Investment markets, we all know, have been extremely volatile over the last year with large falls in share markets around the world.It is interesting, with this context in mind, to look at whether product providers and the products they currently provide will need to change or adapt to the current investment environment.
More acutely I suppose it is whether or not current product design meets the requirements of advisers and investors knowing what we know about how dramatically investment markets can turn – remember that this not actually a new concept!
There is no question that Australia has an extremely good retirement savings regime. What the last year has shown us is that retirees in our “transparent” system are, at specific points in time, at the absolute mercy of investment markets.
By this I mean that income stream recipients (of the market linked type) and new retirees are subject to re-evaluation of their income expectations, as required by legislation, at specific points in time (conversion to income stream and July 1 each year).
One school of thought says that the mere “flip” into income stream phase should not necessarily mean a differing investment strategy given that retirement is now, more than ever, a long term proposition and that we should continue to invest for the long term (i.e. exposed to growth assets).
The problem with this, as demonstrated over the last year, is that the fluctuation in asset values has a direct effect on the income available to a retiree and the effect the drawdown of this income has further on asset values.
Remember, that last time we had investment markets reversing to anywhere near the magnitude of the last year the industry did not yet have the allocated pension product, the “variable income annuity” had been vetoed and all we had really were life company backed immediate annuities.
Capital guarantees are one avenue which could be used to provide some protection but the cost to the investor of an institution providing the guarantee has traditionally been quite high. Does the cost of the guarantee exceed the chance of recovering capital through increased asset prices over the longer term? One would suspect the actuaries have the upper hand in this calculation!
What sort of guarantees should be looked at – deferred guarantees which won’t necessarily solve the problem of drawing down capital from lower real account balances? Income guarantees – which we already have via term and life annuities.
Are there any other ways that this risk can be mitigated or controlled ? Should we challenge conventional wisdom and have clients adopt an increasingly conservative asset allocation as they approach retirement with a more aggressive approach taken early in one’s early working life?
Should products themselves provide these transition steps? When should these transition steps begin – especially seeing as we have seen five odd years of returns wiped from share markets?
Another element behind this quandary is whether or not the events of the past year cause us to re-evaluate how we “assign” or ascribe a specific risk profile to an investor.
Whilst probably a topic to delve into in another post, have we been assigning more aggressive risk profiles to people who should really be more conservative – should our moderate’s have been conservative and our aggressive’s conservative?
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Stuart Milne is founder of Praxis Partners, a consultancy which provides practical solutions to the financial services industry