Retirement risks: how funds and managers should adapt

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Some big super funds are considering setting up separate investment teams to manage solutions for members who have retired from full-time work. Whether or not the funds do that, they all need to be aware of the different risks members face once they are in retirement.

Greg Bright speaks with Laurence Wormald, the head of research and quants at FIS* about some of the risks and how to manage them.

Due to the demographic trends in most western countries, where populations are aging and growth – if there is any – is coming primarily from immigration, the funds management industry faces more than a wealth accumulation challenge.

Increasingly it faces the dual challenges of protecting that wealth and providing yield income. What results is the requirement to provide sufficient low-risk growth in a portfolio to allow that yield income to last longer. None of this is an easy task.

The challenges

Different considerations for fiduciaries managing money for people either approaching or already in retirement include:

  • Paying more attention to short-term share market risks. This is especially so in Australia – more than any other country – because over 90 per cent of all super assets are in defined contribution funds which are currently accessible as lump-sum payments on retirement. If the share market slumps, say, 20 per cent in the year before a lump sum is taken, the result can have a massive impact on a retiree’s payout.
  • Even in a so-called “risk free” asset class, such as cash and short-term fixed income, you can get interest rate shocks. Duration risk actually becomes more of a problem as the proportion of assets held in fixed income strategies rises, as is typical for retirees.
  • Fund managers, being generally creative types, have come up with the term “grey swans”. This refers to market shifts which may not be as severe as a “black swan” event, such as the global financial crisis, but will have particularly damaging short-term effects on funds about to be cashed in.
  • Target-date funds and outcome-oriented strategies take on more significance for members in the retirement phase. The standard benchmarks against which fund managers measure themselves are of little significance to a person in retirement. They want more certainty in the returns they will receive.
  • Taxation, which should always be managed effectively, becomes more complicated in retirement due to the link with various social security payments, such as incentives to take out annuities, and the sliding scale of investable assets which impact on the age pension. On current projections, about 80 per cent of Australian retirees will at some stage be eligible for an age pension.
  • Thinking more like wealth managers: if retirees are seeking more certainty of income and comfort that whoever is managing their assets can be relied upon to do a reasonably good job, then perhaps super funds need to think a little differently about their members in the retirement phase. Wealth managers invariably have a conversation with their clients and tailor a solution based on a range of model portfolios which include risk management techniques. But building up this level of contact and sophistication for a super fund requires time, effort and, of course, money.

Suggestions for rising to the challenges

Super funds and managers can do various things to minimise the potential pain in retirement that many people would otherwise suffer. For starters, a robust and flexible risk management system is an essential tool in the funds management process.

The managers and their super fund clients, who are increasingly fund managers themselves due to the insourcing trend, need to be able to know the impact of every decision they make and the chances of it not going to plan. In retirement, there is not as much scope to recover from adverse market moves which the manager has not anticipated.

At the same time, managers do not want to be driven into making purely short-term decisions. The evidence is overwhelming that a long-term view is more likely to generate a higher return for members over that longer term. Super fund clients may wonder whether they need a different type of fund manager to handle the interests of their retirees compared with their younger, working, members.

To address this dilemma, for instance, a fund could split its portfolios into a series of cohort funds that are separated by the age of their members, similar to how some big fund managers offer “target-date” strategies. This is sometimes referred to as “phased de-risking”.

Funds can also have two broadly based investment teams for the accumulation and the decumulation phases. Some of the largest super funds are known to be considering this, although they are justifiably wary of the potential loss of scale benefits if they go down that path.

A simpler way to address the dilemma is to adjust the asset allocation buckets on a per-member basis as they approach or enter retirement.

Some funds have gone further and taken into consideration the members’ sex (women tend to live longer and have lower account balances) and wealth (as measured by the members’ account balances). Those funds are already thinking more like wealth managers in their approach to retirees.

Technological advances allow super funds and fund managers to more economically tailor solutions to individual members and clients, especially those where risk time horizons are short. This is what the challenges are ultimately about.

Provided a fund or manager can access all the appropriate tools to make a broad range of risk assessments on an up-to-date basis and provided it has the technological capability to adapt its strategies, economically, to individual needs, then the member is being given the best possible chance of maximizing his or her retirement income.

Everyone in the industry would like to do the best possible job for the members. After all, they are members too.

* Laurence Wormald is head of research at FIS Global, the big risk systems provider.

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