Retirement income: mixed-asset versus target-date funds
Retirees who would previously have been shoehorned into a poorly paying annuity or coaxed into a rigid drawdown schedule can now do as they see fit with their pension pots - they can take the whole lot out in cash if they want, or keep their savings fully invested in financial markets.
Some asset managers and industry figures, hoping that most retirees will do the latter, have begun extolling the virtues of multi-asset funds and, more recently, target-date funds.
Multi-asset funds invest in a basket of assets, such as bonds, equities and property, with a view to dampening volatility. Target-date funds do the same, but are designed to take people into and through retirement, reducing exposure to risk assets as they go.
Advocates of target-date and multi-asset funds say these funds' diversification, lower volatility and, in many cases, firm focus on income make them ideal for retirees looking for income and growth with as little risk as possible.
Risk, or the desire to avoid it, is usually central to any discussion about investment in retirement.
Inadequate annuity rates, combined with the fact that the average pensioner is now living 20 to 30 years beyond their retirement age, have led many to question traditional approaches to pension investing (which usually centre on de-risking portfolios as an investor reaches 65).
However, the alternative, remaining invested in the markets, means retirees accepting risk in retirement.
"I think the greatest threat in retirement is that the real value of the income you receive and your pension pot capital erode over that 20- to 30-year timespan," says Robin Stoakley, head of intermediary sales at Schroders.
Stoakley says he intends to remain highly exposed to equities throughout his own early retirement, as he believes equities are "the best form of protection" in terms of maintaining capital and growing income over the long term.
However, he admits his high risk tolerance will not be shared by most retirees, who would find it difficult to sleep at night knowing that their portfolios could fluctuate in value by 10% from day to day.
For those willing to accept a little risk, Stoakley believes multi-asset funds are a good retirement solution, primarily because they tend to be less risky than single-asset funds by virtue of their diversification.
As equities rise in value, bond yields tend to fall and vice versa, so funds invested in both assets - either directly or through other funds or trusts (multi-manager funds) - should be cushioned from periods of underperformance in one asset class.
A number of multi-asset funds also hold cash and real assets such as property and gold, which helps smooth out volatility even further and, in many cases, sustain a stable and growing income stream.
Target-date funds take the multi-asset retirement strategy a step further. These funds switch from investing mainly in higher-risk assets at the start of a fund's life to largely lower-risk assets such as government bonds at the target date, when the holder is expected to retire and can access the fund for drawdown.
Target-date funds are similar to multi-asset funds, but they are designed to cater to investors' changing requirements over time, and focus on retirement-specific needs in the drawdown phase.
Target-date funds are scarce in the UK, however. In 2003 Fidelity launched a range of four funds (Fidelity Target), with target dates falling between 2015 and 2030, for private investors. But demand for the products has been so weak that Fidelity has all but forgotten them.
They can still be bought on fund platforms that sell bundled share classes (those with trail commission to advisers and platforms still built in), but the firm says it has no plans to roll out clean share classes. Fidelity's Target range is likely to drift into obscurity once bundled shares become defunct in April 2016.
The only other target-date funds available to private investors in the UK are managed by Architas.
Developed in collaboration with advisory firm Birthstar and launched in January this year, the Architas Birthstar Target Date range consists of seven funds with target dates falling between 2015 and 2050 (see box above, click to enlarge).
According to Henry Cobbe, head of research at BirthStar, the funds have been received well. "The feedback has been 'right funds, right time'," he says. "We think that with new retirement freedoms come new retirement choices and that, in the context of those choices, we need straightforward products that make retirement investing easier."
The Architas Birthstar funds take a multi-manager approach by investing largely in other funds and prioritising passive trackers over active management. Again, these funds prioritise high-risk assets at the beginning of their life and low-risk assets by the target date and beyond. According to Cobbe, this approach offers retirees more than traditional multi-asset funds do.
He says: "What we are trying to achieve after the target date is a sustainable return. That means you have to think about things such as longevity, duration, currency risk and inflation risk, which are simply not considered in traditional multi-asset funds that only target volatility."
It is, however, worth noting that the Birthstar fund's themselves do not pay an income. This means investors will have to place their funds in drawdown to create an income or indeed transfer into income bearing fund(s) after the target date, somewhat nullifying the "cradle to grave" concept that the funds are marketed on.
Those interested in exploring the more traditional multi-asset space have a little more work on their hands during the selection phase. There are currently 326 mixed-asset and multi-manager funds listed in the Investment Association's three mixed investment sectors, and a further 138 in its flexible investment sector.
Moreover, each fund can differ considerably from its peers in its approach. A fund might target high capital growth, high yield, low risk/capital preservation, high diversification or any combination of these. Similarly, some funds might invest directly in assets, while others invest through other funds and/or trusts.
When choosing a multi-asset fund, investors should first identify their specific needs. If, for example, they require a 5% annual yield to cover regular expenses, yield is likely to lead their search.
However, if they are more concerned about total return or about growing the value of capital over time, a higher-growth fund with a lower yield and a greater exposure to risk assets such as equities may be more appropriate.
If their main concern is capital preservation and/or their risk tolerance is very low, they are likely to focus on funds with a higher allocation to safer assets such as government bonds, which hence carry a lower yield and deliver a smaller total return.
Crucially, multi-asset and multi-manager funds provide diversity, which dampens volatility and helps provide a reliable income, but - unlike target-date funds - they don't de-risk as you approach retirement. If you are considering buying an annuity at retirement, you might therefore want to move to a lower-risk, less volatile fund to preserve your fund's value as your retirement approaches.
A number of investment houses offer multi-asset funds that cater for different risk tolerances and income needs. For example, all four funds in Henderson's Core Solutions range of multi-asset funds take slightly different approaches.
Core 3 Income, Core 4 Income and Core 5 Income pay monthly yields ranging from 3.2 to 4.2% (Core 3 is exposed to fewer risk assets and Core 5 is exposed to more). Core 6 Income and Growth pays a quarterly yield and focuses more on capital growth.
Money Observer's Rated Funds selection includes several multi-asset and multi-manager funds. One of the strongest performers in capital growth terms is CIS Sustainable World. In the year to 30 April, this higher-risk multi-asset fund returned 18%, while over three years it tops the IA mixed investment 40-85% shares sector with a 55% return.
Practical Investment is another strong total return fund, having delivered 73% over five years to 30 April and 131% over 10 years, while also paying a respectable 3.2% annual yield.
For those who require a higher yield, TB Wise Income, a 'go anywhere' fund, currently pays an annual yield dividend of 4.6% (quarterly), and has delivered first-quartile total returns over three and five years. In the lower-risk category, Premier Multi-Asset Monthly Income pays a 4.6% annual yield (monthly) and is top of the IA mixed investment 20-60% shares sector for total returns over one, three and five years to 30 April.
New pension freedoms bring more choice, but this is not always a clear-cut blessing. Investors are best served by not putting all their eggs in one basket, regardless of how broad-based that basket may be.
This article was written for our sister website Money Observer
Investment funds that invest in other investment funds from a wide range of asset managers and are often referred to as funds of funds. Some multi-manager funds only invest in the funds of the investment house providing the fund of funds and these are known as “fettered”. An “unfettered” multi-manager fund is free to invest in what the fund manager believes are the top performing funds from across different markets and industries. Investing in multi-manager funds means your risks are spread across geographical regions and industry sectors but it also adds another layer of charges and some multi-managers also levy an out-performance fee.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.