The decumulation market is in desperate need of innovation. Some six years on from the introduction of Pension Freedoms, the growing investor appetite for income drawdown is not being met with an adequate range of product and investment solutions.
Square pegs and round holes
Because of this, many people are using the same investment strategies and asset allocations used in the accumulation phase; while not quite the same as banging a square peg into a round hole, it’s not far off.
Providers and asset managers are gradually creeping up to speed, but we’re urging them to up the tempo. Managing a portfolio with the dual purpose of generating income while simultaneously maintaining its value is a complicated affair. Advisers need the right tools to serve their clients in this area.
According to the Investment Association, there are 3,000 funds on sale in the UK. How many of these have been designed with asset allocations befitting income drawdown clients is unclear. But it’s certainly not many, or enough.
We must appreciate that decumulation is still a relatively new concept, which offers some explanation for the lack of product and fund innovation. But we’ve witnessed more than enough evidence of the choices investors are making at retirement to understand the types of products they need.
Consumers are at greater risk
During the years following PensionsFreedoms, we have witnessed a strong investor preference for flexible retirement solutions over guaranteed ones. Before 2015, those retiring with defined contribution schemes had to choose between either an annuity or capped drawdown with withdrawals restricted to annual GAD rates. Flexible drawdown was available to those with secure annual income (from existing annuities and/or final salary schemes) exceeding £20,000 – though only a small percentage qualified here. But, now afforded the facility to draw as much as they want, whenever they want, consumers are at greater risk of depleting funds sooner than intended. This is exacerbated by using investment products not fit for purpose.
The situation is reversed
Asset managers have a key role to play here; we need more funds in the market that cater for decumulation risks. There are various reasons why accumulation asset allocations fail to cut the mustard for drawdown customers. For starters, volatility is less of a concern when you have no immediate plans to draw from your investment portfolio. Even in less favourable market conditions, investors making regular contributions to retirement funds can benefit from pound cost averaging, which mitigates volatility by purchasing more units when markets are low and fund prices have subsequently dropped. In decumulation, however, this situation is reversed. Withdrawals outstripping investment growth heightens the risk of pound cost ravaging. If this occurs, the portfolio may never recover to the level needed to provide a sustainable income. The consumer may then ultimately be forced to sacrifice certain retirement objectives due to lack of affordability.
A further problem with using accumulation asset allocations for decumulation is longevity. According to data from the ONS, life expectancy at age 65 years is 19 years for males and 21 years for females. But clearly, many people will live significantly longer. Those relying entirely on drawdown funds for income in retirement need the pot to last until they and/or often their spouse, civil partner or partner passes away. The right asset allocations here are crucial, especially at the start of retirement.
Getting in shape
Retirees need solutions that draw from the most suitable assets in any given market conditions. For example, using more capital secure assets such as bonds or cash when equity markets are subdued.
By 2025, the retirement population is predicted to make up one fifth of UK citizens. Many of these will be retiring with defined contribution pension schemes, and so we encourage asset managers to launch a wider range of decumulation focused funds to help advisers support consumers to live financially comfortable retirements from start to finish.