The disadvantages of the bucket approach are 1) it requires not only the management of each bucket, but also the switching of capital from bucket to bucket, incurring transaction and frictional costs; 2) it requires a very disciplined approach to switch capital across buckets in all market conditions: many advisers/managers risk falling into behavioural traps as they try to time the markets as to when to switch from higher risk to lower risk assets to keep all buckets topped up; 3) the overall asset allocation (as ultimately three buckets is mere presentation, when combined there is only one overall asset allocation) is not being managed in aggregate, meaning it’s harder to control the overall risk profile of the investment strategy.
The bucket approach is best suited for advisers who do not want to use a discretionary fund manager (DFM), and are comfortable managing investment risk themselves and can stay on top of bucket switches consistently across all clients.
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.
