The extreme market volatility caused by the coronavirus crisis is a powerful reminder of the importance of guaranteed income for retirees and throws into sharp focus the problems that super funds will face as retirees draw down their savings, said Challenger investment chief, Chris Plater.
“Now more than ever when the markets are being driven by unpredictable and likely short-term events, retirees need regular cash coming into their bank account,” Plater said at Investment Magazine & Professional Planner’s digitally live-streamed event: “Superannuation and retirement in crisis”
During a panel discussion, Plater outlined the differences between managing a portfolio of decumulating capital and managing one that is accumulating wealth. Further, he argued that there are numerous ways that innovative product development can be explored to include features of sequencing risk control and longevity protection.
“Decumulation is quite different to accumulation – investing for the purpose of funding retirement income is far more complex and requires a very different mindset, as well as different approaches and strategies,” he said.
Having to provide regular cash payments influences the investment choices a super fund can make for the assets supporting that income stream, Plater explains.
Super funds obviously have the benefit of a huge inflow of compulsory super which, for many funds, more than offsets these outflows to retirees for the time being.
However, unlike the accumulation phase, when those inflows support the ongoing purchase of assets, a decumulation portfolio needs to be put in a different context, Plater continued. “It needs to have a clear strategy around which assets it sells to fund the benefit payments.”
The investment chief said the key to success in decumulation was having a portfolio of defined assets that can meet a series of “very defined” cash flows. “So, it’s balancing fixed income type assets – to match cash flow requirements over 5,10,15 years – with other types of longer-term investments that go out past that period.”
First-class skills
Getting this right requires first-class cash flow matching skills, according to Plater. The retirement specialist said this phase requires different thought processes and capabilities to those required for accumulation.
Plater explained to fellow panelists that the guaranteed income component of retirement savings can be broken down into three main components – cash flow, protection against inflation and liquidity.
The most important of these are cash flows, he suggested. “When in accumulation, you are just building wealth for the long term. But then when you move to decumulation it’s about cash flows and sequencing risks,” he said, adding that the current crisis has brought the risks and realities of sequencing risk or “dollar cost ravaging” back into the minds of investors and retirees.
“If you’re retiring and your strategy is to just drawdown from your capital and from other investments on a regular basis, you can hit air pockets when markets sell-off as they have over the last couple of months.
“If you have a big shock in the markets right at the beginning of retirement, it is much harder to recover from that than if it happens later in life.”
Plater said providing regular cash flows makes the job of the investment manager much tougher since it is no longer enough simply to target the highest risk-adjusted return because cash flow needs can shorten the investment horizon dramatically. If not managed properly, he added, the need to sell assets – to meet cash flow requirements- could jeopardise long-term investment strategy.
Other obstacles to navigate include liquidity management which is also a challenge as returns needed to fund retiree’s lifestyle objectives needed to be balanced with very liquid cash flows in case of unexpected shocks, he stated.
“Liquidity in the portfolio will prevent the forced sale of an investment to generate cash for payment, he said. “Generating high returns is made more difficult for the portfolio manager by the need for liquidity.”
Lastly, he will discuss the challenge of ensuring people have stable income throughout retirement.
Plater said portfolio managers typically use the income from interest, dividends or rent from the investment assets; time the maturity of a fixed-term investment to be available when required or sell assets and use the proceeds for the income payments. “If the portfolio manager sold an investment at a time when it is not fully valued, it would crystallise a loss.”
This would, in turn, restrict the possibility of further income or capital growth.
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