Legg Mason urges investors to rethink retirement portfolios

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A new paper released by Legg Mason today argues the burning issue of longevity risk needs to fuel a rethink of portfolio construction for retirees with a greater emphasis on income producing alternatives and equities.
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The paper argues the traditional method of allocating 70% of a portfolio to defensive assets in retirement will not be sufficient to sustain an income in retirement. Instead it suggests a number of alternatives including real assets like property, utilities and infrastructure and income-generating equities.
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“Retirees will require the bulk of their investment return to come from yields to sustain them through retirement,” said the paper’s co-author Reece Birtles, chief investment officer for Legg Mason Australian Equities.
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Solving the income conundrum

While it’s important for retirees to target yields, the exact type of yields needs to be carefully considered.
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“Overly defensive strategies like fixed income don’t provide the necessary growth in line with inflation to continue to meet rising costs and sustain income. However retirees need a lower level of risk, which includes investment, foreign currency and liquidity risk. Therefore some higher yield assets could be too risky for their purposes,” said Mr Birtles.
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A solution to the income conundrum could be real assets, he argues. Utilities, property and infrastructure provide a good middle ground between defensive assets like fixed income and growth assets like equity. They have strong yields but their income stream is not reliant on the cycle, meaning lower volatility.
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High income Australian equities also provide a solution as they boast unique income characteristics in the form of franking credits, according to Mr Birtles. Often ignored, franking credits can boost overall returns by 1% for those on a 0% tax rate (such as retirees). The key with equity income for retirees is to manage risk by picking equities with the power to sustain good dividends through characteristics including strong cash flow and low capex requirements.
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“For instance, mining is very capital intensive whereas non-bank financials with sustainable earnings such as AMP and Perpetual are favourable as are stocks like Woolworths or Metcash,” said Mr Birtles.
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New Legg Mason funds help fill gap for retiree tailored products

For the past 20 years, the industry has focused on accumulating assets with little focus on retirement, leaving a gap for specifically tailored products.
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“In the same way as many product innovations were driven by baby boomers as they moved through their working life, we are bound to see new products and ideas as boomers enter retirement,” said Mr Birtles.
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The newly launched Legg Mason Real Income Fund builds a portfolio of listed hard assets including A-REITs, utilities and other infrastructure such as electricity and gas grids, toll roads, ports, airports and hospitals. This delivers a good yield, inflation protection and is low risk.
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Meanwhile the Legg Mason Australian Equity Income Trust (due to be launched 1 June) will invest in companies listed on the ASX that have attractive, reliable dividends. It is designed to deliver an income yield higher than the market without relying on gearing, derivatives or other complex structures.
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“We think it is the right time to be targeting specific solutions for retirees. As more people reach retirement they need to make sure they have the right portfolio to make their savings last the distance,” Mr Birtles concluded.

cNTA