The secret of a good strategic plan is to look through your initial targets and out beyond them. We should apply this thinking to investment pthways which will be implemented for so called ‘non-advised’ consumers from 1 February 2021.
As has been remarked before, the Financial Conduct Authority (FCA) has widened its definition of ‘non-advised’ in respect of investment pathways. As a result, we are seeing some self-invested personal pension (SIPP) providers that we might think of as adviser-only, preparing their own investment pathways in case they are needed.
The investment pathway decision appears quite clear cut. The consumer will pigeonhole themselves into one of four discrete choices, presented in language that is easy to understand.
It states what they will be doing in the next five years, and the provider should offer a suitable investment mix for each of the four.
However, how many five year plans do you know that run their full course? The Soviet Union, that great exponent of the Five Year Plan, sometimes declared success and terminated them early, or declared failure and abandoned them before they timed out.
It may help our own planning if we look through the first five years of each pathway and see what could come afterwards :
|First 5 Years||Beyond Year 5|
Option 1: I have no plans to touch my money in the next 5 years
|Any of the four options are possible in the next five years.|
Option 2: I plan to use my money to set up a guaranteed income within the next 5 years
|No need to plan further, the annuity purchase has set the consumer up for the rest of their retirement.|
Option 3: I plan to start taking my money as a long-term income within the next 5 years
|After some years of income drawdown, many consumers will decide to buy an annuity, finding annuity rates better once they are older.|
Option 4: I plan to take out all my money out within the next 5 years
|This consumer may have gone, or they may have seen the light and found a better way to raise the cash they needed, preserving their tax-favoured pension vehicle for longer than originally anticipated.|
Over the next couple of months, we will see SIPP providers publishing the investment mix within their four pathways. I’m sure there will be a lot of peering under the bonnet, and comparisons drawn as to who is adopting which strategy.
The FCA will expect that the central focus in determining asset allocation is that first five years. However, I suggest that it would be no bad thing to have one eye on the longer term.
Option 1 – Leaving retirement savings alone
This consumer is not really in decumulation at all. They have probably simply stripped the tax-free cash off the top of the plan.
A good starting point might be the same allocation as would be suitable for a saver reaching the later years of their working life. So, a 60/40 mix of equities and long-term bonds feels right.
Yet I would be mindful that this consumer probably has a second, third or even fourth five year plan beyond this one. With this longer time horizon, a little greater risk can be taken.
Right now, there appears to be some really low-priced shares available for those prepared to take the risk. Nick Train, in a recent update to investors in his Finsbury Growth and Income Trust, declared there is a “very material opportunity” among unloved UK blue-chip stocks, where value is currently being “left on the table”.
Indeed, research of a wide cross section of investment managers, which Dunstan Thomas commissioned during Lockdown no 1, found that the average client portfolio fell in value between February and mid-June by 12.5%. Many companies have yet to return to their former market valuations, despite vaccine developments heralding the end of tight social restrictions sometime next year.
Option 2 – Guaranteed Income Ahead
This consumer has indicated an intention to purchase an annuity within the next five years. They can immunise themselves against future annuity rate movements by purchasing a portfolio akin to the investments that an insurer will themselves buy with the receipts from an annuity sale.
That means long dated fixed interest stocks. So, for many, Pathway No2 will be a long dated corporate bond fund. Except that maybe we should give a nod to the strategy adopted by some final salary schemes that would like to buy out with annuities but can’t afford to.
Our consumer may in fact be in a very similar position – wanting to retire on an annuity within five years, but simply unable to generate the income they need to live on at current annuity rates.
The strategy here is one of an acceptable level of mis-match, blending the bond portfolio with some equities, with the intention of cashing in equity gains as they make retirement affordable. So, I will not be surprised to see some equity allocations under the bonnet of Pathway No 2.
Option 3 – Planning for Drawdown
Non-advised income drawdown is one of the greatest examples of Rumsfeld’s ‘unknown unknowns’. It’s nearly 20 years ago now, that US Secretary of Defence Donald Rumsfeld used this epistemology to extract himself from a tricky question on the Iraq War. It remains the case today that the unknown unknowns are still the greatest threat for those who sally forth bravely but without the aid of regulated advice.
How many non-advised drawdown customers understand sequencing risk? The catastrophic damage that an early period of poor returns, leading to cashing in assets at low prices, can do to the sustainability of a drawdown proposition.
Some protection can be afforded by choosing income funds. If a drawdown portfolio is constructed from assets that deliver a high level of natural income, then the non-advised customer is less likely to need to sell units. If they do, it should be apparent to them that they are eating into capital which is unlikely to be replenished.
In preparation for this, I am expecting to see asset allocations for Pathway No3 that contain equity income funds and other long-term income generators like infrastructure funds and warehouse portfolios.
How might this change if we raise the horizon and look out, not five years, but 30 years because that’s the sort of life expectancy remaining for someone entering investment pathways aged 60? By then we will be in a world of net zero carbon emissions. No gas or oil central heating, no petrol driven cars, no patio heaters. All our ‘devices’, from our fridge to our Electric Vehicle will be smart and fully ‘connected’.
Today there is a growing emergence of low cost funds that track not the standard FTSE all share index but a modified index, constituted from companies with low carbon emissions and high ESG values. One such is the MSCI United Kingdom IMI Low Carbon SRI Leaders Select Index. The more far-sighted providers will add an allocation of ‘low carbon’ to the income generating funds we would otherwise expect to see in Pathway No3.
Option 4 – Planning to take it all out within 5 years
Could anyone be criticised for designating cash and near-cash assets as the portfolio for Pathway No 4? This consumer seems to be giving a clear instruction: “I’ll be back for the rest of my money shortly”.
Except that with interest rates where they are today, cash is almost equivalent to simply burying it in the ground. I am reminded of the Parable of the Talents (Matthew 25 : 14-30), where the servant who buried his talent (the currency of the day) in the ground awaiting his master’s return, was roundly chastised and cast into the “outer darkness”.
I’m also very reluctant to give up on this consumer, as having spent 40 years in what I thought was the pensions industry, I feel aggrieved when it seems people don’t want a pension at all. They just want to cash the whole pot in.
Last month, the Work and Pensions Committee chairman Stephen Timms tabled a sadly-defeated amendment to the Pensions Schemes Bill which would have “ensured members of pension schemes receive a Pension Wise appointment prior to accessing their pension”. Further appointments would have been booked yearly until taken up or a confirmed opt-out was received.
In the hope that they may yet see the light, the asset allocation for Pathway No4 should perhaps forsake at least some of the cash in favour of funds that are low risk, employ volatility dampers and aim to deliver a real return even amidst the stormiest of economic conditions. There is a good selection of Diversified Growth Funds available for this purpose.
We don’t have long to wait now. SIPP providers will be unveiling their investment pathways early next year. We will soon see whether any of my forecasts have come to pass.
Adrian Boulding is director of retirement strategy at Dunstan Thomas