Living longer is one good reason to protect capital for sustainable income

From

Denis Donohue

There are over five million baby boomers (born 1946 to 1964). For most, a bright future awaits. After full-time work, it’s a stage of life which could span 25 years or more, so will the capital last?

Longer, healthier lives against a backdrop of lower investment returns means Baby Boomers have two things to ponder:

  1. Cash, bond and deposit “safe haven” yields are now, in some parts of the world, negative or at historic, all-time lows. Share markets are close to, or at all-time highs.
  2. Property prices (especially Sydney and Melbourne) have been falling for some time. Australian’s wealth through home ownership with falling capital values especially matters if close to receiving your last pay cheque.

Ten years on from the GFC, risk is once again in sharp focus

Loss aversion is a powerful motive. Baby boomers don’t need to take unnecessary risks. Once you’ve taken your last pay cheque, forget the hyperbole of “time in the market” or “buy the dips and sell high”. The simple fact is you’ll need a secure income and by protecting capital you’ll ensure longevity.

What can professional fund managers do to help investors manage retirement savings where certainty is paramount?

Well, we can diversify across asset classes to manage risk. But risk through asset class diversification is not really controlled or managed. Why? Because it relies on correlations which are only stable when they are not stable.

During the Global Financial Crisis, as markets correlated to 1.0, diversification did not help

In other words, when things are at their worse (e.g. during the GFC) correlations converge towards 1.0 (that is everything moves in the same direction) and most asset classes perform similarly, meaning diversification provides no comfort at all.

Can managers time the market?

They can try. However, the success of doing this is just as elusive as it is persistently picking the outperforming stock. Managers that arguably demonstrate skill rather than luck might rely on one big call to underwrite their success in between a lot of smaller bad calls. You just must be there when (or if) the right big one happens. Otherwise, you have to be there for a very long time.

Sequence risk matters

The sequencing of returns over the life of a post accumulation savings pool is unknown. So why risk it at all?

A “protective” portfolio mitigates risk of the future sequencing of returns. Like any insurance it requires a trade-off. We believe this is best done at the individual stock level. It is not episodic. It is not hit and miss. It is not approximated or imperfect. It is defined with precision.

A prudent manager cares about the longevity risk of a portfolio. Why expose assets to unnecessary risk?

Is there an alternative?

We think so. Measure risk and control it to deliver a return within a range of known outcomes. Grow the value of retirement savings through time to fight the effects of inflation. Maintain the purchasing power of money in the future (you may live 20-30 years or more). Generate an income from your retirement savings to fund lifestyle spending.

Life after full-time work, with the blessing of good health, family and lifestyle is a wonderful thought. Meanwhile the role of professional money managers is a serious business as we transition the investor towards the need for less risk and sustainable income.

Creating certainty around all these factors is a key issue for all managers looking after the assets of retired or soon-to-retire clients.

By Denis Donohue Executive Chairman and Head of Investments

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