The whole story

Jonathon Howard looks at how increasing longevity affects retirement investment strategies

It is easy to assume that the term ‘retirement planning portfolio’ relates solely to pension investments. This may have been the case back in the days when a job was for life and that job provided a decent, well-funded final salary pension scheme. Nowadays many people consider their pension fund to be just one facet of their overall retirement strategy with myriad other assets making up the remainder. It is therefore vital to consider the complete picture when setting retirement strategies for clients.

The primary purpose of the investment manager should be to ensure that a client’s capital does not expire before they do. It may sound a little glib, but it is a fundamental guiding principle that has very real benefits to the investor. It is easy to get hung up on out-performing indices and star fund managers, and lose sight of the fact that as long as returns are sufficient to meet future liabilities (in this case, income requirements in retirement) then the portfolio has done its job.

The first stage to ensuring clients do not outlive their capital is to establish what income and capital is needed over the remainder of their lifetime. The next stage is to assess their attitude to risk, and the final stage is to consider what other assets they hold and how they expect to use them in the future.

The average age at which a UK citizen joins his or her first pension scheme is 28. With the typical retirement age being 65, most people will have an investment horizon of at least 37 years. With planned increases to the state retirement age and the anticipated abolition of default retirement ages, this window is set to extend even further in the future. In addition, with the rising popularity of unsecured pensions, investment horizons could theoretically stretch right to the point of death and even beyond where the funds are left to a spouse/partner/dependent.

Long investment horizons

Such a long investment horizon naturally lends itself to an equity-based portfolio since real returns above inflation are paramount. Had you invested £100 back in 1900, by 2007 the ‘real’ annualised returns from an equity portfolio would have been 5.26%. The equivalent return from a gilt portfolio would have been 1.1% and from cash just 0.99%. While the rate of inflation is low by historic standards, so too are cash interest rates and gilt yields. Couple this with abysmal annuity rates and the dependency on real returns has never been greater.

It goes without saying that the equity content should be reduced as the annuity purchase date draws nearer, or as people move into USP. That said, in USP it is still vital to maintain returns above gilt/corporate bonds to ensure the USP fund is able to at least match the equivalent annuity.

So where does all of the above leave us in terms of tapping into current investment trends?
Holding significant amounts of gilts within a retirement planning portfolio carries its own dangers and effectively means that you have taken on your own mortality risk. While the decision by the Boots Pension Scheme trustees to move 100% of their assets to AAA sovereign debt in November 2001 has proved in hindsight to be a sensible one, it is important to remember that when you consider a 30-year investment horizon, the risk of investing in gilts is actually higher than investing in equities. If the Boots pension has sufficient assets to meet its liabilities with the returns available from this type of investment then it is a great strategy. Few pension schemes, however, are in this position.

It is essential to target real returns from the investments that investors expect to use in retirement and the emerging market sector is perhaps the most appropriate for long-term capital appreciation. With real economic growth generally around twice that of the developed markets (three times as high if you are comparing emerging markets with the Euro area) they offer the long-term potential that could suit the portfolios of those planning for retirement.

Advocating a substantial emerging markets exposure is likely to leave some investors a little jittery, but it is nonetheless a logical approach. Short-term volatility within a portfolio that you will not access for decades is as irrelevant as a traffic light turning red and then green again before you reach the junction. 100% Brazil anyone?

Jonathon Howard is head of corporate clients at Courtiers