News & Insights Archives - Page 6 of 6

Risk measurements in retirement solutions

When accumulating savings for retirement, the investment objective is clear – to grow and maximise savings. Risk in the accumulation phase is also well-defined and focused on the loss of capital, as measured by the volatility of investment returns or related downside risk measures. Risk tolerance is then typically used to determine appropriate investment profiles, with the aim of achieving greater wealth to fund retirements.

However, the risk-return landscape becomes significantly more complex once retirement comes into the picture. The primary objective in the decumulation phase ceases to be pure growth and more about using accumulated wealth to sustain a target level of income throughout retirement. Therefore, volatility of investment returns is no longer a suitable risk measure as it does not describe the risk of failing to meet this objective.

Retirement income risk measure

Traditional measures of variance (standard deviation) focus on both upside and downside variation. However, behavioural economists commonly point out that individuals are more averse to downside variation than upside variation. A more relevant risk measure in the context of decumulation is the probability of running out of money, or a measure of income variation. This captures important dynamics such as the sequence of returns, which can be particularly damaging in decumulation.

The risk can be depicted as:

The importance of risk measurement in retirement products is highlighted in a Treasury consultation paper which proposes a range of standard metrics to help consumers make decisions about the most appropriate retirement income product for their own circumstances.

The discussion paper proposes that a measure of income variation be provided in respect of all retirement income products and this measure is presented on a seven-point scale.

The finance industry uses terms like longevity risk, market risk, sequencing risk and inflation risk, which are all relevant to the outcome experienced by investors in a retirement income product. However, these terms are not well understood by a lay person, so an income variation measure could help fill in some gaps.

Retirement objectives

Lonsec’s Retirement Lifestyle Portfolios are objectives-based portfolios focused on delivering a sustainable level of income in retirement, as well as generating capital growth. Specifically, the portfolios are designed to assist advisers in constructing portfolios to meet retiree essential and discretionary income needs, while generating some capital growth to meet lifestyle goals.

Differences to Lonsec’s core accumulation model portfolios are:

Income objective of 4% p.a. for all portfolios
Greater bias to AUD denominated assets – historically higher dividends, franking credits
Greater focus on absolute rather than relative performance
Constructed to manage capital drawdown risk
Fixed income allocations have less duration and greater credit exposure
Key building blocks are Yield, Capital Growth & Risk Control

In reality, risk in retirement is multi-dimensional. An individual retiree may have multiple goals, such as leaving a bequest, with a different level of importance attached to each. An individual’s risk aversion in retirement will therefore be defined by a holistic view of their retirement goals, and the risks to those goals across all scenarios that could play out during retirement. Typically, more than one risk measure is necessary, with multiple scenarios required to truly appreciate the risks inherent with each solution.

September 17, 2019/by Michael Elsworth

Timing of negative super returns can determine fate of retirees

A combination of factors has created fertile ground for market volatility, resulting in a bumpy ride for super members, who have experienced six negative monthly returns over the past year.

According to SuperRatings, the median balanced option return for August was an estimated -0.5%, with the negative result driven by a fall in Australian and international shares. The median growth option, which has a higher exposure to growth assets like shares, fared worse, returning an estimated -0.9%.

In contrast, the median capital stable option, which includes a higher allocation to bonds and other defensive assets, performed more favourably with an estimated return of 0.3% (see table below).

Estimated accumulation returns (% p.a. to end of August 2019)

	1 month	1 year	3 years	5 years	7 years	10 years
SR50 Growth (77-90) Index	-0.9%	5.2%	8.8%	8.0%	10.2%	8.5%
SR50 Balanced (60-76) Index	-0.5%	5.3%	8.0%	7.5%	9.2%	8.0%
SR50 Capital Stable (20-40) Index	0.3%	5.3%	4.8%	4.8%	5.4%	5.7%

Source: SuperRatings

Investors were caught off guard in August as trade negotiations between the US and China broke down, while a range of geopolitical and market risks, including further signs of a slowing global economy, added to uncertainty.

In Australia, a disappointing GDP result for the June quarter revealed a domestic economy in a more fragile state than previously acknowledged. Action from the Reserve Bank to lower interest rates is expected to assist in stabilising markets but could be detrimental for savers and retirees who rely on interest income.

Pension products shared a similar fate in August, with the balanced pension option returning an estimated -0.6% over the month while the growth pension option returned an estimated -1.0% and the capital stable pension option was mostly flat with an estimated return of 0.3%. Long-term returns are still holding up well, with the median balanced option for accumulation members delivering 9.2% p.a. over the past seven years (in excess of the typical CPI + 3.0% target) and the median balanced pension option returning 10.2% p.a.

Estimated pension returns (% p.a. to end of August 2019)

	1 month	1 year	3 years	5 years	7 years	10 years
SRP50 Growth (77-90) Index	-1.0%	5.9%	9.9%	9.2%	11.5%	9.4%
SRP50 Balanced (60-76) Index	-0.6%	6.2%	8.7%	8.0%	10.2%	8.8%
SRP50 Capital Stable (20-40) Index	0.3%	6.2%	5.5%	5.5%	6.3%	6.4%

Source: SuperRatings

“There will always be negative months for super members, but the timing of negative returns can have a real impact on those entering the retirement phase,” said SuperRatings Executive Director Kirby Rappell.

“For members shifting their super savings to a pension product, a number of down months in relatively quick succession will mean they begin drawing down on a smaller pool of savings than they might have anticipated. As members get closer to retirement, it’s important that they review their risk tolerance to make sure they can retire even if the market takes a turn for the worse.”

As the chart below shows, down months in the latter part of 2018 took their toll on pension balances, although they were able to recover through 2019 to finish above their starting value by the end of August 2019.

Pension balance over 12 months to end August 2019*

Source: SuperRatings
*Assumes a starting balance of $250,000 at the end of August 2018 and annual 5% drawdown applied monthly.

Comparing balanced and capital stable option performance shows that the balanced option suffered a greater drop but was able to bounce back relatively quickly. A starting balance of $250,000 fell to $232,951 over the four months to December 2018, before recovering to $252,091 at the end of August 2019.

In contrast, the capital stable option was able to better withstand the market fall, with a starting balance of $250,000 dropping to only $241,746 in December before rising back to $252,201.

While both performed similarly over the full 12-month period, a member retiring at December 2018 could have been over $8,500 worse off if they were in a balanced option compared to someone in a capital stable option. While a capital stable option is not expected to perform as well over longer periods, it will provide a smoother ride and may be an appropriate choice for those nearing retirement.

“Super fund returns have generally held up well under challenging conditions, but there’s no doubt this has been a challenging year for those entering retirement,” said Mr Rappell.

“Under these market conditions, timing plays a bigger role in determining your retirement outcome. At the same time interest rates are at record lows and moving lower, so the income generated for retirees and savers is less, particularly if someone is relying on interest from a bank account. In the current low rate and low return environment, it’s harder for retirees to generate capital growth and income.”

September 8, 2019/by Kirby Rappell

Industry Retirement Insights, News & Insights

Solving for the retiree problem with innovation

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.

August 29, 2019/by Legg Mason Australia

Media releases, News & Insights

Super funds look to move past forgettable financial year

A world-beating performance from Australian shares has been overshadowed by the re-emergence of geopolitical uncertainty and a wave of risk aversion in global markets, leading to softer performance for super funds in the final stretch of the financial year.

According to estimates from leading superannuation research house SuperRatings, the typical balanced option return was -0.7% in May as funds were dragged down by falls in international shares triggered by the re-emergence of the US-China trade conflict and uncertainty surrounding central bank policy.

The bright side has been the resilience of Australian shares and property, both of which saw a brief boost from the Coalition’s surprise election win, but this was not enough to save super funds from a month of negative performance.

Markets have since recovered following May’s weakness, but members should not expect a bumper end to the financial year. The year-to-date return is sitting at 5.1% for the median balanced option, which is below the 8.5% per annum return achieved over the past ten years.

Estimated median Balanced option returns to 31 May 2019

Period	Accumulation returns	Pension returns
Month of May 2019	-0.7%	-0.7%
Financial year return to 31 May 2019	5.1%	5.8%
Rolling 1-year return to 31 May 2019	4.8%	7.3%
Rolling 3-year return to 31 May 2019	6.8%	8.1%
Rolling 5-year return to 31 May 2019	6.6%	7.6%
Rolling 7-year return to 31 May 2019	8.7%	10.5%
Rolling 10-year return to 31 May 2019	8.5%	9.7%
Rolling 15-year return to 31 May 2019	7.5%	8.1%
Rolling 20-year return to 31 May 2019	6.8%	–

Interim results only. Median Balanced Option refers to ‘Balanced’ options with exposure to growth style assets of between 60% and 76%. Approximately 60% to 70% of Australians in our major funds are invested in their fund’s default investment option, which in most cases is the balanced investment option. Returns are net of investment fees, tax and implicit asset-based administration fees.

Members in the median growth option, which includes higher weightings to growth assets like Australian and overseas shares, suffered a larger fall of 1.2% in May, while the median International Shares option fell 4.0% and the median Australian Shares option held firm, returning 1.4%.

“It’s been a disappointing end to the financial year for super, but long-term performance remains robust,” said SuperRatings Executive Director Kirby Rappell. “The median balanced option return over the past 10 years is around 8.5%, indicating that super has delivered solid returns even in a low interest rate environment.”

Downside risks to the Australian economy, including weak inflation, falling home prices, and tighter credit conditions are taking their toll on consumer confidence, while the geopolitical risks in the form of US-China trade negotiations have also contributed to market volatility.

SuperRatings Index return estimates to 31 May 2019

Source: SuperRatings

However, the Australian market has held up reasonably well over the financial year to date, with the S&P/ASX 200 Index returning 7.6% so far to the end of May, outperforming global share performance of 6.3% measured by the MSCI World Ex-Australia Index. Listed property has been the leading asset class so far this financial year, with the S&P/ASX 200 A-REIT Index returning 14.5%. Both property and shares saw a modest boost in May with the negative gearing debate now effectively put to bed following the federal election.

“Labor’s negative gearing proposals were thought to favour developers by limiting tax concessions to new stock, but so far the improvement in sentiment has outweighed any negative impact, which may give some super funds a temporary boost to their property portfolios,” said Mr Rappell.

Long-term super performance steady

The negative performance for super funds in May has been reflected in a slight fall in the Balanced and Growth option indices for the month but long-term performance remains strong. According to SuperRatings’ data, $100,000 invested in the median Balanced option in May 2009 is estimated to have reached an accumulated $217,391 today.

The median Growth option is estimated to be worth $230,873 over the same period, while $100,000 invested in domestic and international shares ten-years ago is now worth $244,382 and $258,181 respectively. In contrast, $100,000 invested in the median Cash option ten years ago would only be worth $129,748.

Growth in $100,000 invested over 10 years to 31 May 2019

Source: SuperRatings

Release ends

June 17, 2019/by Kirby Rappell

News & Insights

Most retirees can’t define risk, but they know it when they see it

When you ask clients how they think about risk in retirement, you are unlikely to get a textbook response. Instead, you’ll probably get a list of their deepest fears: running out of money, leaving their children with nothing, living too long, retiring during the next GFC, or not having enough cash on hand to pay for necessities.

When we define investment risks, we don’t define them in these terms, but these are the eventualities we’re attempting to guard against when we construct retirement portfolios. There are any number of objectives your client might be aiming to achieve, and each will come with their own set of risks.

Is it the chance of your investments going down? Is it asset class volatility? Is it not achieving the returns you need to meet your required income? In the end, risk is getting your investment strategy wrong by not understanding the relationship between your client’s competing objectives and associated risks.

For this reason, we believe there is a need to focus on retirement investing as a separate strategy. Even moving from the accumulation to the drawdown phase means you are managing a different set of trade-offs. The role of the financial adviser is not to eliminate the existence of these trade-offs but to manage them prudently in line with their client’s preferences and risk tolerance.

Source: Lonsec

Each of these competing objectives requires different investment strategies to achieve. For example, a rental property will provide the most consistent income but at the expense of liquidity. If we’re worried about market volatility we might be tempted to move to a more defensive asset allocation, but by foregoing growth we increase the chance of running out of money. In short, clients will always be exposed to various types of risk.

The problem with determining a client’s most important objectives is that often they are all equally important. Consider the following examples:

Paying the bills

Certainty of income is usually the key concern for retirees, but don’t discount the others. When you ask advice clients what their most important objectives are, the most common answers are things like relaxation, travel, family, and leisure. These all have a price associated with them. Liquidity is also a major consideration for retirees. Not having enough cash on hand for things like motor vehicle repairs and other essential spending can result in significant stress and prevent retirees from enjoying the things they were looking forward to after their working life.

Leaving a legacy

Most people wish to enjoy a comfortable life in retirement but also make sure their children and loved ones are left with some extra wealth. A 2017 ASFA study found that households are retiring with an average super balance of $337,000 (the gender breakdown is $270,000 for men and $157,000 for women). Leaving a meaningful inheritance or bequest would mean there is barely enough left over to support their own needs.

Maintaining purchasing power

As any basic economic textbook will tell you, different asset classes will perform better or worse in different inflationary environments. Inflation of 2% per year will erode more than half of your purchasing power over 35 years, which is the equivalent of a single GFC event. Managing inflation is just as important as managing sequencing risk or the risk of a large drawdown, even in periods where inflation is relatively low.

This adds an additional consideration to the construction of retirement portfolios. Real assets are a proven way of managing inflation risk, while fixed income is potentially the worst asset class for this purpose, with the exception of products like inflation-linked bonds.

Different assets perform differently depending on the inflationary environment

Source: Lonsec

Guarding against a crisis

If successfully timing the market seems more like luck than skill, then timing your retirement is no different. While market bumps are nothing to be feared when you’re building your wealth, a sudden major event like the GFC can spell disaster for those entering the decumulation phase. Sequencing risk refers to the order in which investors experience returns, and it can matter a great deal for retirement. Withdrawals during a falling market have the potential to accelerate the depletion of your asset base.

To see how this works, take a look at the returns from Lonsec’s balanced portfolio over the last 20 years. If you reverse the order of returns, there isn’t really much difference for those in the accumulation phase – both sequences deliver the exact same results over the long term. But for those drawing down on their investments, the reversed sequence results in the retiree running out of money much sooner.

The sequence of returns can mean the difference between having enough cash and running out

Source: Lonsec

Addressing sequencing risk requires advisers to look at a wider range of solutions, including variable beta or absolute return strategies, and even some more illiquid options to reduce volatility and manage drawdowns. Once again, there is a trade-off involved in making these decisions.

The reason we struggle to precisely define risk is that there simply isn’t a single source of risk that can be effectively managed or reduced to zero. Managing risk means understanding the often complex relationships between different retirement objectives. Effectively managing these relationships is the purpose of your investment strategy.

When we talk about risk at Lonsec in a portfolio context, what we are really talking about is the risk that the overall investment strategy is wrong or is not properly tailored to the client’s needs and preferences. This informs the approach we take to the management of our model portfolios as well as the selection of individual products to achieve a particular objective. We think this is the proper way to think about risk without being constrained by a single textbook definition, and it is the way in which advice clients intuitively understand risk as well.

May 23, 2019/by Veronica Klaus

Lonsec Retirement Perspectives, Media releases, News & Insights

Lonsec’s Retire program to focus on helping advisers withstand the coming retirement storm

With Australia’s economic expansion under threat, house prices falling, and a wave of people set to retire over the next decade, financial advisers are under pressure to provide advice and solutions that can withstand Australia’s future retirement challenges.

Lonsec’s Retire program addresses the growing need for the financial services industry to work together to come up with those solutions and strategies.

Lonsec has been running its successful Retire program for more than five years, and it continues to go from strength to strength. The schedule of content and events planned for the next 12 months is the largest yet, with nine Retire Partners now on board to deliver in-depth retirement insights, including:

Alliance Bernstein	Fidelity	Legg Mason
Allianz Retire+	Invesco	Pendal
Challenger	Investors Mutual	Talaria

Lonsec’s Retire Partners will be providing a wealth of content to help advisers understand and deal with a range of issues faced by advisers and their clients.

The program will really kick off on May 7^th with the major Lonsec Symposium event at the Westin, Sydney. With more than 600 advisers and wealth managers already registered, along with an impressive line-up of high-profile speakers and industry leaders, this is a must-attend event for all retirement professionals.

April 30, 2019/by Rob Hardy

News & Insights

Designs on retirement: Are CIPR’s enough?

The federal government has taken a step toward providing better retirement outcomes for Australians with the appointment of an industry panel to advise on the development of Comprehensive Income Products for Retirement (CIPRs).

Its brief is to help frame the government’s plans to require superannuation trustees to design and offer appropriate income products for their members in retirement.

The panel’s expertise suggests that the eventual framework will reflect a deep understanding of the legal and technical aspects of retirement as well as the social and financial-planning needs of retirees, and perhaps also their behavioural biases.

Regarding the design of income products, it will be interesting to see whether the framework will point super funds in the direction of annuity-like products or drawdown solutions or a combination of the two―or a more expansive and flexible range of choices.

More interesting still will be to see how effectively the framework synthesises these various elements because, as experience in other markets shows, retirees’ financial behaviour can have a direct impact on the success or otherwise of attempts to develop new retirement income products.

The UK is a case in point.

UK Retirees Sit on Cash

Up until 2015 the purchase of an annuity was effectively the only choice open to UK investors when they retired, but low interest rates and other limitations had made annuities unpopular. From that year, the government allowed retirees to choose between annuities and drawdown products.

Predictably, sales of annuities in the UK have plummeted, forcing a restructuring of the retirement income market. Progress to date has been slow, however, and of limited benefit to retirees.

For example, the drawdown alternatives to annuities are mainly high-cost, being accessed through financial advisers and invested in the markets. Perhaps not surprisingly, regulation of such post-retirement products has increased, making them potentially more expensive and harder to access.

At the same time, new product development has been slow. Inflows into those products which have been launched have been small, providing little incentive for competition.

It’s in relation to this last point that the financial behaviour of retirees appears to be most relevant.

Since the pension freedoms came into effect, many retirees have taken large volumes of cash out of their savings early, despite the higher tax charges this incurs.

They have put that cash mainly into (in order of magnitude) bank accounts earning little to no interest and, anecdotally, into cars, conservatories and cruises.

But that’s not all: large amounts of money have been left invested in plan default solutions. Consequently, the amount of money remaining invested beyond retirement, which is neither being drawn down nor added to but kept for a rainy day, has grown massively.

Little wonder, then, that inflows to new retirement income products in the UK have been small.

What lessons, if any, should the panel―and, indeed, the rest of the Australian retirement industry―draw from this?

Three Angles on Retirement Income

There are three, in our view. One is to integrate into the government’s framework some understanding of retirees’ behaviour with respect to savings and investment, its potential impact on demand for retirement products, and how retirement products might be designed with retirees’ behaviour in mind.

Another lesson is that some thought might usefully be given to the way retirees step from work to retirement. It’s at this point that retirees’ financial behaviour becomes an issue as they make, or fail to make, important decisions for their future.

Their decisions could conceivably improve if they had more time to make them. They could, for example, continue to enjoy some capital growth as well as income for many years before investing at a more advanced age in an income-only product.

The third lesson, which is linked to the second, is to view CIPRs as part of a broader retirement solution which includes equity products that can provide growth while managing downside risk, and fixed-income products that can provide reliable income with better-than-average stability.

As the UK experience shows, the key to creating a successful retirement-income solution might lie in understanding, and allowing for, a range of factors beyond that of simple product design.

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.

March 22, 2018/by Veronica Klaus

Lonsec Retirement Perspectives, News & Insights

The role of annuities in retirement portfolios

In recognition of the growing challenges facing retirees, Lonsec has published a paper on the role annuities can play in retirement portfolios. The paper explores some of the common issues facing retirees such as sequencing risk, longevity risk and market risk.

The main benefits and risks of annuities are considered as well as how annuities can mitigate these risks. The paper examines how annuities can work with the age pension and other investment products to help retirees meet essential spending objectives as well as provide for discretionary spending.

Lonsec believes that annuities are an attractive proposition for retirees looking to secure part of their retirement income stream, including in conjunction with the age pension, to boost the amount of guaranteed income during retirement. Additionally, Lonsec notes that there is a mass market of retirees for whom annuities may be appropriate, typically those with retirement savings of between $250,000 to $1,500,000.

Lonsec does not have a preferred means to best make an allocation to annuities within a diversified investment portfolio but notes there are two commonly held schools of thought. The first is to allocate from the defensive assets within a portfolio and the second is to ‘carve-out’ a separate allocation for the annuity and retain the existing asset class weightings over a smaller asset base.

March 11, 2018/by Veronica Klaus