Asset AllocatorMar 31 2020

Wealth firms cut back as miserable March ends; Decumulation strategies face the music

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Marching downhill

Somehow, it’s still March. But as allocators’ most costly month in years finally draws to an end, equities are finishing up on a slightly more positive note

For some, the quarter’s already over. Overnight, the final tally for Asia ex-Japan indices left them down by around 10 per cent on the month. As of yesterday, Japan itself even had a chance of finishing March in the black - in sterling terms, at least. But its equity indices continued to buck the trend this morning, this time by falling when others were on the up.

Still, these results are as good as it gets in a vicious month for risk assets. Both Japanese and Asian indices will come out ahead of other major markets. Yet it would be a brave wealth manager who ups allocations to either region at the moment.

Japan’s outperformance this month is partly a response to its relative struggles in February. There are other problems: the economic boost provided by the Tokyo Olympics has been postponed, the country risks a second wave of coronavirus cases, and latest monetary policy measures have proven less effective in an economy where the kitchen sink had already been thrown at risk assets.

In Asia, there are other reasons for DFMs to be wary. Relative valuation arguments for riskier equity funds tend to get overlooked in a crisis situation. And this time there’s not even the guarantee that valuations are any more attractive: Asia-Pacific investment trusts, for one, are trading on discounts that are broadly in line with their 12-month averages. Our own asset allocation database is now showing that many discretionaries are cutting back EM equity and bond holdings in a bid to dial down risk. 

And the near-term future is only going to get harder for emerging regions: as economies battle to stay afloat amid mass withdrawals from international investors, the idea of capital controls is back on the agenda in some circles. That isn’t a prospect that will inspire confidence among investors in the short-term.

Pot luck

Wealth firms who have launched decumulation offerings in the years since the pension freedom reforms now face the biggest challenge in these portfolios’ short lives. The concept of pound-cost ravaging is back at the forefront of advisers’ minds - and many are already considering how to lessen the pain for clients.

Encouraging a reduction in withdrawal rates is one option, particularly if dividend cuts lessen the amount of natural income available.

These questions have less applicability to investment managers tasked with running the portfolios themselves. Their focus will be on ensuring income streams stay diverse - and, if possible, remain at respectable levels. 

But wealth managers often complement these portfolios with a recommendation that clients keep several months’ worth of cash on hand. Sometimes this cash will form a separate pot; for those who have all their assets with a single adviser the cash can form part of the same portfolio.

Either way, allocators themselves should perhaps pay more attention to exactly how this cash fits into the portfolio construction process. Research from Finalytiq a couple of years ago suggests there are still misconceptions over what to do with these positions. 

One move that instinctively feels right - lowering risk by replacing some of the equity allocation with cash - in reality “doesn’t mitigate the sequence risk in a retirement portfolio”, according to the consultancy.

The answer instead is to replace part of the bond allocation with “a little bit” of cash - equivalent to say 10 per cent of a portfolio. This switch does appear to “improve the portfolio longevity in worst-case scenarios” - but only if cash positions are kept at around this level. Those who are upping client cash allocations should be aware than an overabundance of caution can be almost as costly as none at all.

Transfer times

Wealth managers encountered another bump in the road at the end of last week, when the Pensions Regulator said it would permit defined benefit schemes to delay transfer requests for up to three months.

The idea is to give schemes more time to calculate transfer values, rather than having to do so in the midst of heightened market volatility. That’s a sensible decision - and will also allow those hoping to transfer out to reflect on the wisdom of their own actions.

For wealth firms, it suggests a further slowdown in one of the erstwhile engines of asset growth. The decumulation portfolios discussed above have been fuelled by a mass of pension transfer money looking for a new home. The FCA crackdown on advisers’ DB transfer practices has already slowed this surge. A delay on schemes’ own part means wealth managers will have to look elsewhere - if possible - for inflows this summer.