in the world with the average man living to 80.7 and 84.9 for a woman. It assumes no improvement in healthcare which can increase life expectancy further.

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.

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An equity-based investment fund that aims to deliver dependable income is likely to deviate significantly from the Australian share market index. It requires an active approach to manage a set of very different risks.

For a typical return-seeking equity fund aiming to outperform the index, the main risk is ‘relative risk’ associated with the portfolio deviating from the index and underperforming this benchmark. But what really matters for income investors is the risk that the fund does not deliver a sustainable and growing income stream.

A different set of risks requires a different approach.

Risks specific to the income investor

Income investors face several unique risks that are often not acknowledged in traditional investment literature:

  • Income level risk

Typically, income investors aim to generate an income stream that enables them to maintain their standard of living. This is a critical issue for retirees, and to achieve this goal they must tackle income level risk – the danger that the income paid by an investment falls in response to interest rate changes and other factors.

For example, in 2010 one of Australia’s leading banks offered its customers a five-year term deposit rate of 8%. Today, the rate offered is below 3.5% and around 2% for a more popular 90-day term. Therefore, for those investors who have relied on short-term cash rates to provide for their needs, the steady fall in interest rates over this decade has exposed them to heightened income risk. Of course, living costs continue to rise.

In today’s lower interest rate world, term deposit investors need to invest larger sums of capital than historically to achieve the same dollar return. Additionally, these lower rates impact the level of return available from annuity type products and create significant challenges to overcome.

  • Inflation risk

Inflation risk refers to the risk that the real value of an income stream declines as the cost of living rises. For investors to be able to maintain their spending power and to protect, as well as maintain, their living standards they must ensure their income stream grows at least in line with inflation. This is particularly important for people in retirement as they are likely to incur increased costs in areas such as healthcare and aged care services.

To illustrate inflation risk, imagine investing in a term deposit that has an interest rate of 2% p.a., when inflation is compounding at 2.5% annually. In this scenario, even though an investor is earning a nominal return of 2% a year, inflation is eroding 2.5% of that, leaving the investor with a real (inflation adjusted) return of negative 0.5%.

Given retirees will usually have a relatively fixed capital base, inflation protection has to be a central consideration in any medium to long-term income oriented financial plan.

  • Income volatility risk

Investors worry about movements in the capital value of their investments but for income investors, we believe it is more important to focus on the volatility of the income stream. Putting this a different way – what matters most for income investors is that their investments deliver a sustainable and growing income stream – and the main risk they face is that it does not.

For income-oriented investment solutions, reducing the volatility of the income stream in search of reliable income delivery should be a primary consideration.

Chart 1: Income volatility over the last 15 years – equities and cash

Past performance is not a guide to future performance. Source: Martin Currie Australia, Factset; as of 30 June 2018.*Average ‘special’ rate (all terms).

The chart above compares the volatility of Australian shares (prices and dividends) and term deposit income over the last 15 years. As you can see, the actual volatility of the income stream from term deposits is more than double the volatility of the dividend stream from Australian equities. In addition, the income from dividends has been materially higher.

With this backdrop, equity income investors are increasingly valuing the more dependable nature of dividend streams especially from higher quality companies and are worrying less about short-term capital volatility associated with share markets.

Asset managers have helped with this process through educating investors on the opportunities and risks of equity-based strategies and by developing specialist funds to enable them to benefit from these attractive income streams.

  • Longevity risk

Australians are living longer. As the chart below shows, the average life expectancy of Australian men and women is now over 90 years, having increased by an average of around 20 years since 1960. So, the probability (risk) that we outlive our savings is growing – this is known as longevity risk.

Chart 2: Australian life expectancy (at birth)

Source: Australian Institute of Health and Welfare, Australian Treasury Intergenerational Report, ABS, March 2018

And not only are we living longer but more and more of us are entering retirement.

Over the next 40 years Australia’s population will experience a major shift – a far greater proportion of the population will be older – as the dominant baby-boomer generation moves into retirement, and these older Australians will be living longer. This combination will significantly increase the nation’s pension expenses and upset the balance between retirees and the working age people who are funding the pension system. Currently, for every person aged 65 and over there are 4.5 people of workforce age (15 to 64) contributing their taxes to help fund pensions. This is forecast to decrease to around 2.7 people per retiree by 2055, putting an increased strain on the entire system[1].

This all points towards continued growth in demand for income generating investment solutions, particularly given the prevailing ‘lower for longer’ view of interest rates. In this world, equities can carry much of the burden, especially funds that utilise proven active management focused on uncovering the highest quality, most sustainable, dividend streams.

The real risk/return trade-off for income investors

For the reasons outlined, investors seeking income need solutions that can generate a yield high enough to meet their requirements today, that is sustainable over the long-term, that can be expected to grow at least in line with inflation, whilst also protecting their hard-earned capital base. In our view, this requires a change in investor behaviour and the need to challenge some traditional investment approaches.

Given these specific risks, what is the true risk/return trade-off that applies to income focused portfolios?

The traditional approach to investing looks at the potential total return of an investment (capital plus income) and compares it to the expected risk. The aim is to create a portfolio that can deliver the best possible return for a given amount of expected risk. But this only makes sense if your investment objective is focused on total return. If you are an income investor, your objective is to generate a sustainable and growing income stream. Hence a different approach to investing and portfolio construction is required as low risk in this context is defined as income sustainability.

Chart 3: Expected income versus income risk

 

Source: Martin Currie Australia, ASFA, Factset; as of 30 June 2018. Income is calculated using manager assumptions for each asset class – because of this, the returns quoted are estimated figures and are therefore not guaranteed. *Data calculated for representative Legg Mason Martin Currie Australia Equity Income (1), Real Income (2) and Diversified Income (3) accounts in A$ gross of management fee; gross performance data is presented without deducting investment advisory fees, broker commissions, or other expenses that reduce the return to investors. Assumes zero percent tax rate and full franking benefits realised in tax return.

The chart above examines how the major asset classes fare when the portfolio construction trade-off is redefined as expected income versus income risk (also known as the expected volatility of the income stream).  Term deposits have deeply disappointed as the dramatic drop in interest rates over the past decade means that the volatility of the income offered is high and actually worse than the income volatility from emerging market shares. Australian shares and A-REITs do much better and these can be improved still further by dedicated equity income strategies that target the companies that matter most to income investors – those with high dividends that are both sustainable in difficult economic conditions and are expected to increase in value over time.

Legg Mason Asset Management Australia Ltd (ABN 76 004 835 849 AFSL 240827) is part of the Global Legg Mason Inc. group. Any reference to ‘Legg Mason Australia’ is a reference to Legg Mason Asset Management Australia Limited. Legg Mason Australia is the responsible entity of the Legg Mason Martin Currie Equity Income Fund (ARSN 150 751 821), the Legg Mason Martin Currie Real Income Fund (ARSN 146 910 349) and the Legg Mason Martin Currie Diversified Income Fund (ARSN 169 461 116) (Funds) and Martin Currie Australia, a division of Legg Mason Australia, is the fund manager of these Funds. Before making an investment decision you should read the relevant Product Disclosure Statement (PDS) carefully and you need to consider, with or without the assistance of a financial advisor, whether such an investment is appropriate considering your particular investment needs, objectives and financial circumstances. The PDS is available and can be obtained by contacting Legg Mason Australia on 1800 679 541 or at www.leggmason.com.au. The information in this article is of a general nature only and is not intended to be, and is not, a complete or definitive statement of the matters described in it. The information does not constitute specific investment advice and does not include recommendations on any particular securities. Legg Mason Australia nor any of its related parties, guarantee the repayment of capital, rate of return or performance of any of the Legg Mason Funds referred to in this document.

[1] Australian Department of Treasury, 2015 Intergenerational Report, Chapter 1.

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.