July 2007

A different approach

Ensuring clients have saved enough to fund a comfortable retirement is a key concern for advisers. Not only should care be taken in ensuring that the client saves enough money but the adviser is also responsible for exposing the client to the optimum range of assets to match their changing circumstances. Increasing longevity is a major issue and people's retirement funds may have to last them 30 years so sufficient amounts need to be saved to maintain the client throughout this time.

The launch of the Fidelity Retirement Funds in April 2007 aims to address these issues. This suite of products comprises six "target" dated funds which the client chooses based on their proposed retirement date and the Fidelity Retirement Income Fund from which the client can draw down income during retirement. The aim of the product is that the client chooses their preferred retirement date and invests in the fund allocated to that date. For instance a 30 year old looking to retire in 32-36 years time would choose the Fidelity Retirement 2040 fund while someone wanting to retire in 17-21 years time would go into the Fidelity Retirement 2025 fund (see graph one). The asset allocation of each retirement fund is carefully developed to reach the right risk/return balance at every stage of the investor's life. As a result there will be an increased percentage of risk assets such as equities to attain higher growth in the early accumulation years with a move towards lower volatility in the years running up to retirement.

While at first glance such an approach may seem like traditional lifestyling, a further look proves that Fidelity is taking an altogether different stance. Traditional lifestyling takes the approach of having the client slowly reducing their exposure to equities over a prolonged period of time, so that by the time they reach retirement they will be invested entirely in cash and bonds. The age based investing approach used in the Retirement Funds involves Fidelity carefully managing each dated fund to smooth out volatility, and the Income fund with the aim of producing a rising income that beats inflation. While the client's exposure to risk assets will decline the closer they get to retirement it is handled in a much more incremental way which could involve adjustments of as little as 0.25% every month. Further, the risk assets are managed down to approximately 30% of the portfolio rather than being managed out altogether.

"It's an intricate process but it has the benefit of smoothing volatility," says Peter Hicks, head of IFA channel at Fidelity International. "If you look at the classic mistakes investors make - one of them is inadvertently timing the markets. The more frequently you make these small adjustments, the more you smooth things out and you avoid this."

On retirement the client's portfolio is automatically switched into the Retirement Income Fund from which they can then draw down income for the rest of their lives. Unlike traditional lifestyling approaches this fund retains a healthy exposure to growth assets with around 22% of the portfolio devoted to equities and 4% devoted to both property and commodities (see graph two).

"Advisers are very comfortable with the approach of keeping someone permanently in some risk assets," he says. "There is a big shift away from traditional lifestyling in the adviser market - it's a new reality that if people are going to be in drawdown then there's not much point in being 100% in bonds and cash."

The aim of this fund is according to Hicks a way of providing a sustainable lifetime income that gives the investor the ability to pass on assets as inherited wealth - something that "hits the spot with a lot of people."

"These products are highly sophisticated and there has been an enormous amount of investment research behind them," says Hicks. "With the savings funds we are trying to achieve two things - one is to give those with some way to go before retirement access to the higher average returns of risk assets. We also try to ensure they have the optimum blend of assets as they get closer to retirement. How you put together the asset allocation to achieve that is highly sophisticated.

"The fund is managed on an efficient frontier basis," says Hicks. "The starting point isn't 'we want to produce this level of income so what asset allocation should we have?' The starting point is that someone needs the portfolio to provide them with an income throughout their lifetime so we need to ask what is the maximum level of volatility that this portfolio can accept as the client will be in drawdown. With that level of volatility what level of return can you expect and what kind of income growth will you want over time? Obviously you would want it to be in line with inflation. Based on those factors, the asset allocation can be determined and managed accordingly."

Industry reaction

The product, along with its accompanying educational material has provoked a lot of positive reaction since launch.

"We've had a great deal of response with regards to the products themselves and also the educational piece which includes our website www.rewritingretirement.com," he says. The response has been really good from both investors and advisers alike. I think one reason is that these products are very different to the products already on the market and people have wanted something more. The current products produced by the traditional life and pensions industry haven't served people as well as perhaps they would have liked and they want something fresh. The website has also proven popular and in the first three weeks there were 20,000 hits. We also did presentations with around 1400 IFAs throughout May and the typical response was 'we like this - it's different."

However, Hicks is careful to say that more work needs to be done with advisers to ensure they understand the products and how they can meet their needs.

"When we talk about the asset allocation piece a lot of advisers say that they do asset allocation and when you talk about managing an income then advisers say they do that too," he says. "However, when you talk about age based investing then many advisers realise they don't do that. It's not a case of saying we do things better; it's a case of saying this is how we can be most useful to you. They don't have to worry about moving 0.25% out of high risk assets every month for 14 years; they can focus on making sure the client is doing all the right things in terms of their retirement planning. I have respect for other IFA business models and for those whose model is built heavily around individual fund picking then there isn't a match with this product. However, there are thousands of advisers who run their businesses along the lines of holistic advice, tax planning etc and these products are ideal for them."

Hicks admits that while there are other options available, none have all of the benefits of the retirement funds.

"There's a rising annuity as one option but often the starting level of income isn't sufficient - it could be used for part of the client's income in retirement though," he says. "Other options include buying equity income funds as you would expect them to produce rising income and capital over time. However, the difficulty is that the income is variable and again the starting income may not be high enough. It also puts you 100% in equities so what happens if there is a big correction in the market? It's fine if you can live off the dividend itself as you don't have to worry about the fluctuating asset values but the reality is that most clients will be in drawdown to some extent so the fluctuations mean more to them."

Further developments

While the Retirement Income Funds have made a strong start, this is by no means the end of the journey. As well as continuing to educate advisers on how the funds can help them, Hicks also believes the advisers can play a part in developing the product.

"We are interested in how we can use the funds within trusts, for instance the equalisation of spouse's estates, but we need to talk to advisers about it," he says. "I'm confident when it comes to talking about things like asset allocation, but where an adviser has greater specialisation in say tax planning then I've got no difficulty in going to them and asking what people do in the real world."

However, changes are already afoot with the use of a distributing share class on the income fund from this November.

"This will pay out 4% (in monthly instalments) of the net asset value at the start of every year so clients will know exactly what the monthly payment will be. This will change on an annual basis based on the movement of the net assets. Over time we expect that to rise and the income will rise accordingly.

"If you take a starting income much above 4% then you seriously increase the risk of your capital eroding," he says. "If you start with 4% and look to get an increasing income and asset value over time then from November we can take care of that for you."

So while Fidelity Retirement Funds have had a good start it is heartening to know that Fidelity is not resting on its laurels. Hicks realises that it is only with active engagement with the IFA user that the product will become even more user friendly and inject further innovation into the retirement planning market.

Peter Hicks
Head of IFA Channel
Fidelity International