InvestmentsSep 1 2020

How to build multi-asset income

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Scottish Widows
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Scottish Widows
How to build multi-asset income
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There is a need to improve income strategies for people already in retirement, but clients are only now starting to realise the problem of drawing down without having enough income growth, according to Robert Hird. 

Mr Hird, head of investment strategy at advice company Premier Wealth Planning, says many of his clients had built their retirement plan around the idea of buying an annuity.

However, as their retirement date draws closer, they have realised how unattractive annuity rates are, and now want to enter drawdown and stay invested in retirement. But that necessitates understanding how that income in drawdown will be provided.

We are now in a world where it is about the necessity to take risk James Klempster

Mr Hird says this is part of the process of “client education” he undertakes as they approach retirement, so they are aware of the options. 

Why is there a problem?

People have not saved enough capital to allow them to draw down and live off the income, and need advice on how to maximise their income strategies.

James Klempster, investment manager at Momentum, says we are starting to see a generation of people who are “chronically undersaved” for retirement, partly due to low interest rates. 

He says: “The advice process has historically been about understanding the client’s capacity and willingness to take risk, but we are now in a world where it is about the necessity to take risk, and that needs to be part of future conversations with clients.”  

The problem isn’t just that annuity rates have fallen to such a low level as to not be a viable option for most clients; government bonds, which have traditionally formed a major slug of retirement income, are also now yielding well below inflation. 

Key Points

  • Many people have not saved sufficient capital to draw down and live off the resulting income
  • A portfolio that is simply diversified across asset classes might not be the best way to boost income
  • A multi-asset approach will blend a mix of assets tailored to individual client needs

This means the client’s journey in retirement isn’t merely from annuity to a portfolio of bonds, but one step further out from the risk curve to a portfolio containing at least some riskier assets. 

But does that mean shifting into income-generating equities and chasing capital growth? 

Mike Coop, investment manager at Morningstar, cautions against a retirement portfolio that is too focused on equities.

He says: “In the years of building up a portfolio, volatility is the client’s friend, as it means there are periods when you can buy the assets you want at a discounted price. But in drawdown, that reverses. Volatility is the enemy, and that’s why a multi-asset portfolio works best at that stage, as multi-asset acts to dampen that volatility.”

One big challenge faced by investment managers is that many of the assets typically owned for the purposes of capital growth, such as “value equities” have tended to underperformed in recent years.

The UK equities that have performed best have been those that pay an income, but are businesses with anaemic growth rates, and so offer little in the way of capital growth.

Add to this the fact that FTSE-listed companies cut dividends or ditched them altogether as a response to the Covid-19 crisis, and it is clear there needs to be a better way of chasing income. 

Capital idea 

Capital growth is important, and clients in retirement will still need to consider how to invest for capital growth.

But, as John Newton, business development manager at Wise Funds, says, the most important thing for a client in decumulation is the reliability of income. Taking money from the capital is unreliable, and creating a portfolio that is simply diversified across asset classes might not be the wisest course of action to boost income. 

This is why William Buckhurst, investment director and head of fund research at Vermeer Partners, says: “Diversification of income streams remains important. Income from high-yield bonds or commercial property can be disrupted along with equity dividends, as we have seen during the recent Covid-19 crisis.

“Investors tend to focus overtly on diversification of asset classes rather than diversification of income streams: many income sources have continued to be abundant during the crisis.”

Matthew Yeates, head of alternative and quantitative strategies at Seven Investment Management, believes the goal of achieving a reliable income in retirement requires a “blending” of different types of investments to grow both capital and income.

This is where a multi-asset approach can help, blending the right mix of assets to suit individual clients’ income needs. For example, Mr Hird says he has replaced government bonds – because they are too expensive and do not offer attractive yields right now – with corporate debt in the multi-asset portfolios he constructs, rather than add more equities.

Diversification is key. Mr Buckhurst says while the performance of asset classes such as government bonds and equities have started to move in line with each other in terms of capital gains, income streams across asset classes remain diversified. 

The capital performance of bonds and equities have tended to correlate in recent years as a result of central bank policies. By buying bonds, and so pushing the price up, equities rose in value as investors fled higher bond prices.

Steve Pennington, head of wealth planning at Arbuthnot Latham, says while many multi-asset strategies will likely have a lower yield than a purely equity income fund, investors who “chase yield” by plunging into equity income funds will be missing out on some of the capital growth that can be had by pursuing a total return-based approach.

He says: “Total return should be the objective and if the yield from their multi-asset funds is not enough, they can simply disinvest some capital along the way.”

Alternative approach   

Investors grappling with the conundrum of bond yields and dividend income falling at the same time have increasingly turned to alternative income assets. 

These have included infrastructure, leasing and property investments, such as student lets, NHS clinics, renewable energy assets and aircraft leasing.

Mr Coop says the problem with some such assets is that “you are almost providing an insurance policy for the owners of the asset in exchange for an income now. But what can happen is that at some point in the future the insurance gets called in, and that is when the asset price falls and the investor suffers”. 

Mr Klempster says: “The way markets typically work is that if a quality asset is trading at a high yield, then investors step in and buy the asset, pushing the price of the asset up and the yield down. So if you see an asset that has a 6 or 7 per cent yield for an extended period of time, then you have to ask why.”

This is why it is important not just to focus on income, but capital; not just on diversification of assets, but of income streams; and not just on finding alternatives, but on how those alternatives fit into a risk-managed portfolio.

Shane Balkham, chief investment officer at Beaufort, says: “Of course investors in retirement will be focused on the diversity of the income streams they are earning. But it is also important to focus on the liquidity of a portfolio, and that is something to be mindful of with alternative income products.”

Building such diverse income-generating assets into a multi-asset portfolio needs to take into consideration the client’s own risk tolerance and individual circumstances. 

Simply diversifying into more risky stocks to generate that income is not a true multi-asset strategy for those in retirement.

David Thorpe is special projects editor at FTAdviser and Financial Adviser