Adrian Boulding: Managing decumulation journeys through Covid-19 market uncertainties

Adrian Boulding examines what’s happening in the world of investment advice at retirement and considers what the world might look like after the pandemic. Financial plans and strategies will need to be both recession-proof and tax-man proof, he writes

There is no doubt that the impact of the global pandemic on markets has prompted many pensioners already drawing on their retirement savings or preparing to, to give their advisers a call.

Many investment advisers have been kept very busy since early March as markets around the world tumbled.

Investment advisers have been talking to clients about a range of issues including fund performance checking, reducing, or stopping drawing income from portfolios, and contemplating or executing fund switches.

A small minority of clients are even seeing some share price falls as an opportunity to put dormant cash to work to invest in identified undervalued shares. They are the brave rather than the many.

Since an initial fall of FTSE-100 of 32% between the beginning of 2020 and the first day of lockdown, things have recovered somewhat. Day by day markets are still unusually volatile, but with no particular direction of travel.

Perhaps more worrying is FTSE-100 companies’ dividend prospects: we’ve witnessed a 60% reduction in dividend yields amongst the UK’s blue chip listed businesses as earnings fell in nearly all sectors over at least two quarters. The Investment Association has already abandoned its requirement that equity income funds must deliver income.

More than three-quarters of UK Equity Income funds (64 of 84) depend heavily on the top 10 dividend payers for their historical success. The safest sectors right now are Food & Drink manufacturers, Tobacco, Utilities, Food Retailers, Healthcare, and basic consumer goods.

Conversely, banks and oil companies are particularly vulnerable in dividend terms right now. The fact that these two sectors make up 37% of the FTSE-100 dividend pool gives an indication of the income prospects for portfolios relying heavily on dividends for retirement income.

A colossal £8.7bn was pulled out of UK-based funds in March alone. Perhaps more interesting is the accelerated swing away from active funds and in the direction of passives which was a trend even before the Covid-19 outbreak: £3.9bn has been moved out of active funds and most of that money, £3.15bn to be precise, has moved into passives since the start of 2020.

Rise of passives

Passive-heavy investment managers such as BlackRock and Vanguard have seen very significant inflows over recent months. Passive funds offer the consolation that, on average, everyone else is doing as badly as you are.

Income-paying investment trusts are also seeing raised inflows as their closed-ended fund status gives them two key advantages over the more common open-ended funds. Many of these trusts hold dividend reserves which give them scope to trade through sudden market shocks while holding dividends or, in some cases even, increasing dividend pay-outs.

Investment trusts have the added advantage of being traded on the stock market, rather than relying on their manager to create or buy back units, they can always be sold. There is no danger of a damaging Woodford-style ‘lock-ups’ with investors powerless to act, while they watch a car crash unfold in front of their eyes.

Clients are often advised to use up rainy day cash reserves. Some IFAs recommend holding up to three years of retirement income reserves in cash to protect income levels during turbulent markets (to avoid selling at prices some 22% below recent levels).

Other clients will choose to reduce the retirement income they are drawing from their pension in line with natural lockdown living expenditure reductions. Lockdown restrictions have removed (or significantly reduced) several major personal expenditure line items such as holidays, fuel for cars and any non-urgent building works etc.

Balance sheets

In many cases, the upshot of all this has been an increase in client money balances. And it’s been of an order of magnitude that the Financial Conduct Authority has noticed it. Indeed, the regulator has written a series of ‘Dear CEO’ letters to firms that provide a non-discretionary investment service.

The ‘Dear CEO’ letters are now almost as feared as the legendary ‘Black Spider Memos’ from Prince Charles to ministers.

The latest one threatens regulatory fire and brimstone on firms building up high client cash balances. Coded references to “in clients’ better interests”, I interpret as a warning to ensure that cash balances do not get above the £85,000 FSCS protection limit per financial institution.

The real question now is where will investments end up looking once a viable vaccine is found for Covid-19? What new consumer behaviours will become entrenched in the meantime and what will that mean for some types of investments?

All change

You have to be brave to predict much of this? However, you could draw some conclusions from what we have observed these last few months. Shopping patterns have changed. The partial recovery of High Street sales has been achieved despite the significantly lower footfall numbers. Those that go to the shops now go to shop, not just to socialise or  window shop.

History will point to Covid-19 as the catalyst for some major social changes.  I’ve detected greater sharing of childcare duties between the genders as both have been locked down under one roof for example. Will that trend continue, as place of work moves more fluidly between the office and the home office going forward?

Markets may well report more agile firms – those embracing changing working practices and consumer behaviours quickly – as the winners. Active fund managers have an opportunity to spot and back these nimbler winners, thereby potentially differentiating their funds’ performance from many of the ever-so-average passives.

Before we were all so rudely interrupted by this coronavirus, the early months of 2020 were seeing a growing awareness of climate change, and the risks and opportunities it presents to investors.

The likelihood is that concern for the environment will return with even greater vigour after a viable vaccine is found.  Governments will rachet up pressure on pension funds, trustees, and others to invest responsibly.

Consumer pressure is being galvanised too, with campaigns such as Richard Curtis’ ‘Make My Money Matter’ seeing a whole range of investors demanding that their money should ‘do good’, as well as generate strong returns.

The flipside of this is all too obvious. Those who are the last investors in environmental or social ‘evils’ such as oil, coal, tobacco and even airlines risk ending up as stranded investors, holding assets whose prices have fallen in an unstoppable fashion as nobody wants to buy them.

Much-discussed left-leaning ideas such as the universal state income and wealth taxes could well gain momentum post-Covid-19 as the government looks to restore the gaping hole in the UK’s finances created by lockdown measures.

During July, HM Treasury launched a ‘Call for Evidence on the administration of pensions tax relief‘. The changes proposed, like closing down ‘net pay’ arrangements when pension contributions are taken out of employees’ pay by their employer before tax is calculated, may simply be laying the foundations for a more wholesale restriction of pension tax reliefs, perhaps to basic rate tax relief only.

Certainly, emergency measures, including targeted grants and the furloughing of millions of employees across the country, reveal the fragility of the economy which we currently work in.

‘Nasty party’ no more

The government’s response so far has been truly amazing in terms of its willingness to dispense largesse to anyone needing a helping hand to keep themselves afloat. All this from a Chancellor of the Exchequer belonging to the Conservative Party. Their opponents won’t be able to call them the ‘nasty party’ any longer!

If your clients are fortunate enough to be sitting on a pile of assets they expect to see them comfortably through retirement, they may be asking whose money is it that will pay the bill for ‘eat out to help out’ and all Rishi Sunak’s other multifarious rescue measures. As a former governor of the Bank of England once advised at the end of a particularly fine lunch – it’s obvious who will pay: those with the most money.

Advisers are uniquely placed in these difficult times to help clients in or entering retirement to navigate the choppy waters ahead. Financial plans and strategies will need to be both recession-proof and tax-man proof.

Adrian Boulding is director of retirement strategy at Dunstan Thomas