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A buyer’s guide to retirement solutions

This post was originally published on this site

Jennifer Hill

Outsourcing is a popular option for advisers seeking an off-the-shelf fit for clients’ investment needs. But there are crucial considerations, such as income withdrawal and risk management, that may leave advisers wanting greater control.

According to a recent report by NextWealth, the most widely used investment strategy – and one that recorded the biggest increase over the past year – is multi-asset and multi-manager funds. Some 56% of advisers say they always or often use these for clients in drawdown, an increase of 20 percentage points from last year (see below). Growth is expected to continue, with 22% of advisers saying they will increase their use over the next three years.

Smoothed funds saw the most significant decline. Only 15% of advisers always or often recommend them, an eight percentage point drop on a year earlier. That is unsurprising given the downward unit price adjustments applied by PruFund following the market rout of early 2020, which called into question the value of fees paid for smoothing.

Likelihood to recommend for client assets in drawdown

Second to multi-asset and multi-manager funds are risk-rated model portfolios managed in-house. They are often or always used by 40% of advisers. Another 20% always or often use risk-rated models outsourced to a discretionary fund manager (DFM), and 12% use bespoke portfolios outsourced to a DFM.

Investment proposition

Half of advisers never use a DFM for model or bespoke portfolios for clients in drawdown, but this may change: 21% of advisers expect to increase their use of DFM models for client assets in drawdown over the next three years, and 16% expect to increase their use of DFM bespoke portfolios (see below).

Likelihood to recommend for clients in drawdown in three years’ time

Source: ‘Managing Lifetime Wealth: Retirement planning in the UK’ by NextWealth, Aegon and Richard Parkin Consulting. Based on an online survey of 212 financial planners conducted between 3 and 11 December 2020

‘Given the majority of advised assets are for clients who are retired or seeking advice about retirement, it’s a pretty big nut [for DFMs] to crack,’ says Heather Hopkins, founder and managing director of NextWealth.

Aligning portfolios with the withdrawal strategy would help to solve the problem. This may be as simple as drawing down holdings based on what has risen in value rather than rebalancing across all holdings, taking income from the appropriate tax wrapper or allowing natural income to be taken as dividends instead of reinvested.

‘Some advisers have built manual processes to withdraw that income before a rebalance, and some platforms have built cash accounts that carve out any income so it’s not rebalanced, but the process remains very manual and cumbersome with many platforms,’ says Hopkins.

It is shortcomings such as these that compel Kingston upon Thames-based Holland Hahn & Wills to retain its entire retirement proposition in-house.

‘The investment portfolio’s relationship with a retiree’s goals can get distorted over time given market volatility and required withdrawals,’ says partner Amyr Rocha-Lima.

‘Our retirement proposition is focused on enabling our clients to manage this risk through a realistic, goal-oriented financial plan and the careful management of withdrawals to minimise lifetime taxes.’

Others are big proponents. Jill Thomas has always outsourced investment at Sheffield-based Future Life Wealth Management, and points to value in propositions like 7IM’s retirement income service.

NextWealth research uncovered other innovations in the market for retirement clients. A large national is developing target-date portfolios where, as each date approaches, the client and adviser decide if the income should be taken or invested in an annuity pot. The solution should offer flexibility of income levels and reduce the cost of the annuity by deferring the purchase.

It also heard of a proposition seeking to integrate a withdrawal strategy modelling tool into DFM managed portfolio services.

‘Innovation needs to come from platforms, DFMs and the tech supporting financial advice businesses,’ says Hopkins.

‘Much more needs to be done to support financial advisers in managing this incredibly complex and risky aspect of financial planning.’

Here is what advisers should look for when assessing the retirement solutions market:

1. Investment approach

The focus for many advisers has moved from income to total returns as changing tax regimes have made the debate over gains from capital or income less pronounced. Total return is the top investment approach to retirement income, employed by 39% of advisers all or most of the time, according to NextWealth.

Holland Hahn & Wills uses this approach.

The most reliable source of investment income is growth

Amyr Rocha-Lima, Holland Hahn & Wills

‘It works particularly well for retirement-planning clients,’ says Rocha-Lima.

‘People are investing today for what potentially will be a three decades-long retirement, during which the cost of living will rise two-and-a-half times at trend-line inflation. The greatest and most reliable source of investment income is growth.’

Another 31% of advisers exclusively or mostly use the ‘bucket’ or time segmentation approach (dividing the assets into short, medium and long-term components to match future income needs), while 25% take an income-driven approach.

For some advisers, targeted returns – which Thomas describes as ‘marrying the need for the plan to work with the intention of the fund’ – are also important.

‘Based loosely on the efficient market hypothesis, investment solutions have moved towards risk mapping and focusing more sharply on outcomes, permitting advisers to map client objectives to a suitable mandate,’ says James Sullivan, Tyndall Investment Management’s head of partnerships. Tyndall provides advisers with an in-sourced investment model, running portfolios to adviser’s mandate.

An objective of around 5% net of charges is commonplace for Thomas’s retirement clients.

For Ryan Medlock, senior intermediary development and technical manager at Royal London, understanding the parameters of an outsourced investment solution is crucial.

‘Some solutions may be fully unconstrained whereas others may be targeting a specific return outcome or, in the case of our Governed range [of risk-rated multi-asset portfolios], risk profile,’ he says.

‘Understanding the structural design of solutions can help advisers understand how the investments are likely to fare throughout different investment cycles and challenges.’

2. Risk management

While investment growth remains paramount, so does managing risk.

‘When investors reach the twilight of their investment lifespan, capital preservation becomes more important than capital generation,’ says James Penny, UK chief investment officer of TAM Asset Management.

Liquidity is another issue. Canterbury’s Pentins Financial Planners has recently moved away from running in-house adviser-managed model portfolios to outsourcing to models run by LGT Vestra. Its models comprise five diversified portfolios and an income strategy for clients requiring natural income.

‘We use a total return strategy for all clients, as a rule,’ says managing director Samantha Secomb. ‘But for those taking withdrawals we will likely recommend a moderated risk profile. Someone with a six-out-of-10 attitude to risk but in decumulation would likely be moderated to a four-out-of-10 portfolio.’

To protect against significant market events Secomb would suspend withdrawals, rest the portfolio and turn to the cash.

For clients requiring a safety-first approach, Yorkshire’s Informed Financial Planning uses annuities for core income. It is considering new products, including The Retirement Account by Canada Life, where clients can buy an annuity within a drawdown product.

3. Diverse toolkit

The NextWealth survey shows 42% of advisers use property funds for clients in drawdown, but one-third would no longer do so if the regulator implemented its proposed 90- to 180-day notice period for withdrawals from open-ended property funds.

With high correlation between equity and bond markets, and retail and office property markets in the doldrums, an investment manager with a diverse toolkit is increasingly desirable.

‘Optimising the portfolio can be helped by looking at sensible alternative assets that add to portfolio diversification and reliability of total returns,’ says Lawrence Cook, head of UK intermediary distribution at Sanlam.

Philip J Milton & Company’s multi-manager portfolios, which can be white-labelled by advisers, are fully unconstrained and invest in a growing range of assets in search of uncorrelated returns.

‘We can basically invest in anything, and over the last few years have widened our reach,’ says director Philip Milton.

The firm uses exchange-traded funds for exposure to currencies and commodities, and investment trusts for exposure to direct lending and property. Current holdings include coffee, wheat, uranium, RM Infrastructure Income, BMO Commercial Property, Ground Rents Income, and Value and Indexed Property Income.

A staunch value investor, it has profited handsomely from takeover bids for directly held companies and buying investment trust shares at deep discounts to net asset value.

4. Income management

Informed Financial Planning recently implemented a new centralised retirement proposition (CRP) for clients entering decumulation. After hearing a presentation by Abraham Okusanya, founder and chief executive of retirement income software Timelineapp, it adopted a two-pot method.

‘In order to preserve clients’ income and protect against sequencing risk, we move three years of clients’ anticipated expenditure into a cash fund, with the remaining funds staying invested for the longer-term income need,’ says chartered financial planner Josh Richardson.

‘If markets reach a certain performance benchmark after 12 months, the cash pot is topped up with another year of anticipated expenditure. If that benchmark is not hit, the cash fund is not topped up but the client can rest easy knowing they have sufficient income for the coming two years.’

When selecting a provider for its CRP, a key requirement was the ability to hold a cash fund alongside a model portfolio.

‘We didn’t want to use a standard cash pot or bank account because a lot of providers take fees from these, which eat into the income we set aside for clients. Cash funds also pay some rate of return, usually around 0.15%,’ says Richardson.

The adviser uses Quilter’s WealthSelect funds and holds the BlackRock Cash fund within that.

Thomas at Future Life says the bucket approach of 7IM’s retirement income service is a ‘great scheme’ that segments income requirements. Falkirk-based Tom Munro Financial Solutions is another fan, having used the service since it launched in 2018.

‘As an alternative to the mythical natural 4% annual yield and the less popular regular monthly sale of units, the service is constructed around the client’s attitude to risk and time frame, providing greater control over long-term income while lessening many of the pitfalls associated with income drawdown,’ says director Tom Munro.

The investment pot holds 12 months’ income in cash to meet immediate income needs, with a further 12 months’ as a buffer to avoid having to sell down in adverse markets.

The next three years of future income is held within lower-risk asset classes. Medium (five to 10 years) and longer-term (more than 10 years) buckets are invested in higher-risk mandates, with the overall portfolio matching the agreed investment strategy.

‘It’s possible to manage a similar approach on a platform but 7IM takes the strain for a reasonable 0.84% per annum, which frees up our time to focus on other important planning issues,’ says Munro.

5. Availability on platforms

Some advisers still see value in smoothed multi-asset funds. Mike Baxter, an adviser at Perth-based GS Group, is one of them. He started using PruFund in 2016 for clients approaching retirement but lost conviction in it and recently jumped ship to a rival fund.

While he believes PruFund was ‘excellent’ at mitigating last year’s severe market correction, he was less impressed by its ability to capture the subsequent recovery.

Crucially, he also recognises its limitations in being used as part of an overall investment strategy. PruFund is only available through the Prudential suite of products or its more expensive trustee investment plan, and there is limited choice of additional funds to blend with the strategy.

A more attractive alternative, according to GS Group’s investment committee, is the Aviva Smoothed Managed fund. It added the fund to its investment panel in March, having waited for it to notch up a three-year track record.

It works in a similar fashion, though its smoothing corridor (how much the value of assets can move above or below the expected growth rate each quarter before a price adjustment is triggered) is a more generous 6.5% compared to PruFund’s 5%.

‘It’s also cheaper both in fund and overall investment costs when held on the Aviva platform, which gives us access to the entire fund universe,’ says Baxter.

6. Service levels

Particularly for retirees reliant on income from their assets, the quality of service and turnaround times for dealing with instructions are very important, according to Kat Smilewicz, a partner in London’s Partners Wealth Management.

For clients in drawdown, she tends to use models or discretionary portfolios held on the AJ Bell or 7IM platforms.

‘For example, a client may want to change the level of income drawdown they take for just one month in March to use their personal allowance or full basic-rate tax bracket,’ she says.

‘Some Sipp providers, like AJ Bell, will only need an email from an adviser to do it and little notice, while others require forms signed by clients, which may not be feasible.’

Service from an investment management perspective is another key factor, as advisers increasingly work in partnership with the provider they outsource to.

‘Asset managers should be working harder to win the trust of the advice community by underpinning solutions with levels of service that one would expect given the importance of the subject,’ says Tyndall’s Sullivan.

‘The flexibility and willingness to empower the financial planner to remain involved and engaged in the investment process is becoming more pertinent. This includes [asset managers’] inclusion in investment committees and being on the end of the phone 24/7 to support the adviser in all matters investment-related.’