Leading equity manager Martin Currie has suggested the superannuation, advice and wealth management industry may have it all wrong, in its new research piece titled ‘Investing for a sufficient retirement income’.
In the paper, chief investment officer Reece Birtles advocates for a “rethink” of the traditional risk-return-dominated approach to portfolio construction, suggesting a “sufficient income for life” approach is better suited to the post-pandemic world.
According to the paper, the financial industry has been too heavily focused on “asset return volatility,” the concept that formed a key part of Modern Portfolio Theory. While price volatility is important in the short-term, and is able to be harnessed by investors in the accumulation phase, “income volatility” is what matters to retirees.
Martin Currie suggests that income volatility and the “risk of impaired living standards in retirement” is what advisers, superannuation trustees and the like should actually be focused on when building portfolios for the growing cohort of self-funded retirees.
Portfolios should be constructed with a higher allocation to equity markets and take into account three crucial, but under-appreciated factors: namely, the sustainability of income, future income growth and the diversification of income sources. This, he suggests, means the accepted wisdom that “when people get to 65, they automatically become risk-averse” must be reversed, stating “we do not agree.”
High-risk and low-risk asset definitions should be reconsidered as the simple pigeon-holing does little in the way of delivering better outcomes for investors. The focus should turn to the quality of income coming from the underlying investments, with low-risk assets like term deposits and bonds having turned out to be “low growth with high income volatility,” in hindsight.
Rather than joining the chorus of growth investors, Martin Currie is a proponent of utilising the unique tax benefits of the Australian dividend system on the basis that the increase in living costs of Australian retirees will be linked to the Australian economy, not the rest of the world. One of the most important factors in portfolio construction and stock selection is free cash flow, which is the true determinant of the sustainability of dividends.
Importantly, the ability to deliver a “sufficient income” requires investors to “minimise concentration risk” by avoiding strategies that “chase benchmark-relative alpha” or high-yielding stocks and focus on the “actual dollar income” paid by companies rather than headline dividend yields. It is this approach that has driven strong long-term returns from the manager’s stable of quality-focused equity strategies, including the Equity Income, Real Income and Diversified Income funds.
The most important factor for retirees, according to the paper, is finding strategies that deliver the “best probability of beating an income return target,” which ultimately leads to equities. This is an interesting counter-position to the current trends in financial markets where many investors are accepting greater levels of risk in their fixed-income proponent, in some cases giving up liquidity and quality, in the pursuit of income.
Managing director of Franklin Templeton Australia, Matthew Harrison, notes the growth complexities facing advisers in delivering for clients, with retirement income the next big issue on the agenda for the superannuation industry.
“Many Australians will spend a third of their life in retirement and it’s critical they can generate the income needed to live well and keep up with rising costs without running out of money,” he says.