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Press Release: Lack of transparency around income risk ratings of popular drawdown investments is hindering adviser suitability assessments, finds EV

Written by EV | Jun 28, 2024 8:27:47 AM

Analysis by leading financial software provider EV, finds that a lack of transparency around the risk ratings of many popular UK multi-asset funds and portfolios used for income drawdown makes it almost impossible for advisers to properly compare investments and assess suitability.

Following the FCA’s Retirement Income Advice Thematic Review (TR24/1), adviser firms need to undertake greater due diligence on the solutions they recommend. EV’s analysis reveals significant challenges for adviser firms in meeting the requirements of the Thematic Review, primarily due to the differing requirements for investments and their risk ratings for accumulation verses decumulation, without greater industry transparency and new approaches.

 

EV reviewed some 170,000 funds and portfolios in the UK retail investment space, focusing on well-known multi-asset funds commonly selected for retirement or providing income. The in-depth analysis uncovered several key insights:

  • Limited risk coverage: Most multi-asset funds and portfolios used for income drawdown fail to cover the full risk spectrum.
  • Excessive risk exposure: A large proportion of retirees, particularly those with cautious to medium-risk profiles, who account for 85% of retirees per EV’s income risk questionnaire, are exposed to excessive risk.
  • Income inefficiency: Many funds and portfolios are inefficient at generating income and are more for wealth accumulation.
  • Fixed vs inflation protected: Funds and portfolios often struggle to efficiently deliver fixed and inflation-protected income generation due to differing requirements for constructing efficient portfolios.
  • Inappropriate risk measurement: The prevailing method of risk rating for income solutions focuses on investment volatility, an inappropriate measure for income sustainability.

EV’s extensive work highlights the need for greater due diligence and urgent action to prevent poor outcomes for retiree’s dependent on sustainable income to maintain their desired standard of living.  

The full analysis, published today in its Income Risk Suitability Methodology paper, highlights how careful advisers need to be when selecting investments for drawdown:

  • Misalignment of income solutions with retiree risk profiles: EV’s psychometric risk questionnaire, developed in 2017, assesses retirees’ attitudes toward income risk. The results indicate that retirees are more cautious about income risk compared to pre-retirement accumulation. Notably, 85% of retirees have a cautious to medium risk profile. However, EV’s analysis reveals that multi-asset funds typically used for providing income do not adequately cover the full range of risk profiles. These funds are often confined to limited ranges, predominately at the higher end of the income risk spectrum. For retirees seeking a fixed income, Aegon’s WS Risk-Managed Accumulation range of 1 to 6 provides one of the best spreads of risk levels, with funds ranging from 4 to 9 on a 10 point risk scale. For those retirees requiring inflation protection, Parmenion offers good coverage for retirees with risk profiles from 4 to 10.

  • Scope for improvement in income efficiency: The efficiency of funds and portfolios in delivering income varies significantly. Some funds offer over 10% more income for the same level of risk. For example, the Aegon WS Risk-Managed Accumulation 3 is nearly 26% more efficient than Timeline’s Classic 0 in delivering a fixed, sustainable income for life. This translates to approximately £40,000 of prospective income delivered by Aegon compared to £31,800 from Timeline Classic 0. Timeline Tracker 0, which offers lower risk and better efficiency, is compared to Aegon WS Risk-Managed Accumulation 2, reducing the gap to 15.4%. This for a fixed income of £40,000 from Aegon 2, Timeline Tracker 0 is expected to produce £34,700 – a notable improvement on £31,800.

  • Investment choice dependent on requirement for fixed or inflation protected income: The risk and efficiency of funds and portfolios vary based on whether the income required is fixed or inflation protected. For delivering an inflation-protected income, Parmenion’s PIM range of portfolios is the star performer. Timeline’s Classic range also performs reasonably well, making it a better choice over the Tracker portfolios for inflation protection. The Parmenion PIM 2 portfolio, at the same risk level as Timeline’s Classic 0, is likely to produce 8% more income for a retiree seeking inflation-protection i.e. £40,000 from Parmenion compared to just over £37,000 from Timeline. Choosing between Timeline’s Classic and Tracker portfolios depends on whether a retiree wants a fixed or inflation-protected income. The Tracker series is not ideal for inflation protection as it is both riskier and less efficient than the Classic range. For example, Timeline Tracker 0, which maps to Parmenion 4 for risk, is expected to deliver over 16% less inflation protected income.

It is important to stress that the above analysis does not take account of charges. More information on the above analysis and EV’s methodology is available at https://info.ev.uk/income-risk-suitability-download

 

Bruce Moss, EV's founder says:

“The FCA’s thematic review of retirement income advice majors on the need for advisers to ensure the risk suitability of their recommendations. Although there are some risk questionnaires designed to measure attitude to income risk, little appears to have been done to map the output from the questionnaire to suitable income drawdown solutions in a reliable and transparent way.

“Capital volatility appears to be used as the measure of risk. This is wrong as capital volatility does not correspond to most retirees’ objective of income sustainability, nor does it take any account of inflation risk, which is one of the biggest risks faced in retirement. The lack of transparency over how investment solutions for drawdown are risk-rated and mapped poses a huge problem for advisers who want to undertake some due diligence following the FCA’s review.”

“To create efficient funds and portfolios for drawing an income, it is necessary first to assess risk correctly. For most retirees, the risk is the failure to provide a sustainable income for life. The no-risk solution is an annuity, not cash. A robust definition of income risk allows advisers to ensure the risk suitability of their recommendations for decumulation.

“EV has developed a suitability process for income that works similarly to the process for a growth objective. Asset allocations can be optimised to create an ‘efficient frontier’ for income, allowing the relative efficiency of funds at delivering income to be measured. While a risk suitability process is well-established for accumulation, according to the FCA’s thematic review, there is little evidence of a consistent approach for decumulation.

EV’s income risk suitability process is completely transparent, aligned with retiree objectives for either fixed and inflation protected income and mirrors our risk suitability process for accumulation.”


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NOTES FOR EDITORS

Press contacts


Jenette Greenwood, PR Director, the lang cat
07710 392303 / jenette@langcatfinancial.com  

Jenny Burt, Director of Marketing, EV
07557 681 080 / jennifer.burt@ev.uk  

About EV

EV is one of the UK’s market-leading digital financial planning solutions providers. We have operated as an independent organisation for over a decade, backed by a further 18 years of financial services consultative experience. We connect and empower our intermediary financial partners with intuitive, customer-centric advice, guidance software, and investment solutions.

We have a history of developing engaging tools that help financial advisers and their clients navigate the complexities of financial markets, ultimately delivering simplified financial planning and enabling clarity over investment options, cash flow forecasting and aligned client risk profiles.

Powered by our proprietary market-leading stochastic asset model, our powerful calculations and strategic multi-asset allocations are used globally across the financial ecosystem by financial advisers, pension and platform providers, asset managers, banks, and building societies, to name but a few.