Reece Birtles
In a major update on their research-based approach to retirement income portfolio construction, leading active equity investment manager Martin Currie Australia reaffirms that retirees need to rethink the use of typical defensive portfolios based on risk/return theory and adopt a ‘sufficient income for life’ approach.
Martin Currie highlights in their newly released research paper[1] that the sufficient income for life approach relies on the concept of income volatility as a measure of the risk of impaired living standards in retirement, rather than asset return volatility.
Martin Currie finds that, in practice, sufficient income for life leads to retirement income portfolios with higher equity allocations.
Importantly, the equity selection for a retiree portfolio will be different from those of an accumulation investor, with the sustainability of income, future income growth and diversification of income sources the critical considerations.
Reece Birtles, Chief Investment Officer, Martin Currie Australia, says: “Retirees require a reliable income stream to replace the wages they received when they were working, so it is more important to focus on the actual dollar income generated over time, rather than the headline yield percentage.”
“The old view of the economic behaviour of retirees that most existing multi-asset retirement products assume is that when people get to 65 they automatically become more risk averse and should move away from risky, growth-style assets and move towards defensive assets. We do not agree,” Birtles says.
“So-called low risk defensive assets have turned out to be low growth with high income volatility over the past decade.”
Sufficient income for life focuses on achieving a high and stable franked income stream to support annual expenses; income growth for inflation protection; and capital growth to manage longevity risk.
Martin Currie’s view is that not all growth assets should be considered ‘high risk’ and all defensive assets ‘low risk’. The attractiveness of different asset classes is significantly different when viewed through the lens of income volatility.
Over the past 10 years, Martin Currie has implemented this approach in its Martin Currie Equity Income, Real Income and Diversified Income Strategies. The performance of those funds presents strong evidence that the sufficient income for life approach may deliver the best probability of beating an income return target, compared with some income alternatives.
Features of these funds include:
- Stocks are selected on a forward looking ‘sustainable dividend’ basis, based on free cash flow generation through different stages of the economic cycle;
- A focus on high quality companies, which generate high free cash flow;
- A benchmark unaware construction. When looking through a sufficient income for life lens, it is more important to minimise concentration risk that chase benchmark-relative alpha. This helps ensure a more stable income stream;
- Maximise franking credits. For Australian retirees, franking credits are the closest thing they will get to a free lunch; and
- Australia focus. Portfolio construction methodology includes inflation drivers designed specifically for Australian retirees. The cost of living is largely domestically driven, therefore the risk to the investor is Australian in nature.
Birtles says: “We have compared results across several metrics, versus traditional lower-risk income alternatives such as term deposits, bonds and defensive balanced funds, as well as other categories such as balanced funds, broader equities and a rules based high-yield index approach.
“While the risk profiles vary, our research finds that the Martin Currie Australia retirement income strategies deliver the best probability of beating an income return target, compared with the income alternatives.”
Matthew Harrison, Managing Director of Franklin Templeton Australia & New Zealand, notes that investors and financial advisers face a complex challenge in constructing portfolios for a financially secure retirement.
“Many Australians will spend a third of their life in retirement and it’s critical they can generate the income needed to live well and keep up with rising costs without running out of money,” says Mr Harrison.
“Martin Currie’s innovative approach to retirement income provides a practical, research-based solution to this challenge and we are pleased to make their expertise and income strategies available to Australian investors and advisers.”
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[1] Investing in a sufficient retirement income in a post COVID-19 world