There are proven solutions and that employ managed risk strategies and are available to Australian financial advisers to assist their clients with achieving their retirement.

Retirement signals one of the most important periods in an individual’s lifetime – once their work-life cycle begins, it is for many people a significant life-stage on the horizon.

Even though it could be many years away, retirement planning requires careful consideration when it comes to their finances. For many, it presents the picture of a time to relax after years of hard work, time to travel and to enjoy their nest-egg, yet there is a very serious side to it. Managing one’s finances and planning for this important life-stage is therefore one of the most challenging tasks in financial planning.

As highlighted in another recent article by Milliman, Building portfolios to keep retirees invested, requires moving a client’s mindset from simply growing a pot of savings in accumulation to managing the longevity, as well as behavioural and sequencing risks associated with decumulation.

It’s an extremely important part of the advice conversation and in the current high-inflationary and uncertain market environment, the outlook for retirees has never been more challenging.

At the end of the day, it all boils down to two key (not so simple) questions:

1. How much income can I take in retirement? And following that:
2. How can I improve it?

Traditionally, the approach used to answer this question was tackled by setting an asset allocation coupled with an assumed withdrawal rate (e.g. 4%) and then modelling this along various paths of a single return stream (i.e. historical market returns at different points in history).

We know from historical events that this rudimentary approach is indeed not fail-safe; as history has taught us, it has significant flaws that haven’t accounted for some of the most significant market crashes in the past 20 years.

If we therefore tackle these questions with a stochastic lens across the retirement income challenge, we get some very interesting results.

Rather than setting a withdrawal rate and testing it for success, a stochastic approach enables us to optimise the level of income using thousands of projected scenarios that are based on a probability of success, while also factoring in unexpected tail events. In doing so, it enables the consideration of a much-wider spectrum of potential outcomes including multiple cases of severe market corrections and continual portfolio withdrawals, which together may significantly impact the sustainability of any retirement portfolio.

Jack, 67 with $1m invested in a Balanced portfolio, is retiring and has a question for his adviser

How much retirement income can he comfortably draw down each year, from his portfolio, to carry him through retirement?

To answer this, we have first projected 5,000 sets of real-world market scenarios^[1], including projected inflation rates. Income is assumed to increase in line with the projected inflation rates at each scenario and time step and is then assumed to be withdrawn from Jack’s balance at the end of each year across the planning horizon.
The planning horizon, or really the question of ‘how long will Jack live for?’ is another unknown that adds a whole new dimension to the retirement challenge (and one which we won’t delve into in this article). For the purpose of this analysis however, we will make the assumption that the planning horizon is 20-years, i.e. the life expectancy of a 67-year old male^[2].

For each of the 5,000 scenarios, we can measure if Jack is able to maintain the level of withdrawal without running out of money at the end of the 20-years. Based on this, a probability of success is obtained. Whilst this probability of success is an important and easily understood measure, it is a binary measure (for each single return path) and doesn’t provide any information around how ‘bad’ the outcomes can be.

As such, we also look at the ‘conditional tail event’ – answering the question “in the event things do go bad, how bad can it go?” This is determined by looking at the average shortfall in the worst 1 out of 10 scenarios.

In this analysis, the following constraints are placed to determine the sustainable withdrawal rate:

• At least 90% probability of success; meaning he won’t run out of money throughout retirement in 9 out of 10 scenarios
• Potential shortfall of no greater than 5 years in the worst 1 out of 10 scenarios; meaning that in the event where he does run out of money, he can expect to not be short for more than 5 years.

For Jack, our 67-year-old male with $1m retirement balance, this approach leads to a sustainable retirement income when invested in a Balanced portfolio of $45k per year (real income). This is based on an average compounded annual growth rate (CAGR) of the Balanced portfolio over 20 years of 7.2% (pre fees) in the scenarios used.

Whilst calculating the sustainable withdrawal rate is useful, what’s more important for advisers is being able to improve it reliably for their clients

Traditionally, this has been done by shifting allocations between equity and fixed income assets. And whilst this approach was generally successful in the 1980s and 1990s, today’s market conditions with lower real yields, high levels of market volatility and soaring inflation have made it much more difficult for many retirees to generate (real) income, without taking on too much risk.

The challenge in the traditional planning methods lies in the trade-off of risks between allocation to equities and fixed income assets. Too much in equities may mean too much market risk, whilst too much in fixed income may equate to a lack of growth. In some ways, it is a zero-sum game. This can be quantified by examining the effects of allocating into 100% equities, and 100% fixed income, respectively.

Table 1 below indicates the attainable sustainable withdrawal rate, average CAGR as well as the standard deviation of returns for each of the Balanced, all equities and all fixed income portfolios we examine.

The effect of allocating to 100% equities is a sustainable withdrawal rate of $40k per year, $5k lower than the withdrawal rate obtained when invested in the Balanced portfolio.

This is largely due to the impact of adverse market environments and the sequence of returns risk associated with the equity markets. That is, due to the higher risks (volatility) associated with equity markets, there are more scenarios where the return paths lead to the retiree running out of assets by the end of the planning horizon, despite the all-equities portfolio having a higher average CAGR of 9.2%

The sustainable real retirement income of the 100% fixed income portfolio is $38k per year, $7k lower than the sustainable withdrawal rate obtained when invested in the Balanced portfolio.

It is evident that whilst the risk is much lower on the fixed income portfolio, there’s much less growth potential as well given the average CAGR of 4.6% over 20 years. As a result, in an environment with insufficient yield, or when excess risk must be taken to achieve the sufficient yield, investing in fixed income provides some protection around market risk, at the cost of greatly reducing the retirees’ withdrawal rate.

What makes the building of retirement portfolios especially challenging is the need to find a delicate balance between the exposure to growth assets with the risk averting tendencies of retirees and their elevated exposure to sequencing risk. Nothing could be worse than taking money out at the bottom of the market only to put them into something with much less growth potential in the future.

We delved into this topic in more detail in our recent CPD accredited piece Building portfolios to keep retirees invested.

Managed Risk strategies

Fortunately, there are now Managed Account solutions available to Australian financial advisers and their clients, that employ managed risk to provide clients with a cushion in market downturns.

These solutions employ strategies that dynamically hedge the portfolio against volatility and extended market downturns.

It is all done systematically, with the level of hedging being adjusted daily based on the market environment and implemented in real-time using futures contracts throughout the day. This is a similar strategy used by large insurers and institutional investors over many years to hedge their long-term liabilities and have successfully saved them billions of dollars during the Global Financial Crisis

The result for investors being that it helps to lower and stabiles volatility, whilst also reducing the impact of large market drawdowns giving investors that confidence to stay invested in growth assets to achieve their retirement income goals. By not providing a ‘hard guarantee’, the cost for these strategies can be efficiently managed.

For the adviser it can help solve the retiree conundrum that is all too familiar: ‘Recommend a more aggressive portfolio to generate healthier returns and risk taking the heat when a market downturn devastates the client’s retirement savings. Alternatively, if we keep retirees’ capital in conservative investments, we risk their retirement savings run out well before their life expectancy.’

The table below illustrates the same metrics explored above, for a Balanced portfolio with the inclusion of a managed risk strategy.

Here we note there’s a $2k improvement in the sustainable withdrawal rate with the managed risk strategy included, coupled with a marginal reduction in the volatility of returns albeit with a slight reduction to the average CAGR as well.

By utilising managed risk strategies to address issues such as market shocks and sequence of returns risks, there is more room for Jack to potentially reduce his overall exposure to fixed income assets and participate in growth assets to a greater degree, which can also help to improve his sustainable withdrawal rate.

Now, Jack has another question for you – what happens if a market correction like the ‘GFC’ happened today, right when he was about to retire?

Given the volatile markets we’re experiencing, where we seem to have lived through a couple of ‘1 in 100 years events’ in less than 20 years – with the Global Financial Crisis (GFC), 2015 market sell-off, Covid-19 market crash in 2020 and most recently the impact of unwinding over a decade worth of monetary policy, it is not a surprise that market corrections are at the very top of retirees’ minds.

To proxy this, we observed the actual performance of different asset classes during the GFC^[3]. The results show that the benchmark Balanced portfolio dropped 24.45% in value over the period. However, an equivalent fund with the managed risk strategy in place fell only 6.74%.

Jack’s retirement balance ($1m) was then reduced accordingly based on the reduction level observed and we performed the same calculation to determine his sustainable withdrawal rate.

As can be seen in the charts below, the resulting sustainable income in retirement drops to $33,500 per year for the Balanced fund. This indicates a 25% reduction in the standard of living in retirement for Jack. However, with the managed risk strategy alongside, it drops by just under 7.5% to $43,500 per year, enabling Jack to safely maintain his retirement lifestyle.

Conclusion

For decades, conventional wisdom has said “When the market goes down, ride out the storm. Eventually the damage to your portfolio will be corrected” or “Wait it out; and batten down the hatches”. Unfortunately, for many – especially those closest to retirement who do not have the benefit of time in the market to recover – this advice has not proven the best and they have been left significantly short of their retirement income goals, from their portfolio.

Traditional methods used within financial planning for calculating a ‘reliable’ income stream and shifting asset allocations between growth and fixed income asset classes have unfortunately fallen short and for many retirees, that can have a huge detrimental effect upon their retirement income. As we have noted here, real income for retirees in the current market environment: investing in equities may mean too much risk; whilst investing in fixed income typically results in lack of growth.

We have explored the concept of turning a large pot of money (retirement balance) into a number that is more relatable for retirees – a level of sustainable income that enables them to live their desired retirement lifestyle.

The real value-add that advisers are able to bring to their clients, is the ability to either reliably increase a client’s sustainable income; or maintain it during times of high market volatility.

Today, there are proven solutions that employ managed risk strategies and are available to Australian financial advisers to assist their clients with achieving their retirement, particularly in the current and ongoing volatile environment.

——–

References:
[1] Using Milliman’s Economic Scenario Generator as at 30/12/2022.
[2] Based on ALT 2015-17 with 25-year mortality improvements.
[3] Asset allocations based on Morningstar Australia Balanced Target Allocation Index
[4] Asset allocations represented by Milliman’s SmartShield Balanced Strategy
[5] Period 31/10/2007 – 27/02/2009

Disclaimer: For investment professional use only. Milliman Pty Ltd ABN 51 093 828 418 AFSL 340679 (Milliman AU) for provision to Australian financial services (AFS) licensees and their representatives [and for other persons who are wholesale clients under section 761G of the Corporations Act]. Not for public use or distribution. Past performance is not indicative of future results. Recipients must make their own independent decisions regarding any strategies or securities or financial instruments mentioned herein. Milliman does not make any representations that products or services described or referenced herein are suitable or appropriate for the recipient. Many of the products and services described or referenced herein involve significant risks, and the recipient should not make any decision or enter into any transaction unless the recipient has fully understood all such risks and has independently determined that such decisions or transactions are appropriate for the recipient. Any discussion of risks contained herein with respect to any product or service should not be considered to be a disclosure of all risks or a complete discussion of the risks involved. The recipient should not construe any of the material contained herein as investment, hedging, trading, legal, regulatory, tax, accounting or other advice. The recipient should not act on any information in this document without consulting its investment, hedging, trading, legal, regulatory, tax, accounting and other advisers. Milliman does not ensure a profit or guarantee against loss. Materials may not be reproduced without the express consent of Milliman.

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What are the key risks facing retirees in the current economic climate?

Building portfolios for retirees is one of the toughest tasks in finance. Retirees in typical defined contribution superannuation funds must transition from the mindset of simply growing a pot of savings to having to manage the now very real risk of outliving their savings (longevity risk). Additionally there is the risk of making poor investment decisions (behavioural risk) and finally, the risk of large market corrections hitting their retirement savings at the worst possible time (sequencing risk).

This is a difficult set of risks to manage at the best of times. However, with inflation rocketing to its highest level in recent times, Australians living longer than ever before along with the threat of a global recession, the outlook for retirees has never been more challenging.

This article will tackle each of the risks faced by retirees and walk through some of the solutions and strategies that can be employed to tackle them.

Longevity risk

According to the latest Australian Bureau of Statistics study on our population, the number of people aged 85 and over has more than doubled in the last 20 years (an increase of 110 per cent). 

Figures from the United Nations are projecting a dramatic increase in people aged 65 or older. By the end of the 21^st century, 22 per cent of the global population will be in this age group. That’s more than double the proportion of 9.3 per cent reported in 2020.

What does it mean for your clients? A 67-year-old now has a life expectancy of age 87 (for men) and age 89 (for women). This represents an increase of 5 years  for men and 3 years for women compared to the life expectancy of a 67-year-old just 20 years ago. Actuaries will then come along and spoil the party, with the fact that a retiring couple aged 67 have a joint life expectancy of age 92, which is distinctively not the average of 87 and 89^[1].

However, it’s important to keep in mind that even if you plan for your income to last this long, then there is a 1 in 2 chance (or a flip of a coin) of actually living past life expectancy.

If the same couple want to be 90% sure they don’t outlive their savings, then they need to be planning an income that lasts till age 99^[1]. That is a required retirement income of more than 30 years.

How should this impact your clients’ investment strategy?

From an investment lens, this means a typical pot of retirement savings for a 67-year old should reflect an investment horizon of 20-32 years. Based on a typical superannuation fund’s fact sheet^[2], the minimum investment horizon across their investment options range from 7 years for their conservative fund, to 12 years for their high growth fund. This implies, a typical 67-year-old actually has a long enough investment horizon in retirement to justify being in investment options with higher growth allocations.

In fact, in most standard deterministic retirement calculators, we’d see that the investment option leading to the highest longevity, or most amount of expected income in retirement, is a portfolio invested in 100% Australian equities.

We all know this is a flawed argument. The drive to deliver higher returns needed to combat inflation and longevity risk needs to be delicately balanced by the risk taken to achieve this.

Behavioural risk

As a result of the market impacts of COVID-19, a typical Balanced fund^[3] would have fallen -10.4% in the first 3 months of 2020.

For an accumulator, a market shock like this can be viewed as an opportunity to contribute at cheaper levels. However, for a retiree who is no longer contributing, they could be facing a substantial reduction in their retirement income for the rest of their life.

At this point, it is natural for them to look at averting further losses. Unfortunately, it is exactly this ‘loss aversion’, that leads to one of the most common and detrimental behavioural biases for investing.

According to a 2007 study^[4] by AARP and the American Council of Life Insurers, the average person feels pain from a loss twice as much as the pleasure they feel, from a financial gain. From an emotional perspective, this means that the pain from losing $100, is just as strong as the pleasure from gaining $200.

The same study then shows that Retirees are actually FIVE times more sensitive to these losses. That is, losing $100 for a retiree is as painful as the pleasure they experience, from gaining $500.

This type of a bias is a key reason investors de-risk or ‘cash out’ of their investments at the worst possible time.

How can bucket strategies help?

Fortunately, advisers can play a big role in giving their clients that confidence to stay invested throughout these market cycles.

Common approaches such as using bucket strategies can also play a big part in keeping retirees invested; by segregating their investments into designated long-term buckets for their investments and short-term buckets for their spending.

These strategies can be very effective in giving investors the confidence that they have enough cash to support their income needs for a few years, irrespective of where markets are headed and helps tackle the tendency for investors to sell out at the bottom of a market cycle.

However, when viewed from an investment perspective these strategies don’t actually manage the underlying risk in the portfolio, meaning that these cash reserves can still run-out in a sustained market downturn and overall the outcomes for investors are therefore unlikely to improve materially.

Market/Sequencing risk

The elevated loss aversion as we approach retirement can be justified by our increased exposure to sequencing risk in the few years before retirement and also in the early years of retirement. Sequencing risk is a function of the sequence of returns year on year, for an investor who is drawing down on their assets.

The chart^[5] below illustrates this by showing the number of years of retirement income lost from the same 30% shock, applied at different ages.

It is clear for investors within plus or minus 10 years from their retirement, that the impact of the 30% shock is at its highest. This is because within this period, their savings are at their highest, so they have more to lose and there is also little, if any, in the way of further contributions (nor time!), to help them recover from a severe market shock.

With this dynamic at play, it is clear that reducing the likelihood and severity of large market corrections for investors in this zone, is particularly important to improve their risk adjusted outcomes.

How does de-risking address market risk?

The most common approach to managing market risk as members approach retirement is de-risking. That is, reducing allocation to risk assets (typically equities) and allocating it to ‘defensive’ assets (typically fixed income). The theory behind this approach is that defensive assets such as fixed income can help lower the market risk of a portfolio through diversification benefits as well as simply being a lower risk asset class. The trade-off is of course, lower expected returns in the long run.

The following chart illustrates the average returns and volatility expected from typical investment options ranging from High Growth to Conservative^[5]:

Based on this, de-risking from a typical Growth fund to a Balanced fund is expected to reduce volatility by 2.8% but also lower average returns by 1.2%. For a typical retiree aged 65, this has a cumulative impact of reducing the longevity of their portfolio by 3 years^[5][6].

In practice, de-risking hasn’t been as straightforward. Last year, it was no surprise that as rates rose, bond prices fell. The Bloomberg Global-Aggregate Total Return Index (AUD Hedged) has a duration of approximately 6.8 years, so it has fallen -12.3% in 2022, whilst the Bloomberg AusBond Composite 0+ Index with a duration of 5.2 fell about -9.7% in 2022. This is one of the largest corrections in bond markets in recent history and what’s made it worse for investors looking to de-risk is that it has happened in a year where equities have sold off as well.

Instead of providing a buffer for equity markets, fixed income has actually contributed to the losses of these diversified multi-asset portfolios. The end result is that for many multi-asset portfolios, the lower risk portfolios with higher fixed income allocations have actually suffered just as much if not greater losses compared to more aggressive investment options.

Diversification is ultimately a tool that relies on correlations which are inherently an unstable relationship. For the purposes of managing market risk, diversification should be paired with more explicit and robust risk management strategies.

How do managed risk strategies address sequencing risk?

There are now managed account portfolios that have been designed specifically to address sequencing risk for retirees. These portfolios incorporate a ‘managed risk’ strategy to systematically target two objectives:

• stabilise the volatility of the portfolio
• minimise the impact and likelihood of large market drawdowns.

The two objectives combined, aim to create a strategy that helps improve the expected outcomes for retirees.

Stablising the volatility of the portfolio

The realised volatility of a typical balanced investment option has averaged 5.8% over the past 10 years. However, in 2020, and 2022, this would have spiked to 12%, and 7.2% respectively. This creates uncertainty and nervousness for investors.

Fortunately, market volatility exhibits a level of ‘stickiness’, that allows short-term market volatility to be forecasted. This can be done through short-term statistical forecasts and market based measures based on option pricing.
Within these new managed account portfolios, if the forecast volatility exceeds a certain level, it will actually generate a progressive increase in hedge levels and if the forecast volatility is low, it can very quickly remove the entire hedge position, to enable maximum participation in any market upside.

In the long-run, this approach is expected to keep volatility of each portfolio within a significantly narrower band, delivering a more predictable outcome and true to label risk profiles.

Minimise the impact and likelihood of large market drawdowns

Large market drawdowns happen more often than you think. The All Ordinaries had six 20%+ falls since the 80s. In fact, the likelihood of a 20%+ fall happening in equities markets over a typical 30 year retirement is 1 in 7.

It is these types of market drawdowns that can trigger the wealth destroying behavioural risks outlined earlier, and disproportionately impact retirees as a result of sequencing risk.

There are financial instruments such as put options that can be structured to contractually provide a payoff in the event of a market drawdown. However, because these instruments provide what is effectively a guarantee, persistent options-based strategies can be expensive, especially when you need them the most, in volatile markets.

Managed risk strategies instead, use a technique to replicate/manufacture a long dated put option using futures contracts. This is the same approach taken by large insurance companies and investment banks to manage the risk on their own balance sheets. The objective is to simply reduce the likelihood and severity of large market drawdowns.

The following chart illustrates the likelihood of experiencing a large market drawdown within typical portfolios compared to these Managed Account portfolios with a built in managed risk strategy:

Conclusion

As this article discusses, when it comes to building strong retirement portfolios, moving a client’s mindset from simply growing a pot of savings in accumulation to managing the longevity, behavioural and sequencing risks associated with decumulation is a challenging but extremely important part of the financial advice conversation.

What makes the building of retirement portfolios especially challenging is the need to balance growth assets with the risk averting tendencies of retirees and their elevated exposure to sequencing risk.

Fortunately, techniques that have traditionally been used by institutional investors to manage market risks and have successfully saved billions of dollars during the Global Financial Crisis, have been made available to Australian financial advisers and their clients.

The portfolios with these ‘managed risk’ strategies have been designed to deliver a smoother ride and can provide a cushion in market downturns, giving pre-retirees and retirees that confidence to stay invested in growth assets, to achieve their retirement goals.

———–

References:
[1] Based on Australian Life Table 2015-17 with the 25-year improvement factor. Statistics from 20 years ago is based on Australian Life Table 2000-02
[2] Based on Investment options from Australian Super
[3] Based on the Morningstar Australia Fund Multi-sector Balanced Index
[4] http://assets.aarp.org/rgcenter/econ/guaranteed_income_1.pdf
[5] Assuming a starting annual contribution of $5,000 (in today’s dollar terms) that grows at a CPI + 1% wage growth annually and capital growing at CPI + 4% annually, retirement is assumed to occur at age 65 with an yearly withdrawal of $40,000 (in today’s dollar terms).
[6] Calculated based on the output from 5,000 1-year stochastic market scenarios, calibrated using Milliman’s economics scenarios generator
[7]  Based on retirement balance of $500k and $30k annual retirement income

Disclaimer: For investment professional use only. Milliman Pty Ltd ABN 51 093 828 418 AFSL 340679 (Milliman AU) for provision to Australian financial services (AFS) licensees and their representatives [and for other persons who are wholesale clients under section 761G of the Corporations Act]. Not for public use or distribution. Past performance is not indicative of future results. Recipients must make their own independent decisions regarding any strategies or securities or financial instruments mentioned herein. Milliman does not make any representations that products or services described or referenced herein are suitable or appropriate for the recipient. Many of the products and services described or referenced herein involve significant risks, and the recipient should not make any decision or enter into any transaction unless the recipient has fully understood all such risks and has independently determined that such decisions or transactions are appropriate for the recipient. Any discussion of risks contained herein with respect to any product or service should not be considered to be a disclosure of all risks or a complete discussion of the risks involved. The recipient should not construe any of the material contained herein as investment, hedging, trading, legal, regulatory, tax, accounting or other advice. The recipient should not act on any information in this document without consulting its investment, hedging, trading, legal, regulatory, tax, accounting and other advisers. Milliman does not ensure a profit or guarantee against loss. Materials may not be reproduced without the express consent of Milliman.

The post Building portfolios to keep retirees invested appeared first on AdviserVoice.

Victor Huang

Milliman’s SmartShield managed accounts, which offer dynamic protection against market downturns, have passed $100 million in funds under management.

This milestone shows growing demand among advisers and clients for a low-cost solution to protect portfolios against market crashes and volatility without giving up the potential upside.

Milliman Principal and Head of Investment Solutions Asia-Pacific, Victor Huang, said the SmartShield managed accounts were successfully launched to the retail market just as the COVID-19 market downturn hit in early-2020.

“The COVID-19 downturn offered up a real-world situation to test the strategy. It demonstrated to investors how effective dynamically hedging their portfolios against significant market downturns can be. Global insurers, pension funds and wealth management firms have successfully used these techniques for decades. Through SmartShield, retail investors have been able to protect their portfolios in the same simple and low-cost way.”

Milliman’s Financial Risk Management (FRM) practice is a global leader in managing financial risk, providing investment advisory, hedging and consulting services on approximately $A246 billion in global assets. Milliman FRM has a well-established track record of over two decades, navigating the past three market crises. It employs more than 200 professionals across four offices globally, helping protect the portfolios of insurers, pension funds, and wealth management firms around the world.

The four SmartShield portfolios (Moderate, Balanced, Growth and High Growth) have been designed to provide a cushion against downturns and volatility (rather than a hard guarantee). The dynamic risk management strategy is implemented using futures contracts to ensure it is low cost and liquid, while providing investors with strong participation in bull markets.

Contrarian Group Financial Planning Certified Financial Planner, Damian Liddell, says the SmartShield strategy suits his retiree clients, particularly given this year’s challenging market conditions.

“The market is really choppy at the moment – we’re long overdue for a pullback,” he says. “Property and share markets have been propped up by falling interest rates for a long time. Now that rates are rising, it’s really difficult, and that’s where the SmartShield approach is good – it lets people have their cake and eat it too.”

A growing proportion of the population are approaching retirement or already drawing down capital, where they face sequencing risk, which describes the bigger impact a market downturn can have when struck in early retirement, compared to being in the accumulation phase.

Liddell’s other clients also face similar market timing risks when they invest large sums of money, such as from a property sale or inheritance.

“My clients are prepared to accept some risk – they know SmartShield is not full protection – but one that strikes the right balance at low-cost. They don’t want the risk of a sharp downturn hitting a traditional balanced portfolio and are prepared to give up some upside if they can generate reasonable returns over the long-term.”

Since inception, Milliman SmartShield High Growth portfolio added 1.22% p.a. above its benchmark (see footnote), whilst reducing volatility from 15.13% to 9.47%.

The built-in risk management within SmartShield gives advisers the confidence to increase their exposure to growth assets, knowing that the protection will kick in when needed. This potential for extra growth is important to increase the chance of delivering positive real returns in this high inflationary environment.

A growing number of investors are also now starting to consider term deposits or online savings accounts, which are becoming more attractive as interest rates rise, according to Liddell.

“For the last 5-7 years I’ve probably been too conservative,” Liddell says. “If it wasn’t for SmartShield I’d probably still have 40-50% exposure to growth assets, but with SmartShield you can just bump it up that extra 10-20% rather than going to fixed interest or even term deposits.”

Market conditions remain uncertain as central banks around the world continue to raise rates to fight surging inflation. Inflation is expected to nudge almost 8 per cent in Australia by the end of the year, while other factors, such as geo-political turmoil, are adding to volatility.

However, investors should continue to focus on their long-term goals, according to Huang.

“Dollar-cost averaging remains a popular strategy among advisers investing large sums on behalf of clients. The Milliman SmartShield managed accounts now provide another way to manage uncertainty given it provides strong protection against extended market downturns while also allowing investors to participate in bull markets.”

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[1] Performances are calculated net of underlying investment cost and management fee. Fees applied on the benchmark = 90bps, it represents the average management fee charged by investible multi-asset diversified portfolios as published by Morningstar research. Past performance is not indicative of future performance.
[2] Aside from hedging strategy performance, short term performance relative to the benchmark differs due to imperfect performance tracking of the underlying sector ETFs against its benchmark on a month to month basis. This is mainly caused by difference in the period that performance is accounted for between various time zones, as well as difference in effective date of dividend distributions relative to the benchmark.
[3] Inception Date: 3rd Mar 2020

The post Milliman’s SmartShield managed accounts surpass $100m as advisers seek solutions to tackle market volatility appeared first on AdviserVoice.

Damian Liddell

Investors are exploring new ways to protect their portfolios in the face of rising inflation, central bank tightening, recession fears, and geopolitical instability.

Australian and global shares were down 6.5 per cent over 12 months ended June 30, 2022^[1], while bond returns also fell deeply into the red as their traditional diversification benefits failed when confronted with sharply rising interest rates.

Those falls caused the average super fund to post its first negative financial year of returns (-3.1 per cent)^[2] since the Global Financial Crisis, although performance has since bounced back in July and early-August.

“Whilst investors know the best thing they can do is sit tight and ride things out – it’s easier said than done,” says Damian Liddell, Certified Financial Planner, Contrarian Group Financial Planning. “As humans, we’re not wired that way. Most people are willing to accept modest declines but they genuinely fear a deep and protracted market decline.”

In the wake of the 2020 COVID-19 market downturn, super funds cash holdings increased by 3-4 per cent of funds under management, and up to 8 per cent for one medium sized fund – higher levels of switching to cash than reported during the Global Financial Crisis, according to the RBA^[3][4].

Protecting portfolios against deep market downfalls helps investors stay the course through all market conditions, Liddell says. One of the tools he uses is Milliman’s SmartShield range of portfolios, which have attracted steady inflows since they were launched in early-2020.

“Having a systematic, rules-based process that makes dynamic changes, provides investors with comfort that something is being done,” Liddell says.

“As a result, they’re less likely to let their emotions take over and thus better equipped to stick to the long-term strategy. It also makes my job as an adviser a lot easier, because I don’t have to crystal ball gaze or alternatively be that guy that always just says ride it out, ride it out.”

The long-term impact of shifting from a typical Growth to Balanced portfolio is expected to reduce average returns by 1.1 per cent per annum and can approximately halve the average amount left in super as a bequest (from $245,000 to $120,000) under the same withdrawal strategy^[4].

Milliman is a global actuarial firm that hedges $A176.5 billion in assets under management, helping protect the portfolios of insurers, pension funds, and wealth management firms around the world.

The Milliman SmartShield managed accounts manage volatility and provide a cushion in market downturns to manage investor behaviour. It is one of the few solutions offering an explicit built-in risk management strategy that has consistently performed through both strong and weak markets.

SmartShield’s consistency stems from its rules-based approach, which dynamically hedges the portfolio by trading futures. It creates a smoother ride for investors, applying more protection during difficult markets and allowing full participation when volatility subsides.

“The SmartShield portfolios have performed really well during the time I’ve been using them,” Liddell says. “They’ve allowed my clients to have the best of both worlds – exposure to growth and peace of mind.”

———

Notes:
[1] S&P/ASX 200 TR and MSCI World Ex Australia NR AUD indices.
[2] Media Release: Best performing balanced super funds for 2022 financial year – Super Fund. (2022, August 03). Retrieved from https://www.lonsec.com.au/super-fund/2022/07/15/best-performing-balanced-super-funds-for-2022-financial-year
[3] https://www.rba.gov.au/publications/fsr/2021/apr/box-c-what-did-2020-reveal-about-liquidity-challenges-facing-superannuation-funds.html
[4] Box C: What Did 2020 Reveal About Liquidity Challenges Facing Superannuation Funds? | Financial Stability Review – April 2021. (2021, April 08). Retrieved from https://www.rba.gov.au/publications/fsr/2021/apr/box-c-what-did-2020-reveal-about-liquidity-challenges-facing-superannuation-funds.html
[5] Bequest at age 90 for a person aged 67 with a starting balance of $500,000 and $25,000 per annum withdrawals indexed to inflation. Detailed assumptions can be found at https://smartshield.millimandigital.com.

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“We are very pleased to have someone of Durand’s calibre join us to lead the national distribution strategy. Durand brings extensive local retail investment experience with him to Milliman and will play a pivotal role in the expansion of this area of the business” said Principal and Head of Investment Solutions Asia-Pacific, Victor Huang.”

Prior to Covid-19, Financial planners were already facing a raft of challenges in the wake of the Royal Commission, with regulatory requirements such as Best Interest Duty drawing a focus on the fees and benefits of investment solutions for clients. Our SmartShield Managed Accounts have armed advisers with an investment solution for their clients at an important time.

“This new appointment further demonstrates our commitment to providing advisers with simple and affordable solutions that leverage decades of institutional expertise to help Australians achieve their retirement goals.

“The solutions are designed to fit within existing processes and provide a level of certainty that was previously lacking.” said Mr Huang.

Mr Oliver has previously held a number of roles at Netwealth and HUB24 and was most recently State Distribution Manager for independent platform provider and investment administrator, XPLORE Wealth. “I’m delighted to be joining the Milliman team here in Australia in this important role and at such a critical time of growth for the business and the SmartShield Managed Account solutions. I believe that we are well positioned to take advantage of the many opportunities ahead of us and look forward to working closely, with the team,” Mr Oliver said.

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Wade Matterson

Milliman, Inc. a global consulting and actuarial firm, has launched its first range of managed account portfolios, with built-in protection against volatility and capital losses.

The Milliman SmartShield series is the first managed account offering from the firm, which advises, hedges and consults across $240 billion in assets globally. It has been designed here in Australia and has launched initially on HUB24 with other platforms to follow shortly.

The SmartShield series initially consists of four portfolios (Moderate, Balanced, Growth and High Growth), with each one designed to meet the evolving needs of financial advisers and their clients.

“Financial advisers continue to face a raft of challenges, as the industry undergoes both a structural and regulatory adjustment,” Milliman’s Australian Practice Leader Wade Matterson said.

“Through our conversations with advisers, we understand that there is an intense focus on simplification and efficiency while preserving the core values and benefits of financial advice. At the same time, regulatory requirements such as the Best Interest Duty are resulting in a greater focus on the fees and benefits of investment solutions for clients.

“We’ve designed the SmartShield portfolios specifically, to assist advisers as they respond to these changes and are delighted to launch with HUB24 as they continue to gain significant interest from advisers wishing to use managed accounts, and will be announcing further alliances in the coming weeks.”

SmartShield’s portfolios are built using best-of-breed, low-cost exchange-traded funds (ETFs) that invest across Australian and international equities, Australian and international fixed income, property, and cash – and leverage Milliman’s global risk management expertise.

Each managed account portfolio contains a built-in risk protection overlay that dampens volatility and capital losses in a market downturn and, importantly, can be switched on or off as required by advisers, without their clients having to incur capital gains tax or lose dividends.

The risk protection overlay uses the same techniques that Milliman has applied for decades while working with large institutions across the globe, and through a wide range of market environments, including the Global Financial Crisis.

“This approach reinforces a financial advisers’ advice proposition by giving them the flexibility to meet each client’s unique needs through the highly efficient managed account structure. SmartShield provides advisers with the ability to give their clients much more stability and strength at the core of their portfolio, through a flexible and efficient approach. Given ongoing macroeconomic uncertainty and concerns with respect to valuations and global volatility, we are seeing increased focus on managing risk within portfolios.”

Most major asset classes surged in 2019 despite lacklustre corporate earnings as central banks around the world once again began loosening monetary policy. However, valuations are now stretched and investors face a series of new risks such as the outcome of the US election, the spread of coronavirus, and how governments will tackle climate change.

SmartShield Balanced portfolio

Advisers and investors need the ability to move quickly in this changing environment – a key reason they are turning to the more efficient managed account structure.

Managed account net flows doubled to $4.43 billion in the June 2019 half, boosting total sector assets to $71.38 billion, according to the IMAP (Institute of Managed Account Professionals) and Milliman’s six monthly Managed Accounts FUM Census series.

HUB24 was recently awarded Best Platform Managed Accounts Functionality* which ranked 18 platforms across six categories and 509 criteria.

“We are pleased to be working with Milliman on the launch of their new managed portfolio offer, our market-leading managed portfolio functionality provides the capability for Milliman to effectively execute their investment strategy. As market conditions shift it is critical that we continue to provide advisers and their clients with a wide range of investment options to meet their needs’’ said Brett Mennie HUB24’s new Head of Managed Portfolios.

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Amara Haqqani

Milliman, a global actuarial consulting firm and leading provider of risk management and retirement services, has appointed retirement expert Amara Haqqani as director of strategy and solutions in Australia.

Haqqani has spent close to two decades in financial services including four years at annuities provider Challenger, where she served as senior manager, retirement income policy, and advised chairman of retirement income, Jeremy Cooper.

She was most recently consulting to the Financial Services Council on superannuation, retirement income and funds management policy initiatives, in particular those related to the Productivity Commission’s Superannuation inquiry and the Royal Commission into Banking and Financial Services.

“Australians are retiring with larger superannuation balances than ever before but many people, particularly middle-income earners, still feel uncertainty about what to do with that money,” Haqqani said.

“In a world where many are now beginning to focus on this issue, Milliman has the deep thinking, big data, analytics and technology to actually help people build the retirement they want and to help the industry deliver the products and services that retirees need. I look forward to working with the Milliman team at this important time for the industry.”

Haqqani’s appointment comes at a time of intense scrutiny for the financial services industry as it deals with the fallout from the Royal Commission and Productivity Commission inquiry into superannuation. Meanwhile, the industry is also faced with developing a range of new income-focused products that support the sector’s new objective of providing income in retirement to substitute or supplement the Age Pension.

Milliman Australia practice leader Wade Matterson said building retirement solutions was one of the most complex problems faced by the industry.

“Building retirement solutions requires actuarial, data science, investment management, behavioural finance, communications, and digital skills. Yet, at heart, it is a human problem that requires an understanding of how people act rather than how we expect they should behave. Milliman’s expertise covers all aspects of the retirement value chain and Amara’s appointment further boosts our ability to help the industry create truly tailored retirement experiences.”

Milliman’s services include:

• The Milliman Retirement Expectations and Spending Profiles (ESP), which uses a variety of big data sources, including the anonymized bank transaction data of more than 300,000 retirees, allowing funds and advisers to better understand the spending patterns of retirees.
• Risk overlay services, which manages excessive volatility and provides a cushion against extended market downturns. These services are used by a wide range of firms including Colonial First State, Plato Investment Management, BetaShares, Maritime Super and financial planning dealer groups.
• The Milliman Goals-Based Advice Platform, which brings enterprise-grade algorithms to analyse thousands of scenarios based on clients’ personal financial position and goals. It provides deep insights and allows clients to make informed decisions about competing goals and priorities.

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Longevity risk, we’re told, is the problem. Boys and girls born in 2013–2015 can expect to live around 33 and 34 years longer than their ancestors born in 1881–1890, according to a government analysis.

But dig a little deeper and the underlying data suggests it’s a faulty diagnosis.

Living a long life isn’t a problem for individuals – their problem is that they don’t know how much their lifestyle costs and how that expenditure is likely to change over the course of their retirement.

Uncertainty: lifespans or expenditure?

Longevity risk is a problem for governments, which bear that risk directly via defined benefit fund liabilities and the Age Pension. It’s also a problem for the financial services industry, which offers products such as life insurance and various types of annuities.

But ordinary Australians think differently. Too many are worried they’ll run out of money in retirement but this issue may be solved, like any other asset-liability problem, with the correct data.

The missing data has been accurate personal expenditure which underpins retirement lifestyles. Until recently, the industry has rarely even attempted to measure actual expenditure in retirement, instead relying on limited surveys based on individuals’ memories and estimates.

There’s an old joke about a physicist, an engineer and an economist stranded on a desert island with nothing to eat except a can of baked beans. The physicist and engineer argue about how to get the beans out of the can without wasting any. The economist advises them: “It’s simple. Assume a can opener.”

Look at any pension or annuity product forecast and you’re likely to find a similar glaring assumption: that retiree costs are based on their current expenditure rising in line with inflation each year. The cost of this assumption is borne by retirees having lower standards of living.

Data pinpoints the misdiagnosis Real-world big data, captured and analysed through Milliman Retirement Expectations and Spending Profiles (ESP), shows that spending consistently declines over retirement by about 6-8% in each four year age band before plummeting from age 80.

A number of overseas studies have produced similar results.

The Center for Retirement Research analysed multiple age cohorts using US government Consumer Expenditure Survey data and found that retirement spending drops by about 1% a year. Other US studies have also found declining retiree expenditure.

A study by the International Longevity Centre – UK found that a household headed by someone aged 80 and over spends, on average, 43% (or £131) less than a household headed by a 50 year-old.

However, typical industry-produced retirement simulations that assume expenditure increases with inflation would have a female retiree saving for peak spending in her final year of life, age 85 – when her spending is around its lowest.

This flawed assumption encourages retirees to be over-conservative with their spending. The many retirees who take out account-based pensions and then live frugally by drawing down the minimum allowable rate, is the classic case. Unfortunately they’re banking on a higher cost lifestyle that will never arrive.

We need to start to address this problem through the customer’s eyes and not through the industry’s lens.

A deeper understanding of real-world data and behaviour is the starting point. It allows us to segment different types of retirees based on multiple facets such as wealth band, postcode, home ownership – the options are endless.

A future edition of the Milliman Retirement ESP, which analyses the bank account expenditure of more than 300,000 retirees, will delve further into the retiree spending categories that have high degrees of uncertainty or variation.

If we can diagnose the true problem, retirees living a long life stand to enjoy a better life.

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Milliman Retirement releases the Expectations and Spending Profiles (ESP) report.

The Melbourne area of Stonnington is home to Australia’s biggest spending retirees, according to the latest Milliman Retirement Expectations and Spending Profiles (ESP) report.

The average annual expenditure of Stonnington retiree households is $56,711, which is two-thirds higher than the national average ($33,943), with more expenditure directed towards discretionary areas such as leisure.

The area (defined in the last Census analysis as “Stonnington – West”) includes the traditionally wealthy enclaves of Armadale, Prahran, Windsor, South Yarra – East, and Toorak.

Meanwhile, the Caboolture region in Queensland (including Burpengary – East, Caboolture, Caboolture – South, Elimbah, Morayfield – East, and Wamuran) is home to Australia’s lowest spending retirees.

Average retired households there spent just $26,286 a year: 23% less than the average across Australia, but with a far greater proportion of expenditure on essential goods and services.

The Milliman ESP analysis, which is based on bank account transaction data gathered anonymously from more than 300,000 retirees across Australia, shows the significance of location on the cost of living in retirement.

This data, which can also reveal the expenditure of retirees in every region and suburb, is crucial for financial services businesses wanting to provide effective general and personal advice, design new investment products, persuade clients to make good decisions, and increase the level of client engagement.

The average annual expenditure of retirees in Caboolture could be entirely funded by the full Age Pension.

However, the super balance required to sustain average spending through retirement for a couple in Stonnington (with 75% certainty if invested in a ‘balanced’ investment option) would be over $403,000.

This is still significantly lower than many industry forecasts. One reason is the interaction of the Age Pension, which effectively provides an inflation-indexed, government-guaranteed lifetime annuity backstop. Regardless, some retirees will prefer to have a higher degree of certainty, which requires a significantly higher super balance.

The Milliman Retirement ESP’s region and suburb analysis shows how varied the retirement position of members can be. Small changes in annual spending can result in significantly different levels of savings required to last through retirement.

The bulk of super fund members don’t receive personal advice, leaving funds to make assumptions based on surveys, Census snapshots, and industry recommendations, often resulting in a ‘one size fits all’ super saving recommendation.

This can potentially make retirees in wealthier suburbs complacent while those in poorer suburbs are likely to become disengaged, given they will never meet the industry’s general advice on super saving targets.

But even modest differences in savings can translate to a hugely positive impact on members’ actual retirement lifestyles. The Milliman Retirement ESP can help point the way to helping members and investors make practical changes.

For example, the proportion of expenditure aimed at essential goods and services is significantly higher for Caboolture retirees (60%) compared to Stonnington retirees (44%). Drilling down further into the data, Caboolture retirees spend almost twice as much of their total expenditure on food (19% versus 10%) but half as much on leisure (8% versus 16%).

Funds can interpret this data in various ways (the Milliman Retirement ESP also shows 10 other expenditure categories).

Funds and retirees in wealthier areas have numerous choices given the flexibility of their expenditure – but similarly, the data is just as important to the way funds engage with retirees who are less wealthy.

Non-discretionary costs (such as food, electricity and gas) rising at a greater pace than inflation will have a significantly greater impact on retirees in poorer areas than more affluent areas. However, many funds still rank their returns against CPI, which includes the cost of discretionary goods.

Using CPI as a benchmark means falling prices of discretionary goods and services (such as technology and travel) can distort the true impact of non-discretionary costs. Australia’s inflation rate remains less than 2%, while expenditure patterns amongst super fund members vary substantially. These spending patterns are also affected by a wide range of other big data points which are analysed by the comprehensive reporting included in the Milliman Retirement ESP.

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Wade Matterson

After more than a decade working with Australia’s leading institutional players, Milliman is bringing its unique experience, sophisticated tools and big-picture thinking to bare for Australia’s advice community in an effort to markedly improve retirement outcomes.

Milliman Australia Practice Lead, Wade Matterson, acknowledged the entire industry is emerging from a bruising few months in the wake of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

“There’s no doubt we’re arrived at a tipping point for our industry,” said Practice Lead, Wade Matterson.

“The advice business must grow and develop in sophistication to match market expectations. Technology and big data will play a huge role in rebuilding trust and giving advisers new ways to understand and present advice to clients. Leveraging both now will be the differentiator between success and failure in future retirement outcomes as well as advice practices.”

On moving into the retail space, Mr Matterson said “Milliman’s investment solutions are based on data driven algorithms and research, that really support financial advisers to deliver superior client outcomes in a complex and fast-changing environment.”

Milliman sees the speed of the change as a clear opportunity to help shape the market by finding solutions to the biggest challenges facing advisers and their clients including managing sequencing and longevity risk.

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