Everything begins to change, according to Vincent McEntegart, when a client hits 60.
But while the need for good financial planning has never changed, Mr McEntegart – who runs the £800m Kames Diversified Monthly Income fund – says the sort of advice given has changed over recent years.
According to Mr McEntegart, it used to be the case that if an advised client was five years away from retirement, which at one time would have occurred at the age of 60, then the prudent thing to do would be to move the client into safe-haven government bonds.
He says: “The idea was, if the client was retiring in five years, then they would be buying an annuity at that point, and because an annuity is a bond-like product, the sensible thing to do was move the client to bonds.”
While one can make lifestyle choices and work longer, one cannot defy market ‘gravity’ Mike Coop, MorningstarHowever, things have changed. He says: “With annuity rates now so low, and people living longer, annuities are not really an option for a lot of people, yet the advice remains to go into bonds as soon as they near retirement, even though an annuity isn’t going to be purchased.”
Key Points
- The rise in life expectancy and fall in annuity rates mean the advice to buy an annuity at retirement needs to change
- Government bonds should no longer be considered the default haven for those approaching retirement
- A low-risk exposure could mean a failure to meet a client’s objectives
Annuity rates are calculated based on the prevailing interest rate of the day and the anticipated life expectancy of the client. But with interest rates at record lows and life expectancies now much longer, annuity rates have fallen sharply.
Mike Coop, investment manager at Morningstar, says: “While one can make lifestyle choices and work longer, one cannot defy market ‘gravity’. A 40-year-old today has a life expectancy in the mid-80s and a one-in-four chance of living to be 100.
“In that situation, the major risk is inflation, and this necessitates looking at the allocations one might have had to defensive bonds.”
Government bonds are generally viewed as a defensive asset class because, historically, they have tended to go up when equities have gone down, offering a measure of safety during periods of market strife.
For example, during the pandemic-induced sell-off in March, government bonds rose while equities fell. Gold also rose during that time.
But during the nadir of the Credit Crisis, all assets fell together. And in the decade since the financial crisis, bond prices rose sharply, alongside equities, while the income yields dropped far below the rate of inflation.
James Klempster, investment director at multi-asset fund house MGIM, says: “If the aim is to preserve capital and nothing else, then it makes sense to own bonds – but unless you have a large pot of wealth, you are going to need other asset classes.
“The way the advice process interacts with this is, it examines the client’s ability to take risk and appetite to take risk.”
Amalia Nuñez, investment director fixed income and multi-asset solutions at First State Investments, says the way she thinks about multi-asset’s role in retirement planning is to divide the pot of assets into “three buckets”, with different time horizons to reflect the different priorities at each stage of retirement.
She says: “We would create one bucket, which would have a time horizon of about three years, with the aim being to preserve capital. That part of the portfolio would have lots of defensive government bonds, cash and other assets of that risk profile.”
Fixed income failings
She continues: “The second bucket would have a time horizon of three to seven years, with an average of five years – you have some growth assets. And in the third bucket, which could have a 10-year time horizon, you have lots of growth assets. Investors need to get away from the idea that bonds mean low risk and equities mean high risk.”
William Buckhurst, investment director and head of fund research at Vermeer Partners, says traditional asset allocation has been based on the 60/40 model, with the split between equities and bonds largely determined by the time until retirement and the client’s risk appetite.
He says the sharp changes in asset prices in recent years means it may now be time to add more equities and fewer government bonds to portfolios as retirement approaches.
He says: “We believe clients approaching retirement should consider having more than 60 per cent of their portfolio in global equities.”
Mr Buckhurst says there are two main reasons for this:
• Bond yields look particularly unappetising at the moment. He says: “The largest credit in the US high-yield index is now yielding as little as 2.8 per cent, exactly what a 10-year US treasury was yielding only a couple of years ago.”
• Following a severe market shake-out – outside of the top mega-cap stocks – equity valuations are looking more attractive in many areas.
High-yield bonds are those with a credit rating below BBB. Those bonds are often called ‘junk’, as the credit rating is below investment grade.
Mr Coop says a key consideration for advisers is to diversify portfolios globally, as much of the other wealth clients have as they approach retirement, such as their residence, is located in the UK. “Being diversified by region as well as asset class is important,” Mr Coop adds.
Risk taker
Karl Craig, investment manager at Canaccord Genuity Wealth Management, says: “The general rule of thumb remains that as you approach retirement and go into drawdown you should look to reduce that risk profile – this doesn’t necessarily mean that you should increase exposure to bonds.
“There are other risks with fixed income; the low yields, and in many areas negative real yields, mean that they risk not achieving your client’s objectives. This needs to be considered if clients are approaching retirement and looking for an income – unlike in the past, fixed income is fraught with risk.”
However, Darius McDermott, managing director at Chelsea Financial Services, disagrees. He says: “As a client nears retirement, it’s an idea to have less stock market exposure as stocks are more volatile.
“As we have experienced over the past couple of decades, stock markets can undergo significant corrections, and they don’t care if someone is about to retire. Stock markets do recover, but it can take time, and it can hit a portfolio, especially if you are just about to start taking an income.”
Mr McDermott adds if a client has a reasonable pot of money, and is looking at converting it to an income-paying strategy, asset allocation is likely to be changing anyway, depending on both the client’s attitude to risk and the income available: “For example, at the moment, dividends are being cut right, left and centre, and both government and corporate bonds are not yielding much.”
This highlights the fact the old ways of picking a pension and sticking with it have indeed changed.
David Thorpe is special projects editor at Financial Adviser and FTAdviser
