If you’re a young person with no job and little prospects, then Rishi Sunak’s recent jobs announcement would have given you cause for hope for the future.
But it was less positive for committed savers with retirement on the horizon and recent retirees wondering what income to draw from a ravaged portfolio.
If anything, the Chancellor’s summer statement was notable for not axing the triple lock that supports rising state pension payments. What’s more, the demographic picture is getting less helpful as populations grow older. The latest EU projections say that by the year 2100 there’ll be less than two working people to fund every retiree. That’s a far cry from the current three workers to one retiree.
Given that 2020’s markets have been unhelpful to those near or in retirement, now is probably a helpful time to offer the reminder that income can be generated from a bottomed-out market. Readers will no doubt be aware of the risk/reward dynamic. In bull markets, investment strategies pile into risk assets to capture these market gains. And this works very well. Until it doesn’t.
As all-too-many retirees find, risk assets can quickly turn into huge liabilities. This is something we saw almost universally when COVID-19 drove economies into lockdown and stopped history’s longest bull market in its tracks earlier this year.
Stock markets were decimated, unemployment rates soared and central bank support once again slipped into unprecedented territory. Value was wiped from almost every investment strategy, but those with the highest risk allocations were left the worst-affected.
For younger investors, investments are not typically their primary source of income and they have time on their side. The same cannot usually be said for retirees, who rely (or plan to rely) almost entirely on their investments for income – and this need doesn’t disappear just because markets are crashing.
Unfortunately, this can give rise to a well-known and potentially serious issue called “sequencing risk” – also known more colloquially as “pound-cost ravaging”. For retirees wanting to draw income from their portfolio in falling markets can leave capital depleted and, in turn, future income permanently lower. After all, while a 10% loss in any one year would require an 11% gain to break even, a 30% loss requires a rise of 43% to break even. Relatively short-term losses can have a lasting impact and drawdowns only emphasise this.
The result? Either those affected ultimately accept a reduced level of income or their pension pot will deplete further and further until a return to its initial value becomes virtually impossible to achieve. Put another way – it is the effect of compound interest in reverse.
With COVID-19 wiping hundreds of billions off pension pots across the UK, pound-cost ravaging is a harsh reality that many will now be facing.
So, how can retirees minimise the long-term impact of wider market performance?
To start, the investment performance of a fund relative to another should take a back seat. After all, funds posting large gains could indicate a higher proportion of holdings in risk assets and equally huge losses could follow when markets turn against them. Instead, a much more important consideration is whether the product can provide for their retirement goals consistently. This will almost always involve providing income and preserving capital as much as possible in all market conditions.
This is where multi-asset and, more specifically, absolute return funds come to the fore.
They have often been misunderstood with investors relying on performance tables to determine their investment strategy. However, the very nature of well-managed absolute return is to smooth returns and limit losses rather than ride the rollercoaster at the mercy of single asset movements.
With careful investment across asset classes, it is possible to target a 3% to 4% annual income drawdown, with capital remaining largely intact over the longer term and with the income growing in line with inflation.
It also helps to have a clear focus when managing these funds. Do the fund managers themselves invest in their own strategies? Do their families? For example, our own Fund, the Church House Tenax Absolute Return Strategies Fund, was launched in 2007 borne out of a single client’s priority to protect the value of his capital and take a consistent income. They’re still invested today. As are the Fund’s managers.
This is a really effective stabiliser as just about every decision made on the fund is made through the lens of this investor and that of our families and own retirement pots.
Prevailing market conditions have exposed many investment funds and, in so doing, have sadly had a devastating effect on retirement pots. We must start to learn from these times. By keeping volatility to a minimum throughout market cycles, a much greater emphasis can be placed on overall capital preservation relative to peer funds that sacrifice ultra-low risk for a shot at greater returns.
Of course, well-run multi-asset absolute return funds tend not to participate in the entirety of the upside when wider markets are booming, but that doesn’t matter. When the tide changes, their ongoing provision of “cash plus” returns and capital preservation (or at least minimal losses relative to the markets in which they invest) will look a whole lot more appealing to a retirement investor than a blown-out account.
Building a retirement pot should be a marathon not a sprint.