In some quarters, nothing short of a top-to-bottom rethink of the financial planning process is considered necessary as increasing numbers of clients retire and find the traditional approach to financial planning and portfolio construction to be wanting.
That the traditional approach doesn’t work isn’t the fault of anyone in particular, “because the way things are done at the moment, we [all] treat people in accumulation phase the same as in drawdown phase – it just doesn’t make sense”, says Dan Miles, managing director and co-chief investment officer of Innova.
Every client is different, Miles says, and has a different starting point, a different path to the goals they want to achieve, and different goals. Effective planning and investment solutions need to take all of this into account.
“What stage they are in life and how much money they’ve got saved can make a huge difference to how their portfolio should be constructed,” Miles says.
“If you follow the typical process and the way things are done at the moment, somebody may come out [of a risk profiling tool] as a three out of five, have a 20-year investment time horizon and be in a balanced or a growth-style of portfolio; but that person could be 40 or be 65. The 40-year-old might have a 20-year time horizon, and the 65-year-old might have a 20-year time horizon. They might have the same ‘risk tolerance’, but there’s no possible way their portfolios should look the same – that’s ridiculous.”
Evolving rapidly
Wade Matterson, principal, senior consultant and the leader of the Australian Financial Risk Management practice for Milliman, says the thinking on how to plan and construct portfolios for retirement is evolving rapidly.
“The traditional approach is driven by the advisory process – so, how does the advice process work?” he says.
“People have that conversation around what are your goals and objectives and dreams and everything else, and then the adviser proceeds through this checklist to create a risk profile.”
The problem that often emerges, Matterson says, is “that [a] high-growth risk profile may bear no resemblance to the risk they actually need to achieve their goals and objectives”.
“But from a compliance perspective, you can’t break that,” he says.
“This is where it gets really interesting, about how you implement it. My thesis now, having worked through a variety of products and worked through the advisory process numerous times, is that you’re not going to break that, you’re not going to break that whole risk-profiling mechanism.
“One way we’ve started thinking about it is to use the bucket analogy and say the bucket analogy is a really good one.
“It’s good to have your cash-flow buckets, but where are my buckets lacking? There’s three obvious areas: the ability to manage…sequencing risk; the ability to manage longevity risk; and over time, the ability to manage things like long-term care.
“You can then start to enhance the bucket structure they’re already inherently familiar with. “And then take risk profiling. In our opinion the risk profile is disconnected from the goals and objectives, so how do you bridge that gap again? I think rather than saying throw it out, you maintain the risk profiling approach, but then you introduce the concept of stress testing.”
Start with liabilities
Joe Fernandes, executive director and global head of Colonial First State Global Asset Management’s (CFSGAM’s) Investment Solutions Group, says developing a solution starts with assessing likely liabilities in retirement.
“Each of us has a liability profile, a future liability profile, which is our spending requirements in retirement,” Fernandes says.
“We can define what that looks like; that’s really the start of the process. Once we agree there’s a future liability profile that we invest towards, that leads to a discussion about what is the combination of exposures that are going to achieve that objective.”
Fernandes say the CFSGAM Multi Asset Real Return Fund return objective is Consumer Price Index (CPI) plus 4.5 percentage points. The fund was seeded with CFSGAM’s own money about 18 months ago; it is now open to the investing public.
“When we designed the product, we took advice from a number of different channels,” he says. “There’s a demand aspect for CPI+4.5, as well as our conviction to be able to deliver that. It’s also a target which we feel is relevant for a number of different investors, both pre- and post-retirement.”
