With market uncertainty and low interest rates continuing, how can financial planners build portfolios that maximise and safeguard clients’ retirement income? Miriam DeLacy speaks to Lindsay Garnock CFP® and Caitriona Wortley from Allianz Retire+.

Giving clients confidence in the future of their finances is a fundamental goal for the advice process. In the context of the pandemic and global recession that arrived in 2020, many clients have been struggling to feel secure about any plans for the future, including their financial plan. Then there are the dual challenges financial planners face in changing portfolio allocations and product selection to continue generating risk-adjusted returns, while at the same time, having discussions with clients about adjusting their return expectations.

Conversations like these must be handled skilfully to ensure that overall confidence isn’t undermined by the fact that portfolios aren’t delivering the returns clients have come to expect. “Returns are down across all asset classes,” says Lindsay Garnock CFP® Managing Director of Boyce Financial Services. “That means generating sufficient income for clients is a tough game now. Three or four years ago, a five per cent income return was not a difficult proposition. With a sufficient balance invested across a combination of Australian and international shares, property securities, bond funds, term deposits and hybrids, you could be confident in achieving that.”

Managing expectations

This quest for returns has an added dimension for clients in retirement. In Lindsay’s experience many will be determined to preserve capital and fund their lifestyle from returns only. Other clients have the opposite goal and plan to spend all their money within their lifetime, which makes the timeframe more challenging for financial planning purposes.

Regardless of where on this spectrum a client sits, Boyce Financial Services will follow an approach designed to secure enough of their capital for long enough to meet those goals. “Our investment philosophy is to generate returns to meet investment objectives with a capital preservation mindset,” says Lindsay. “We’re always cognisant of what we’re doing now and what that means for our clients, for now and in years to come.”

“If a million dollar retirement portfolio was expected to generate $40,000 to $50,000 annually in income four years ago, you might be revising that estimate down to, say $30,000 to $40,000 in 2021,” says Lindsay. “So we’ll be having conversations with clients to confirm their income needs and this can be a tough discussion sometimes, because the cost of living certainly hasn’t gone down for any of our clients over the past five years. To make this less alarming, we often talk about what we should consider defining as ‘income’ from their overall portfolio. If an investment is performing well, we should be comfortable to take a portion of that capital off the table and park it in cash to be meet income requirements.

“Then the next part is a discussion around their appetite to making changes to their agreed asset allocation to growth assets in order to increase the likelihood of capturing that capital return. We might take growth assets up to 65 per cent, from 60 per cent – knowing that the remaining allocation in fixed income won’t be returning much more than two per cent.”

Putting new tools to work

Whether it’s to make the most of a modest increase in growth allocation or improve fixed income performance, Lindsay is casting the net much wider for the tools needed to sustain portfolio returns. “We’re using every tool in the kitbag,” he says. “To drive income returns from growth assets we’re looking at things we wouldn’t have necessarily been as interested in when income was easy to generate. Options like retirement specific products or specialised income equity funds with a focus on targeting sustainable income around six or seven per cent and sacrificing some capital gains to achieve that. A few years ago these investments would not have been as firmly on our radar.”

“In the defensive part of the portfolio we’re exploring more of the options around corporate debt, credit and the short and long end of the yield curve and blending it all together with input from our asset consultant with the goal of producing a two or three per cent return without taking on unnecessary risk. Even returns from something as ‘safe’ as an Australian Government bond portfolio can deliver unwelcome surprises. In February the Australian bond market had one of its worst ever monthly returns, being just under minus four per cent. If you were expecting 1.5 per cent in income from a ten year Australian Government bond in your portfolio you’ve just wiped out nearly three years of income.”

Some of Lindsay’s clients have been very aware of the potential shortcomings of long-dated fixed income assets in contributing to returns should interest rates begin to rise. This can make for a more positive start to conversations about taking on a somewhat greater degree of risk by switching some capital to other fixed income options. “Most clients already know how poorly term deposits are performing,” he says. “They’re more open to moving up the risk curve slightly to make that part of their defensive allocation work harder.

“Of course we must ensure clients understand what the risk trade-off is. With a diversified exposure to corporate debt or hybrids, we would expect a return of roughly two to three per cent as an alternative to less than 0.5 per cent in a term deposit. So we need to have our clients understand and be accepting of that as a reasonable risk before making a change.”

Risk and return over time

It might seem that low rates for fixed income and the COVID-19 pandemic have led to this crisis for return expectations. But the risk/return trade-off has been shifting in the ‘wrong’ direction for investors for several decades.

Caitriona Wortley Head of Distribution at Allianz Retire+ points to modelling from Callan Institute in the US that shows the asset allocation required for an investment portfolio to earn a 7.5 per cent income at 15 years intervals starting from 1989.

Source: Callan Associates, Risky Business Update: Challenges Remain for Today’s Investors, Julia Moriarty, 2020

“For investors to earn a 7.5 per cent return 30 years ago, they needed no exposure to growth assets,” says Caitriona. “This wholly defensive portfolio would have had a standard deviation of just over three per cent 15 years on and the allocation is an even split across growth and defensive, almost tripling the risk. In 2019, the exposure to growth is at 96 per cent with a standard deviation skyrocketing to 18 per cent.”

“This is quite the challenge for financial planners. It shows clearly that a new approach is needed to generate returns of 7.5 per cent for retired clients who certainly cannot tolerate that level of risk in their portfolio.”

Perceptions change in retirement

These conversations that Lindsay, like so many financial planners, is having with clients very much reflect the nature of the risks retirees face. “There is a broader range of risks specific to retirement that are not faced by accumulation investors,” says Caitriona Wortley Head of Distribution at Allianz Retire+. “There is sequencing risk that can arise from a sudden and significant loss from their portfolio. Then we have longevity risk. Retirees need to maintain exposure to growth assets like equities if they are to avoid running out of money, which is what scares them most. Research shows 61%[1] of Australian retirees fear running out of money more than they fear death.

“On the flip side of this we see the behavioural risk that is also part of the retirement investing challenge. Retired clients need sufficient allocation to growth assets for an income that lasts a lifetime. And yet they have hyper loss aversion compared with accumulation investors. They feel the pain of a loss in their portfolio 10 times as much as the joy of a gain[2]. For accumulators it’s twice as painful.

“This means a large drawdown will have a far more significant impact on retirees’ emotions and behaviour. We saw how this can play out after the Global Financial Crisis, with retirees experiencing a crippling fear of further financial losses and checking their balances five times a day or more. In 2020 we were reminded that we never know when these volatility spikes are going to come. Not only can they substantially erode retirement income over time, they can result in severe impacts on quality of life for retirees.”

Caitriona takes the view that this convergence of risks for retirees gives rise to the need for a new approach to retirement portfolios. “It’s really important to evaluate retirement portfolios in the context of these risks. The real question becomes how can we create portfolios that generate adequate levels of return while still mitigating these many risks? In addition to fixed income, retirement-specific products can play an important role in delivering both the financial outcomes and the peace of mind retired clients need.“

A shift in approach

During more than a decade delivering services and support to financial planners, Caitriona has seen a fairly uniform approach to retirement investing. In that time she has become very passionate about the importance of finding solutions that better serve the changing needs of retirees. In her view, an advice approach that might have been effective in decades past needs to take account of both longer life expectancies among retirees as well as the increased risk associated with a decent portfolio return, as seen in the modelling and figures from Callan Associates.

“For some time, investing for retirement has been following a very similar framework to the one used for accumulation,” says Caitriona. “It’s taken time for the financial advice ecosystem to evolve and offer strategies that look beyond the 60/40 solution. When you had fixed income delivering much better returns this was a good option. But the old way is not going to cut it anymore.”

“As well as retirement specific products we also need to deliver better advice modelling tools for retired clients. We need to forget about using average returns and deterministic modelling for this audience. These calculations give them a flip of a coin, 50/50 chance of whether their money will last or not. Again, it’s well suited to accumulation, but it’s not giving retirees the certainty they need to feel confident in meeting their objectives.

“Instead we need to be having conversations where we can say to a 65 year old client, based on modelling, that they have a 90 per cent chance of having $x in annual income and their money will last until age 95. The good news is these tools for financial planners exist. Last year Allianz Retire+ partnered with InvestFit to give financial planners access to a planning tool with a stochastic modelling engine.”

In review meetings with his clients, Lindsay is always careful to show them what the journey could look like from this point for their projected income and assets. The Allianz Retire+ Future Safe offer of protection and income is one of several tools outside of traditional defensive and growth options he will definitely consider when they become more easily available to his clients and business model.

“We’ve been looking at Allianz Retire+ and what they’re doing for some time,” he says. “It’s just a matter of getting the product integrated into platforms so we have the clients total financial picture in the one place.

“We are also potentially interested in deferred annuities, when available, as another option for some clients who are drawing down their asset base just a little too fast for their capital to last past their life expectancy. Holding some of their assets back in a deferred annuity would give them that safety net to at least keep them comfortable until they reach 95 or even 100.”

Caitriona adds that the whole advice value chain, including platforms, has a responsibility to smooth the process for financial planners. “We need to see a stronger focus on the retirement framework,” she says. “A large component of that is ensuring planners can easily access the products they feel are best placed to help achieve their clients’ goals in retirement”.

The bottom line

As a financial planner working in financial services since 2001, Lindsay has played a crucial role in giving his clients peace of mind through many periods of uncertainty, both in their lives and investment markets. “We’re always there to help people make informed choices about what to do with their money, taking into consideration their needs now and the impact of these decisions in the future” he says. “Making sure they’re not suddenly faced with the prospect of running out of money in 10 years because of a market event like the one we saw in March 2020 is why we do what we do.

“At the same time, in 2021, you need nine million dollars in a short dated term deposit to generate an income of $47,000 a year. As I sometimes say to clients ‘you are being punished for a crime you didn’t commit.’ But for the time being that means, to generate a reasonable return, you have to put some of your capital at risk.”

This extra assurance financial planners provide to their retired clients has been well documented by independent research. To continue providing that confidence in the current context, a shift in approach could deliver even more robust retirement portfolios. “Providing confidence to retirees is the job of a retirement portfolio and we know that financial planners are delivering on this objective,” says Caitriona. “Our Allianz Retire+ Black Swan research from 2020 shows that retirees who receive financial advice are more confident and secure. The 95% satisfaction rate reported is a great endorsement for the quality of advice they’re receiving.

“Confidence was a big theme of the report from the Retirement Income Review last year. The effect of not having confidence is that retirees are having to self-insure against longevity, limiting their spending because they fear the worst. What they need is the assurance of certain outcomes and the right solutions in their portfolio can provide that. A promise from a life company to provide protection and income security is worth considering for financial planners to bring peace of mind to clients and deliver on their best interest duty.”

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[1] Allianz Life, Reclaiming the Future Study (2010)

[2] AARP and the American Council of Life Insurers, How Retirees Manage Money to Make it Last Through Retirement (2007)