Pros and cons of drawdown in multi-asset funds

Multi-asset funds, with a balance of growth and income-generating assets, can help to provide this flexibility. But how can this flexibility be matched with the needed inflation-beating returns and a measure of protection against inherent market downturns?

Alistair Byrne, head of European defined contribution investment strategy for State Street Global Advisors, comments: “Most retirees in drawdown need a fund that will provide a return above inflation, while protecting them from market volatility.

“A low-cost, well-diversified multi-asset fund will provide that. The diversification should reduce volatility, compared with equities alone.”

Multi-asset funds can access non-traditional asset classes like loans and infrastructure, which generate attractive inflation protected income. Eugene Philalithis

To do that, Mr Byrne suggests a composition of more effective diversification, and an efficient asset mix, rather than a focus on purely income-producing assets.

He adds: “Members can cash in units to provide the income they want. The fund should have some element of dynamic asset allocation to protect from losses in falling equity markets, which can eat into capital when withdrawals are being made.

"This is the so-called sequencing risk.”

Sequencing risk 

However, there are dangers of drawing down too much income, especially in a high-inflation world where the pensioners’ pound must stretch further, and in a world where people are living longer.

Latest data from the Office for National Statistics puts the average life expectancy at 65 as 19 years for a man and 21 years for a woman.

According to the graph below from State Street Global Advisors, the effect of steadily taking 4 per cent plus inflation withdrawals from a £100,000 pot could vary significantly, from an optimal age of depletion of around 95 years old (the median), to 86.5 (the 5^th percentile).

The longevity of that fund therefore depends on various factors, such as whether the person drawing down the pot in the early stages are likely to suffer an early, serious market shock.

The effect of this – the sequencing risk – on the remaining assets can not be mitigated by better performance in the long-term.

Therefore, any multi-asset fund that will be suitable for a drawdown strategy in the decumulation stage must be constructed with this in mind.

According to Paul Ilott, director, multi-asset research at Scopic Research, part of The Adviser Centre, the biggest problem facing people who wish to create income from regular capital withdrawals without depleting their investment is how to balance the requirement for capital growth, while avoiding damaging drawdowns.

He says: “Not enough growth, too high a level of capital withdrawal or a significant drawdown, requiring a long recovery period, could all be detrimental.”

Pro points

There are, obviously, many ways in which using multi-asset funds for the core of a drawdown portfolio, can be a good strategy.

Eugene Philathitis, multi-asset portfolio manager for Fidelity International, believes the flexibility offered to investors in drawdown funds makes for a good reason to have multi-asset funds as part of the retirement plan.

He explains: “Multi-asset funds can access non-traditional asset classes like loans and infrastructure, which generate attractive inflation protected income, in contrast to traditional inflation linked bonds, which provide a relatively low level of income (but good inflation protection).”

Moreover, he says income from multi-asset funds tends to be more stable, drawing from multiple asset classes across the world.

In addition to this, many multi-asset funds offer monthly distributing share classes, which can help provide some clarity over the regularity of any income - a great boon when it comes to financial planning in retirement.

The timing of and frequency of withdrawals also needs to be carefully considered. Paul Ilott

Additionally, Dan Kemp, chief investment officer for Morningstar Investment Management, believes income investing can create a “greater alignment of interests” between the management of the company and the end investor.

Mr Kemp also suggests that, by not needing to draw on the capital element of a portfolio, retired investors can have more confidence in the investment solution created for them by their adviser, and can be more likely to stay the course instead of taking out an annuity or cashing it in.

At-a-glance: Pros and Cons 

Pros

• Multi-asset funds can access non-traditional asset classes which generate attractive inflation protected income.
• Income from multi-asset funds tends to be more stable, drawing from multiple asset classes across the world.
• Investors not needing to dip into capital may be more likely to remain in their investment plan.
• Many multi-asset funds offer monthly distributing share classes for regular income payments.
• Better alignment of manager and investor interest.

Cons

• Investors wanting capital to last should draw income from funds which pay out of natural income, not capital. Otherwise, they risk seeing their capital sum diminish over time.
• Some income distributions are too aggressive to be sustainable in the long term.
• High yields can be reflective of a falling fund price.
• Chasing yield can lead to an inferior total portfolio structure.
• Some income-focused multi-asset solutions can carry high fees – not great in retirement.

Con-cerns

On the other hand, there are potential negatives to relying on a multi-asset fund alone to provide that regular income objective, which go beyond the sequencing risk mentioned above.

Mr Kemp comments on certain risks which advisers would do well to heed when it comes to advising clients to rely solely on a multi-asset solution for drawdown.

One of the key risks is not so much running out of money by drawing down too much but the temptation to go up the yield curve to seek income, potentially leaving investors with a more risky multi-asset solution in their retirement years, just when they need to be reducing risk.

Mr Kemp explains: “This could incentivise the multi-asset fund to increase drawdown risk at a portfolio level.

"For example, by preferring riskier assets, such as high-yield debt relative to government debt, and by chasing yield, this could result in an inferior total portfolio structure, if not considered holistically."

Mr Kemp also warns of the eroding power of portfolio fees – for a high income earner who is starting on the accumulation journey, fees might not matter too much, but when the income stops and the person is in retirement, “investors should be wary of higher fees as it can have a compounding effect over retirement”.

Then there is timing – you could put yourself at risk of taking too much at the wrong time, depending on what is happening to markets at the point of retirement and commencement of drawdown.

Mr Ilott adds: "The timing of and frequency of withdrawals also needs to be carefully considered" - a point that should be made regardless of whether the retirement portfolio is a multi-asset one or not.

Ultimately, multi-asset can help provide that income-generation in retirement which fits well with a drawdown-style approach.

However, advisers will need to ensure their clients are not chasing too high a yield, and therefore too high a risk, with their multi-asset portfolios.

They must also make sure clients are not blinded by the diversification and income stream potentially offered by multi-asset funds, and therefore ignoring potential sequencing risks or higher associated costs when it comes to investing for retirement.

simoney.kyriakou@ft.com