If you’re invested in a fund labelled ‘conservative’, you would no doubt think the fund is positioned to deliver retirement goals including a stable income and low volatility in all market conditions. But in the current environment the traditional ‘conservative’ and ‘moderately conservative’ fund label may not necessarily be optimally placed to deliver those goals.
Retirees expect their funds to be very, very defensive. A conservative fund typically has around 70 percent in defensives, a moderately conservative fund around 50 per cent. When you lift the lid on that ‘defensive’ allocation you’ll find some cash, but a large allocation to bonds.
The problem is that it appears we have entered a part of the market cycle when the outlook for bonds is somewhat challenged and there is a probability that they deliver returns which could mean retirees' assets fail to grow with in line with inflation, and therefore they fall short of meeting their retirement goals.
The end of the bond bull
We now seem to be at the end of an extended 35-year-long bull market in bonds that began with the end of high inflation in the 1970s. Interest rates are at record lows and there is a possibility they won’t fall any further. As rates start to normalise and rise, and bond prices fall, bonds may not deliver the returns seen in recent decades.
Bonds at the end of a 35-year bull market
Yields have so far just had a flick off the bottom.
The outlook for bonds is also clouded by the fact that the duration of bond indexes has also risen by two to three years since the GFC as companies and governments borrowed at the lower rates for longer periods. The duration of the Barclays Global Aggregate fixed income index has risen from 5 years before the GFC to 7 years. The longer the duration, the greater the losses incurred when rates rise. So bond investors face greater interest rate – or duration – risk at a suboptimal point in the cycle: when interest rates are at record lows.
And, of course, bonds are also exposed to a spike in inflation - a general rise in the cost of goods and services. Inflation risks are obviously heightened for retirees. All their essential expenses such as food and clothing will be going up.
A broader problem
The heart of the problem really lies in the fact that some conservative and moderately conservative funds simply haven’t been optimised for post-retirement. They are wealth accumulator solutions that haven’t been built to address the specific needs and risks faced by retirees e.g. inflation exposure, income and tax awareness, interest rate risk and sequencing risk (the risk of a big market fall at the start of retirement).
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We believe there is a better way to invest in a diversified portfolio that meets the many needs of retirees and that can seek to deliver stable returns suitable for them without being reliant on having a large exposure to bonds.
If we were to look at the characteristics of what we believe to be an ideal core retirement fund we would find it:
- Is actively managed, seeking diversification across asset classes, risk factors and investment managers to lower risk concentrations and smooth volatility
- Employs Dynamic Asset Allocation (DAA) to provide portfolio flexibility in response to expected market changes
- Implements tail risk hedging (eg put options) to protect capital and limit severe drawdowns
- Focuses on income and fully franked credits for low margin tax investors
The goals-based solution
Of course, goals-based funds do address the two challenges above: they have the flexibility to manage bond market exposure; but they are also designed specifically for the unique needs that retirees have and the unique risks they face.
Funds such as the MyNorth Retirement Fund and AMP Capital Multi-Asset Fund are examples of goals-based funds that have attributes specifically relevant for retirees.
- Have real return investment objectives to ensure the funds seek to deliver a return above inflation, independent of how bonds or other markets are performing.
- Can hold more tailored fixed-income exposure.
- Can be more dynamic in responding to the market (and can even entirely sell out of bonds
- Hold much larger hedges such as options, currency positions or relative value positions to help protect capital in the event of a major sell off\Have a greater ability and flexibility to use alternative investments to supplement fixed income allocations.
The need to assess a retirement portfolio
The post-GFC world has seen governments and central banks push yields and rates to record lows in a bid to stimulate growth. But governments are now saying they want to step back from stimulating the market.
Investors haven’t experienced this unwinding process in the past and it’s important to acknowledge there is still a lot of uncertainty about how the process will unfold.
Even if it goes smoothly, there is still a real chance that traditional conservative funds may not perform as they might have in the past. This is exacerbated by the fact there is heightened interest rate, or duration, risks in benchmarks.
Retirees therefore need to constantly assess whether their investment solutions not only manage the outlook faced in the bond market, but also has the key attributes desirable in a retirement portfolio.
It’s important to be aware that there are risks associated with investing in the MyNorth Retirement Fund and AMP Capital Multi-Asset Fund. Before investing, please read the Product Disclosure State which can be found by visiting our website.
Important note: Investors should consider the Product Disclosure Statement (“PDS”) available from AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) (“AMP Capital”) for the AMP Capital Multi-Asset Fund and MyNorth Retirement Fund (“Fund”) before making any decision regarding the Fund. The PDS contains important information about investing in the Fund and it is important investors read the PDS before making a decision about whether to acquire, continue to hold or dispose of units in the Fund. AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (“AMPCFM”) is the responsible entity of the Fund and the issuer of units in the Fund. Neither AMP Capital, nor any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this document. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this document, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including without limitation, any forecasts. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to their objectives, financial situation and needs.