Building a decumulation investment strategy for clients

  • Be able to describe a “liability relative” approach to investing.
  • Identify the different implementation approaches to liability-relative investing.
  • List the “hybrid strategies” which incorporate annuities and/or insurance into a portfolio.

Model portfolios: Model portfolios are a popular way of creating and managing a consistent asset allocation for a given risk profile.

Model portfolios can be constructed with active funds, index funds or exchange-traded funds (ETFs). Given the focus for decumulation is ensuring an appropriate asset allocation to fund future liabilities, it makes sense to achieve this allocation using the lowest cost instruments available.

Most traditional model portfolios are mean-variance optimised strategies that assume an asset-only approach based on long-run risk, return and correlation assumptions.

Model portfolios for decumulation should be consistent not only with risk profile, but also with investment term to ensure that portfolios are durable. 

The advantages of decumulation model portfolios are 1) they can be built specifically for a broad range of risk profiles and investment terms; 2) there is greater consistency and control around the asset allocation; and 3) model portfolios of different investment terms can be mixed to fund the specific withdrawal profile of a client.

The disadvantage of a model portfolio approach is the frictional costs of any asset allocation switches as with any model, and the larger number of “line items” on client valuations.

The model portfolio approach is best suited to advisers who are comfortable outsourcing the management of investment risk to a discretionary fund manager, to allow them to focus matching different term-based model portfolios to a specific shape and term of a client’s different withdrawal profiles, for their various retirement objectives.

Where platform functionality is limited, unitised versions of this approach may make sense.

Target date funds: Target date funds are used mainly as 'default investment funds' in defined contribution pension schemes. A popular misconception is that the date in a target date fund is the 'end date' of an investment strategy.

In fact, it’s the 'turning point', when the asset allocation shifts from being an accumulation strategy to a decumulation strategy. The target date can be matched to an investor's normal retirement date, their age e.g. 65, or simply the date that withdrawals are expected to commence.

So for a client who wants to take an income now, a target date fund 2016 to 2020 would be appropriate.

The advantages of a target date fund are 1) it offers a managed investment strategy within a single fund; 2) asset allocation changes are made consistently for all fundholders with a shared objective, and 3) the collectivised approach creates economies of scale in underlying fund and trading costs. 

The disadvantages of a target date fund is that it is a “one size fits all” approach for a given investment strategy for a shared objective. The target date fund approach is best suited for non-advised and DIY investors, and for advisers who want a single fund solution for less engaged clients, where the investment strategy requires the withdrawal of capital to fund a retirement income.