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.

Multi-asset income funds: Multi-asset income funds distribute capital and income to fund a “gross distribution yield”. They invest in income-generating equities, property and other asset classes in addition to bonds. 

The advantages of a multi-asset income fund are 1) they are well-established with plenty to choose from; 2) they are straightforward to understand; and 3) they report a higher headline yield.

The disadvantages of a multi-asset income for decumulation investing is that 1) they are “one size fits all” with respect to the management of interest rate (duration) risk; 2) gross distribution yield includes capital so it’s not actually 'natural yield'; and 3) they necessarily have to seek out higher risk assets to be rewarded for higher yield.

Multi-asset income funds are also best suited for non-advised and DIY investors, and advisers who want a single fund solution for less engaged clients, where the decumulation strategy includes the investment strategy and does not require the withdrawal of capital to fund a retirement income (a yield only approach).

Target term fund: Target term funds only exist in the US. They are closed-ended funds with a stated maturity date where investors invest upfront, receive a monthly income distribution over the life of the investment and receive their original capital back at the end of the term; similar to a bond.

This intervening lock-in means that investment managers do not have to worry about redemptions, so can invest in less liquid assets to harvest an illiquidity premium from asset classes such as real estate, commercial debt and private debt, as well as more traditional liquid equities and bonds.

Hybrid strategies (annuities): Annuities no longer offer good value for money as a retirement income aged 65, given changing demographics and lower interest rates.

The optimal point for annuitisation is life expectancy, meaning 85 or so in the UK. This is because annuities are not designed to provide insurance against outliving assets towards the end of your life, so should not be taken out when as young as 65.

By using annuities later in life, annuity rates are much more attractive (double-digit), and provide certainty around essential later life expenditures. By annuitising a portion of a portfolio aged 85, advisers can help clients lock-in a base income at a decent annuity rate.

To mitigate point-in-time conversion risk, advisers can consider “lifestyling” a portion of a portfolio to a mix of investment and a range of annuity contracts of different commencement dates.

Hybrid strategies (protection): By incorporating portfolio insurance strategies into an investment portfolio, there is scope for creating additional downside protection - to help mitigate the impact of sequencing risk.