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Robert Vaudry | Head of Commercial, Wealthtime and Copia Capital | 19 March 2024

The Financial Conduct Authority is set to publish its long-awaited thematic review of retirement advice by the end of the first quarter, but while we wait for the official report, I think the direction of regulatory travel is already clear.

When it began last June, the review concentrated on investigating charging models and fees for clients saving for retirement and those taking an income from their investments.

The information received in the initial discovery work, which involved 1,300 companies and an 87-question survey, clearly did not entirely satisfy the regulator though. It sent a follow-up questionnaire in December to take a deeper look at target markets and investment suitability.

The investment questions asked companies for information on their processes and procedures around risk alignment, investment suitability and income-withdrawal strategies for clients drawing on pension assets. To my mind, this all points to companies needing to take a different approach to clients in decumulation from those in accumulation, or at the very least, demonstrate that their centralised investment proposition is suitable for clients who are taking an income. 

Of course, the latter point is not new. Advisers have long had to demonstrate client suitability. However, what has changed in recent years is that, due to market conditions, changing wealth composition and pension freedoms, the risk of running out of money too soon has become a much more real possibility for many people in retirement.  

In rising markets, the different risks facing those in accumulation and those in decumulation are less pronounced. Obtaining real returns and beating inflation when building wealth, planning for longevity and sequencing risk when taking an income are easier to manage when markets are going up.

Different investment approaches

When markets and economic conditions are more volatile though, as we have seen in the past couple of years – with soaring inflation, high interest rates and poor equity and bond performance – the need for different investment approaches to address the risks of those in decumulation versus those in accumulation has become far more apparent.

The FCA’s consumer duty states that companies must avoid causing foreseeable harm, and this specific focus on clients taking an income sits very much in that camp.

The rising cost of living has also ramped up the amount of money people need to fund their retirement. Recent figures from the Pensions and Lifetime Savings Association find that a single person will need £12,800 a year to achieve a basic standard of living in retirement, up almost 20 per cent year on year, while for a comfortable standard, it is £37,300.

When you add falling home ownership and fewer defined benefit pensions into the mix, the importance of certainty over investment income to fund an individual’s lifestyle in retirement becomes even more important.

In the past couple of years, we have seen volatility and the correlation of equities and bonds resulting in traditional 60/40 portfolios falling by as much as 20 per cent.

While someone building their wealth may have time to recover those losses over the longer term, for those already in decumulation, especially in the early years of retirement, these falls can be devastating and force them to accept a lower standard of living, change plans or even return to work.

However, for advisers to be able to take different approaches to decumulation that mitigate some of the specific risks faced while generating the income retirees need to fund their needs in later life, discretionary fund managers need to offer propositions that support this. For instance, portfolios that include both traditional and alternative assets, such as hedge funds, infrastructure, real estate and commodities.

Providing downside protection

While alternative assets can be higher risk than more traditional assets, they can be particularly useful in decumulation portfolios as they reduce the impact of any potential equity and bond correlation and may help provide downside protection and generate absolute returns during periods of stress to ensure income needs are met. Or portfolios that use guaranteed income as an asset alongside a managed portfolio.

By paying a guaranteed income for the life of the client, the guaranteed income part of the portfolio results in fewer assets within the managed portfolio needing to be sold to generate income, so they can stay invested for longer.

There is also greater potential for growth as it can be weighted slightly more towards equity and alternatives and slightly less towards bonds, without increasing overall risk for the client. 

At the same time, platforms need to offer the functionality to support these propositions and enable further innovation while offering advisers flexibility and choice over tax wrappers and managing income. 

It will be interesting to hear the FCA’s findings, but we already know that the retirement landscape is evolving with different pension models, changing working patterns and greater pressures on people’s income – both before and after retirement.

To address these challenges, retirement planning needs to evolve too, and along with it the solutions available to deliver income and mitigate the specific risks faced in decumulation to give advisers greater flexibility to meet the different needs of their clients.

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