A looming demographic shift will challenge financial planners’ ability to produce income solutions for clients. But fund managers are under increasing pressure to find smart solutions, too. Simon Hoyle reports.
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It has been estimated that by the year 2025, there will be more money being withdrawn from superannuation than being contributed to it. This fundamental shift will be the result of the “pig in a python” demographic of the Baby Boomers as they switch from the accumulation phase of their superannuation lifecycle to the drawdown or “decumulation” phase.
That’s quite a big change, considering that the Australian Prudential Regulation Authority (APRA) says that in the year to June 30, 2010, there was $70 billion added to the system by way of contributions, and $35 billion by way of investment earnings. Since the advent of the Superannuation Guarantee (SG) regime in 1992, the focus of fund members, fund managers and advisers has been on the accumulation of funds, and issues associated with that activity (including contribution levels, choice of fund and choice of investment strategy, and investment performance).
The aim, obviously, has been to maximise members’ savings, within relevant risk parameters, so they enter retirement with the greatest possible sum of money on which to generate a regular income.
By and large, the system has done this well. What it has done less well is meet the retirement income needs of members. As things stand, the general approach by super funds to providing retirement income solutions is to create some sort of account-based product, which is designed to produce regular income, but which is often based on the same asset allocation that the member had during the accumulation phase.
But that focus must shift, and the skills needed to construct robust portfolios that can meet the income needs of an individual over their expected lifetime in retirement are quite different from the skills needed to build accumulation portfolios.
A white paper entitled Super Fund Retirement Planning – how prepared is your fund?, written by Tony Hildyard, a senior vice president for fund manager Pimco, says the post-retirement income product market is underdeveloped.
“The recent Super System Review has recognised that the retirement income market is underdeveloped, currently dominated by account-based products with little product in- novation to manage longevity risk for retirees,” the white paper says.
“The combination of the changing demographics of the Australian population, [and] the limited product offerings…is driving the industry to focus on retirement products and on retiree needs.”
It’s not only the case that the asset allocation and structure of a product designed to deliver an individual’s income needs should be different from the allocation and structure during the accumulation phase.
Hildyard says it’s also clear that an individual’s attitudes towards investing change quite markedly as they first get close to, and then move into, retirement. He says they become more risk-averse; they become less tolerant of volatility; they want greater control of their assets; and the issue of longevity becomes very real to them. Dealing with their income needs, therefore, is as much about dealing with behavioural issues as it is about dealing with technical asset allocation issues.
And those behavioural issues must be addressed, Hildyard says.
“It’s a problem that we’ve been aware of for quite a while, but it’s going to get bigger rather than smaller,” he says.
“The current trend is, in general, that if your balance is quite small, you spend it and you get the Government pension; or you leave it in the fund and you get an account-based pension, which is based on the same asset allocation as the fund was running when you retired.
“If you have a larger balance, you take a lump sum, set up a self-managed super fund or get some private advice and get into a retail retirement fund that suits your needs.”
Hildyard says there’s nothing necessarily wrong with the latter approach except that retail funds can be relatively expensive. But staying in a fund to receive a pension might not be the better option, because the asset allocation of the fund might not be optimal for supporting an income stream that may have to last 20 years or longer.
The argument to support the account-based approach is that in the long run, the asset allocation will, on average, produce a return suffcient to see you out. But “on average” means that “50 percent of the time you’ll be OK”, Hildyard says.
“And when you plan your retirement, you do not plan on there being only a 50 per cent chance of there being enough money.”
The longevity issue is addressed by structured products such as OnePath’s MoneyForLife product, and AXA’s North product (both offer capital protection, and the opportunity for income to rise over time), and by a product that for some time fell from favour: the annuity.
Phil Anderson, senior business development manager for Challenger, says the allocated pension is now 20 years old as a product. It was the best retirement income solution at the time, but it’s time for better product solutions.
“If you do historical back-testing, [an allocated pension strategy] has delivered a huge variation in return, or the longevity of capital, over that period,” Anderson says.
