Risky business: Retiree portfolios need upheaval

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The investment world is getting more complex, and there is a demographic shockwave sweeping the country.

Today’s retirees and pre-retirees face a reality that is quite different to any operating environment in the past two or three decades, and Wingate Asset Management chief investment officer Chad Padowitz says, ‘vanilla’ solutions are unlikely to help these clients achieve their aims.

“[I]nvestment strategies trying to include the three aims of low risk, maintaining living standards, and dealing with longevity, are blending incompatible aims,” says Padowitz.

“The reality is that in retirement, risk must be maintained or even increased. This may sound concerning for many retirees, however the risk of an underfunded pension should be more alarming.”

Padowitz says equity markets are among the most suitable asset class to achieve clients’ objectives, for several reasons:

  • Capitalism works - return on equity is a long term proven model
  • Dividend yields now often exceed long bond rates – an historically rare occurrence i.e. selling equities to buy bonds actually reduces expected cash returns
  • Quantitative easing and low interest rates support equity prices, albeit this support is declining
  • Corporate share buybacks and dividends support returns in the absence of earnings growth
  • Cash and fixed income rates are supressed by deleveraging and central banks
  • Many other asset classes suffer from liquidity issues, making them incompatible with a decumulation phase.

Padowitz also says that sources of return – such as option premiums and dividends – that are not based purely on capital growth, can reduce the volatility of returns and reduce sequencing risk.

AXA IM Director for Australia and New Zealand Craig Hurt agrees that Australia’s ageing population needs smarter strategies that make their money work harder for longer.

“As we are living longer superannuation shouldn’t just been seen as a drawdown option after retirement age. Investors need to consider continued growth of their capital for a longer period of time with less volatility,” says Hurt.

A new research paper from AXA IM, titled Thoughts about the rise in longevity, predicts that retirees dissave (where spending is greater than income) to maintain their standard of living despite lower income.

“When savers reach retirement, switching more assets into quality fixed income vehicles is the conventional strategy of choice. Yet, low yields and large scale retirements go against this traditional strategy, as they create substantial pressure on pension funds to chase after yields,” says the paper.

It suggests investing in higher return assets such as equities or real estate in order to pay additional annuities in the short-term.

Japan is the most advanced country in terms of the demographic ageing process.

The paper says that the recent decision by the Japanese public pension fund (GPIF) to diversify its allocation toward overseas securities and to increase the size of its domestic equity pocket is interesting.

“The Japanese experience shows that, in the context of depressed real yields (in local currency), the home bias of pension funds is likely to be re-assessed and to generate a search for higher return overseas.”