The Seven Ages of Income In association with
CONTENTS
2-6
8-11
12-16
2. The Seven Ages Of Investing From cradle to retirement, needs are constantly changing.
8. The Student Debt, debt and more debt. And how to plan for it.
12. The Playboy Pensioner Better health, longer retirement horizon. More risk appetite, or less?
3. Birth Baby’s first savings are a family statement, first and foremost.
9. The Lover Impress your future mate. Know something about money….
14. Taking care of Grandpa The time when proper planning ought to be paying off.
5. School Kids One investment that mustn’t be allowed to go wrong.
10. The Mortgage Warrior Peak earnings, peak responsibilities. Suddenly life’s changing.
FORWARD A Plan For All Seasons It seems odd to think that, not so very long ago, income investing was struggling a little bit for the public’s attention. That, of course, was a reflection of the way the investment markets were moving at the time. Equities were booming, fixed interest was seen as expensive, and yields from ‘safe’ products were limited. Fortune favoured the brave, and all that. What a difference a year can make. The froth has been blown off the capital growth scene, yields have picked up, and – crucially for the UK – the arrival of next April’s pension reforms has opened up the prospect of a whole sea of demand for alternatives to the hated annuity
requirement. We can be certain that a lot of this incoming demand will be for income-type products that can balance high yield returns with decent levels of capital security. But let’s not focus just on the defensive needs of the retired. As we hope to show, income products come in a range of shapes and styles that can meet the needs of pretty much every age group. From a child’s first savings accounts to planning for school fees, and from saving for a house deposit to providing for comfort and security in later life, income investments tick an awful lot of boxes. But those needs tend to change and evolve as people’s lives progress. Appetites for risk or security are
IFA Magazine is published by IFA Magazine Publications Limited, The Old Wheelwrights, Ham, Berkley, Gloucestershire GL13 9QH Full subscription details and eligibility criteria are available at www.ifamagazine.com ©2014. All rights reserved.
constantly shaped by changing personal circumstances A lot of that has to do with the needs of people’s dependants - because let’s not forget that a critical reason for favouring income investing is the desire to protect one’s family from unwelcome shocks. It’s all about taking the long view. Think of this survey, then, as a whistle-stop tour of the human situation. And let’s enjoy the journey. Michael Wilson, Editor, IFA Magazine
Telephone: +44 (0)117 9089 686 Editor: Michael Wilson editor@ifamagazine.com Publishing director: Alex Sullivan alex.sullivan@ifamagazine.com Design: Fanatic Design
NOVEMBER 2014 IFA Magazine
1
The Seven Ages of Income Michael Wilson Explores The Role That Income Investing Can Play In Financial Planning
T
ake it from us, we’re going to be hearing a lot more about income investing in the next six months or so. As next April’s pension reforms come in to eliminate the requirement for retirees to buy annuities, there are going to be an awful lot of people looking for alternative investments that will allow them to keep the capital value of their pension pots. Those people will be looking for a combination of high income – probably not usually as high as the 4% or 5% annuity rates that a 65 year old couple can currently hope for, but this time with the additional prospect of capital gains. Accordingly, in the coming months we’re expecting to see a profusion of new income funds directed at exactly this market. The wraps are still in place for most of these funds – but not for much longer, we suspect… Who Needs Income Funds? But don’t run away with the
2
IFA Magazine NOVEMBER 2014
idea that income funds are just for wrinklies. As this sector of the market expands, we’ll see more interest from other sectors of the demographic spread: • Children and aspiring students. Favourite aunts and uncles. People with long-term illnesses who need as much financial security as possible. • Anyone who’s anxious to defend a rainy-day savings pot, or a one-off inheritance, or a divorce settlement.
• Charities. Anyone who’s managing a trust on behalf of a minor. Anyone with powers of attorney. No Way of Eliminating Risk Don’t get us wrong. Even though the traditional trend among equity income stocks leans toward larger (and hopefully safer) companies, there’s nothing necessarily super-safe about an income investment per se. Logic says that you’d need to be some way into the equity risk zone to bring in a 4% pure dividend yield when the All-Share is only scraping 3% and the US barely 2%. And if it’s bonds your clients prefer, they’d either be locking themselves into ten year maturities or else flirting with BB grades before they managed to beat 2% by any serious margin. Much of the rest would probably come from capital appreciation. Fortunately, the tide of history is on income investing’s side, especially
for equities. The last few years have provided conclusive evidence that higher-yielding stocks, as a group, are outperforming their peers in terms of the capital appreciation. Especially in America, in Japan and in parts of continental Europe where it simply hasn’t been fashionable until recently for companies to distribute their profits to shareholders. The growth of demand for dividends has created a self-fulfilling groundswell in income share prices. And there’s no reason to suppose that it’s over yet. During the twelve months to mid-September 2014, UK Equity income funds from market leaders such as Blackrock, Perpetual, M&G, L&G or Aviva achieved total returns in the 6-12% range at a time when the FTSE-100 was making less than 4%. And comparable figures for Global income funds would been almost as high.
A Whistle Stop Tour of Life One thing you’ll notice about the following report is that we’re keeping a constant close eye on how much risk our various demographic groups can afford to tolerate. For some, it’s a lot – for others, none at all. It’s all about their respective stations in life. So think of it as a whistle-stop tour of a growing human being’s risk profile, and perhaps we’ll get a little closer to understanding why income investing is still one of the most potent answers to the fundamental needs that will arise at certain key moments in life. Okay, over to you, Shakespeare….
Trustnet UK Equity Income index, September 2014
1.6%
0.4%
2.9%
7.6%
47.1%
62.9%
1 Month
2 Months
3 Months
1 Year
3 Years
5 Years
% cumulative growth
BIRTH
“And one man in his time plays many parts His acts being seven ages. At first the infant, mewling and puking in the nurse’s arms…”
A
ah, doesn’t everyone love a christening? The hats, the flowers, the vicar, the scrummage of fond aunties competing for the photographer’s attention. And, in the middle of it all, the next generation making its little presence felt, generally in the loudest way possible.
It isn’t at all ridiculous to start a savings plan at the christening
It’s one of those tenderly dynastic moments that focuses the mind wonderfully on the needs of tomorrow. Which is probably why the arrival of a new baby is an excellent time for your clients to pass the hat round and to get the savings habit started. It’s not just that the longterm compounding effect of money is - as Einstein remarked - the most powerful force in the universe. It’s also that the child is ideally positioned to make the most of any unused tax breaks on income. Remember, each child is eligible from birth for a
full income tax personal allowance and a full annual capital gains tax exemption. It’s up to the family to use it.
Do We Really Need To Reduce Risk For a Baby? Whether it’s a Junior ISA or a complex legal device or just a bare trust administered by an adult, the options are as open to a small child as to any adult. Cash, bonds, high yield or capital growth - the choice is the child’s. (Or rather, its parents or trustees who’ll make the decisions.) But, to be sensible, in most cases it’s likely that the investment will remain untouched for long periods - during which it may remain poorly supervised. Parents are busy people too. The same early-start logic goes for a pension fund of course. It isn’t at all ridiculous to start one at the christening – if the grandparents agree to pay £30 a month into a fund producing 5.5% a year (after charges),
If grandparents agree to pay
£30 a month into a fund producing 5.5% a yeaR, after charges, the 6,480 in payments are likely to have become a pot of
£13,200 AT THE AGE OF 18
£175,00 AT THE AGE OF 65
NOVEMBER 2014 IFA Magazine
3
BABY’S FIRST
SAVINGS are a family statement, first and foremost.
4
IFA Magazine NOVEMBER 2014
the £6,480 in-payments are likely to have become a pot of £13,200 on the 18th birthday and £175,000 at age 65. And that’s assuming no further in-payments after age 18. It looks like Einstein was right. But hang on. Isn’t it a bit counterintuitive to opt for the relative safety of an income investment for such a young child? Surely the Barclays Equity Gilt Study taught us long ago that UK shares – as measured by the Barclays UK Equity Index - have produced an average real annual return of 5.5% over the last 50 years, compared with 2.5% for gilts and a pathetic 1% for cash? And surely, history tells us that even the worst equity crashes reverse themselves. Isn’t it enough that the sprog’s nestegg would have the next 18 years in which to recover lost ground?
That Protective Instinct Well, maybe. But there’s a particular reason why safety is attractive when it comes to babies. We humans are born with something called Loss Aversion imprinted on our primitive brains. If push comes to shove, and if all else is equal, we would rather avoid the risk of a loss than enjoy the chance of a gain. Strange, but we’re just made that way. And it’s never more relevant than when we’re looking down onto the gurgling, vulnerable infant at the font. Never mind the mathematics – and they’re not that bad, actually – the relative safety of income investing is likely to prove one of the best ways of separating grandpa from his cash. The sentimental old softie. And remember, it can be IHT-efficient too.
SCHOOL DAYS
“ And then the whining schoolboy, with his satchel and shining morning face, Creeping like snail unwillingly to school”
S
hakespeare’s generation didn’t have the opportunities that today’s youngsters enjoy, of course – but nor did they have to grow up in a world where if you weren’t educated you weren’t going to get a job. And these days, the better the education, the better the child’s chances. It’s no surprise, perhaps, that despite spiralling fees, there are now 620,000 children in independent schools - about one in fourteen children nationally or one in six in London. Day-school fees now average £7,500 a year at age five and well over £12,000 at secondary level. It could all tip the scales at £130,000 just for the basics – equivalent to nearly £250,000 for a 40% taxpayer. How to pay for all this? Bearing in mind, of course, that it comes out of the parents’ after-tax income? Well, it used to be common to set up covenant schemes that would mitigate the tax costs, but nowadays the tax opportunities revolve around trust planning – and, of course, funding the expense through the child’s own
unused allowances. (Warning, however – the exemption won’t usually work if the assets come ultimately from the child’s parents. Better to fund the scheme through capital gifts from grandparents or other relatives.)
620,000 Children in independent schools
Shorter Term Need, Lower Risk Appetite There are specialist advisers who do nothing else but set up these schemes – some of which are not much more than ‘holistic’ diversionary tactics that aim to utilise all available resources – perhaps by re-assigning life policies or investment bonds. But what they all have in common is that they’ll encourage the client to ‘lock in’ the growth as far as possible. It would be just disastrous if junior couldn’t make
it through school because the fund had bombed. Remember, unlike a new baby with an 18 year savings horizon, your schoolchild may have only a five or six year window within which to get it right. Income funds have an important role to play here. And for most, an predictably unadventurous balance of risk will fit the bill in most cases. But of course, the decision on exactly how much capital risk can be tolerated - if any - is a very personal one which requires intense care at the planning stage. IFA
NOVEMBER 2014 IFA Magazine
5
That Long Term Perspective
Andrew Wheatley-Hubbard Portfolio Manager, Blackrock Global Income Fund
We think about companies which are not just about getting a dividend today, but much more importantly, about the dividend that you’re going to get in five years’ time.
6
Andrew Wheatley-Hubbard believes that when it comes to looking at investing throughout a lifetime, it’s all about the long game and getting in early. He also says that it’s better to be a tortoise than a hare. Andrew and co-manager Stuart Reeve have worked together since 2009 and run the BlackRock Global Income Fund since launch in 2011. By investing in high quality, dividend paying companies with the capability for sustainable yields, the fund has achieved 8.9% annualised returns, net of fees, since inception - and the portfolio yield increased by 10% in 2013. A longer time horizon is always better: “Imagine buying a stock today which currently shows a yield of 3.5%. Think of that as the cash payment you could expect to receive, relative to the purchase price (Dividend / Price). 3.5% might not seem particularly high but assume the yearly cash payment grows at 6% p.a.* and see how the story changes. After five years of compound growth you could find the cash payment now represents a 4.7% yield based on your original purchase price from five years ago. After another 5 years it could have grown to 6.3%. Another way to think of this is imagine investing £100 on day 1 and receiving £3.50 of dividends during your first year. That is your initial 3.5% yield. If the dividend grows like in our example then after 10 years your income could be £6.30, or a yield on your original investment of £6.30 / £100 = 6.3%. However one should consider that inflation will have reduced the purchasing power of our £6.30 and that capital value and dividend income is variable and not guaranteed.” “Try thinking about this as someone planning for their retirement. On the day that you put your investment in,
that yield might not seem necessarily that attractive. But if you’re looking at a 10 or 20 year horizon, what that means is that you could find that after 20 years you’re getting a 10 or 11% yield on your original investment.” He highlights three key aspects of the fund. “First, we are at the lower risk end of equities. Second there’s our focus on quality, and the third issue is getting people away from thinking about the benchmarks. The market has gone too benchmarkorientated.” The same multiplier effect applies to choosing investments. “We think about companies which are not just about getting a dividend today, but much more importantly, about the dividend that you’re going to get in five years’ time. So it’s not just about the growth this year - it’s about the long term.” “In the short term we know it’s about valuation. It’s all about sentiment and emotion, but over a five year period, 80% of equity market returns come from the yield you are paid, and the growth of the profit/dividend.” As for when people should buy the fund, Andrew thinks the best time is when an investor wants exposure to equity markets, with lower volatility, but not at the cost of giving up returns. As Andrew said, more tortoise than hare! Source: BlackRock. Annualised performance since Fund’s inception on 06.05.2011 to 31.10.October 2014 in sterling terms, dealing bid-to-bid prices with net income reinvested, net of fees for A Accumulation Unit. *As of 21/11/14, the historic 5 year dividend growth rate of companies in Benchmark was 6.2%, MSCI All Country World Index. Past performance is not a guide to future performance and should not be the sole factor of consideration when selecting a product.
IFA Magazine NOVEMBER 2014
IFA Ma
Compatibility: Requires IOS 6.0 or later. Compatible with iPhone, iPad, and iPod touch. This app is optimized for iPhone 5. Available on Android. IFA Magazine App.indd 1
Twenty Four Seven IFA Magazine, Britain’s premier online portal and print publication for financial advisers, has launched its ver y own app designed to help you stay up to date with all the latest financial and economic news as it happens.
Main Features: Reviews Features Funds Market and Economics Trading Expert FCA Compliance Jobs
21/11/2014 09:43
W
e’ve already agreed that there are times when a young man or woman can probably afford to rip it up and live dangerously for a bit – perhaps by taking a higherrisk position in the knowledge that if it all goes wrong they’ve still got another forty years to recover their losses. But, as we’ve also stressed, risk isn’t such a great thing if the money involved belongs to your infant child, or your parents, or if it’s been earmarked for school fees, marriage, house buying, future healthcare needs or retirement. Income investing can be a family thing, and psychology plays an important part. That’s why this section of this report is probably the most important of all. Today’s young-to-middle-aged saver
is coping with all kinds of pressures – so much so, it seems, that it sometimes seems he (or she) can’t afford to save at all. And yet these three decades of life are the ones in which the foundations are being laid down not just for the client’s own future, but also for his or her family. Getting the right mix of safety and risk is crucial throughout – and, although it isn’t that hard for an outsider to identify the client’s needs and priorities, it seems to be darned hard work persuading him or her to choose the right courses of action. But let’s get back to Shakespeare, who knew a thing or two about the essential stages of life even if he didn’t always hit quite the right notes for all of us. As we’ll see:
The STUDENT “And then the student, on learned erudition bent With solemn morning mien and pot noodle belly And chirping smartphone bearing text and twitter feed…”
N
o, you’re right, the quote’s a fraud. Shakespeare never wrote much about student life. Fat magistrates and bawdy alehouses were more his sort of territory. But then, a few new stages of life have entered the picture since the Bard’s day. One of them is that college study is pretty well compulsory for kids who want to make good careers. But it’s still diabolically expensive. The students of Shakespeare’s era had rich dads and gambling debts; today, however, they have student loans that can run to £35,000 by the time they’ve got their degrees. And that’s not counting the cost of the gap year in Peru, or the car that they can hardly survive without. Being a student takes a bit of planning for. We just talked about the importance of using junior ISAs, child trust funds and other ways of getting parental money into place ahead of the event. And, as we agreed, the majority of this money will usually have been invested
8
IFA Magazine NOVEMBER 2014
by the family and then left untouched, because most parents are too busy or too unfamiliar with investing to do it in any particularly hands-on way. Equally, although every case is different, it doesn’t take a lot of thought to appreciate that students’ future financial interests are probably better placed in reducedrisk investments where the pain of potential loss won’t be quite so personally felt.
student loans can run up to
£35,000 What works in this interim situation? Possibly a blend between a higher-yield equity income fund and a bond fund. Then again, we’ve also been intrigued by some short-term high-yield bond funds, such as one we’ve seen from Wells Fargo which is producing a steadyish 4%-4.5%
yield from a 150-strong portfolio of quality US corporate paper with average maturities of two years or so. By surfing the borderline between higher risk and short maturity, they say, capital risk can be reduced to a minimum; they haven’t had a default in 12 years. There is, of course, the small complication that the cash in a junior ISA, a child trust fund or a blind trust is very likely to have been transferred into the student’s eager hands at age 18. It’s a good moment for parents to teach him, or her, a little financial planning. And then cross their fingers. And hope…
Image: www.flickr.com/Sergio Vassio Photography
The Student, the Lover and the Mortgage Warrior
Image: www.flickr.com/Sergio Vassio Photography
The LOVER
“And then the lover, sighing like furnace, with a woeful ballad made to his mistress’ eyebrow.”
S
hakespeare is back on message here, thank goodness. The path of true love doesn’t lead to the altar so often these days – which is almost a good thing, since the average wedding costs nearly £25,000 – but there’s (almost!) nothing quite so guaranteed to turn a girl’s head as the thought that her partner shows signs of being capable with money. (And, I’ll add hurriedly, he’ll be likewise reassured if she’s similarly savvy.) Couples never run out of things to spend money on. Whether it’s romantic holidays or car repairs or having the latest iPhone, it will all take precedence over saving for the future. Which is one of the reasons why so few people begin saving before age 30, unless of course they’ve been strong-armed into starting a pension. With the one exception of saving for a house purchase, of course. Getting a deposit together is one long, tedious struggle without the added complication of capital risk. That’s one very good reason for playing it
relatively safe with a well-judged income investment, rather than an allor-nothing lunge at the latest social media IPO. But, apart from that, if there’s one time in a person’s life when longterm equity investment risk becomes palatable, it’s when they’re earning but have no commitments. These are
£25,000
AN Average wedding costs nearly
bond fund that’s able to use leverage, although usually only for the purpose of hedging. (Even the median performers here have been making 7% a year recently.) Or any number of income funds that promise high returns from emerging markets or recovery situations. As long as they’ve been structured so as to return most of the gains as income, there’s plenty of choice.
the periods where a carefully-selected but ‘adventurous’ fund might suit. Such as? A higher-yielding bond fund that may provide total annual returns of 7-10% or more in the medium term from sub-investment grade corporate bonds. A strategic
NOVEMBER 2014 IFA Magazine
9
The Mortgage Warrior “Then a soldier, full of strange oaths, and bearded like the pard…”
W
hoops, it looks like Shakespeare’s gone off the point again. The swaggering swordsmen of Syracuse and Verona are worlds away from the hard-working family men whose cutting and thrusting is more likely to involve a brolly on the train, or perhaps a skirmish over promotion to the corner desk. Life might have been safer than in the Bard’s day, but it’s risky enough as it is - and it’s stressful too. You won’t need any introducing to the mortgage warriors. From now until their late forties they’ll be raising kids, paying for schooling, trying to move to a better neighbourhood, and cursing the neighbours for having bought a flashier car. They’ll be paying into a pension, but otherwise they aren’t finding saving as easy as it was five or ten years ago. The squeezed middle-age and middle-class are a real demographic phenomenon. The point here is that the mortgage warriors don’t have money to burn. And, although the fortysomethings may be approaching their lifetime earnings peak, it won’t feel like that because it goes so fast. They may be supporting other relatives - perhaps with care, perhaps
10
IFA Magazine NOVEMBER 2014
with cash. They may be experiencing health hardships of their own. If possible, of course, we’d like to see them putting money away for their own children. And conversely, they may come into inheritances, which are another subject entirely. They’re more likely to be running a lot of insurance policies.
The squeezed middle-age and middle-class are a real demographic phenomenon.
An Extended Middle Age? And then there’s the question of portfolio balance. Ten years ago we’d have said that a 50 year old man was getting within sight of his eventual retirement, and that he should start shifting his assets away from equities and into fixed interest. (1% of your portfolio in bonds for every year of your life used to be a sort of watchword.) But it’s questionable whether all that could be said to apply any more? For one thing, bonds are now pricey enough to be regarded as a bit of a capital risk in their own right – and, for another, he’s likely to be retiring
five years later than his antecedents, so the ‘risk clock’ has been put back by a couple of hours. The structure of an income portfolio for him has changed just as much as the reason for doing it in the first place. So should a 50 year old be taking more risks than his old dad? Actually, with 16-18 years to his probable retirement, and with bonds the way they are, there might be a good case for it. Hey, it’s the way of the world. And look, he’s probably got a pile of ripped denims and a cherished stack of Sex Pistols discs to prove it…..IFA
Europe’s Strong Potential
Andreas Zoellinger Co-Manager, Blackrock Continental European Income Fund
We think that dividend growth is going to be close to earnings growth, maybe a little bit below. But in general we remain constructive on the markets.
Andreas Zoellinger manages the BlackRock Continental European Income Fund alongside Alice Gaskell. And, he says, European markets are ideally suited for income investors. Not just because Europe is a large and liquid equity market, with some of the highest dividend yield rates to be found among developed regions. Or even that it boasts many quality and well-run businesses which are exposed to international growth. But that generally, it’s a less mature market than the UK, or the US. Zoellinger completely agrees that the fund’s clients’ investment priorities evolve as they move through their lives - from growing their wealth when young to wanting a regular income drawdown that can meet their financial needs when they reach the later stages of their lives. The problem is, he says, that with today’s low interest rates and increasing market volatility, they will likely have to find new ways of reaching their key goals. For those prepared to take on the associated risk, dividend-paying European equities could be an important part of the solution. Generally, Zoellinger is upbeat about prospects in Europe. “Quite clearly, European equity markets have performed quite strongly over the last few years on the back of a very strong multiple expansion.” And the outlook for the next 12 to 24 months is a pick-up of the macro economic momentum, he says. “All of the lead indicators in Europe are consistent
with one to one-and-a-half per cent GDP growth, and also with around 8% earnings growth over the next 12 months.” “We think that dividend growth is going to be close to earnings growth, maybe a little bit below. But in general we remain constructive on the markets. Valuations are clearly not as attractive as they were two to three years ago, but they are very much in line with the long term averages. With an improving macro environment and a continuously falling political risk premium, we definitely think that there is more upside in absolute terms to European equity markets over the next 12 months.” The fund has achieved an impressive 4.4% net yield (30th September), with 9.3% annualised total returns since inception, and with a claimed 11% less risk than the market since inception. Source: BlackRock. BlackRock Continental European Income Fund 12 month trailing yield, as at 30 September 2014. Fund inception date: 06.05.2011. Fund’s annualised performance: 9.25%. Performance is shown in Sterling terms and is based on published dealing bid to bid prices with net income reinvested, A Accumulation Unit, net of fees, as at 30 September 2014. Relative volatility ratio (Fund vs Benchmark): 89.4%. Calculation based on annualised standard deviation since Fund’s inception (6 May 2011), A Income unit, net of fees, as at 30 September 2014. Past performance is not a guide to future performance and should not be the sole factor of consideration when selecting a product.
NOVEMBER 2014 IFA Magazine
11
The Pensioner, And Beyond And so we come to the final two stages of an investor’s life – the stages, you might suppose, where the wise saver gets to enjoy the fruits of a lifetime’s sensible planning. And you’d be right, obviously. If the investment pile has been well judged and well protected, the golden autumn can be secured - assuming of course that health and mobility remain strong. As you’d also expect, the evolving needs and priorities
of a saver also change as the ‘time horizon’ (is that a good enough euphemism for you?) becomes a little less infinite, and then progressively less until, like a bond, he eventually reaches his redemption date. (Sorry about that.) And as you’d also expect, the younger clients won’t even look at the realities of older age unless we encourage them to. More’s the pity. They have a lot to learn.
The Playboy Pensioner The sixth age shifts Into the lean and slippered pantaloon, With spectacles on nose and pouch on side… It’s a bit of an oddity that we should use the phrase ‘Third Age’ to describe what Shakespeare clearly thought of as the sixth and penultimate stage of life – but then, in those days I suppose life was ugly, brutish and short as well, so perhaps we don’t need to need to take the Bard too literally on that score? It also comes a shock to discover that, barely forty years ago, your 55th birthday was widely considered to be the point at which you ought to start tidying up your papers and getting ready to wind down. You were expected to start trading in some of your equity portfolio (or the equity parts of your self-employed pension funds, should you have such a thing) for bonds and cash deposits, in readiness for picking up your pipe and slippers at 60 or thereabouts something that not very many people would recommend right at this moment. But then, back in 1984 a man aged
12
IFA Magazine NOVEMBER 2014
65 was only expected to last another 13 years, of which ten years would be in good health - and a woman might get 17 years, of which 12 would be healthy. These days the man could reckon on another 19 years of life, and the woman another 21 years. So yes, at 55 they’d currently need to be budgeting for the thick end of thirty years - and forty if they reckon their chances of beating the average. So, finally, we get to the point. Today’s pensioners have been in a fix - shorn of their final salary pension entitlements but also getting a raw deal from annuity rates that are still falling away steeply as we write.
Pensioners aren’t at all like their parents. They’re fitter, more health-conscious
It’s that delicate balance between tightening fixed interest yields and a longer life expectancy horizon that is
making so many of them reconsider the advantages of taking on more risk that their parents would ever have dared to do. Income strategies are still the ideal way forward for this cohort – but yesterday’s super-sage preferences won’t completely fit the bill.
Health and Wealth That’s because today’s pensioners aren’t at all like their parents. They’re fitter, more health-conscious and often better fed. Unlike my own parents, who grew up expecting the National Health Service to fix their bodies regardless of what they did to them, today’s Third Agers regard their own health as a collaborative effort in which a sensible approach to exercise, diet and mental stimulus are a part of the deal. But the most important way that today’s pensioners distinguish themselves from their predecessors is that they’re asset-rich, even if they
happen to be cash-poor. The arrival of equity release schemes gives the beneficiaries of the housing boom a safety net which they probably hope never to need. The ability to trade down to a smaller, less demanding home is another. Together, these two developments are a game-changer.
Resetting Our Expectations Between them, the Third Agers undermine the logic of accepting the need for absolute-minimum-risk investment in what might prove to be only the opening decades of a very long retirement. As advisers, we’d probably be wrong to encourage these clients to go long on high technology and frontier markets; but the other, ultra-safe extreme options are all wrong as well. As Blackrock’s Head of Sales Jeremy Roberts told IFA Magazine only in September 2014, tomorrow’s pensioners just aren’t taking enough risk to secure themselves a properly funded retirement.
Mr Roberts was, of course, talking about people who were still saving, rather than those who’ve cashed in their pension funds and retired. But one of the things we can certainly expect from next April onwards is that many new pensioners will be hanging onto their investments and managing them actively until 75 and beyond, with or without drawdown. That’s another game-changer.
harder sell these days because of the particular point of the investment cycle at which we currently find ourselves. But, as we’ve seen elsewhere in this report, there are many bond portfolios which are still giving equities a good run for their money.
What’s The Ideal Recipe? What will the Third Agers want from their income investments? A high degree of capital protection, probably, given that their pension pots still need to last for the rest of their lives. On that reckoning, large and capital-heavy income stocks will continue to be favoured - even if a few sectors among them (mining, banking, chemicals) have fallen by the wayside over the last six or seven years. Income funds based mainly on bonds rather than equities are a NOVEMBER 2014 IFA Magazine
13
Taking Care of Grandpa Last scene of all, That ends this strange eventful history, Is second childishness and mere oblivion, Sans teeth, sans eyes, sans taste, sans everything.
H
mmm, Shakespeare didn’t exactly mince his words, did he? And not for the first time, we’d have to take issue with the accuracy and relevance of his observations. Today’s healthier pensioners don’t settle for going without the eyes and teeth bit any more than their children and grandchildren would. And as for the supposed loss of taste, I’d doubt whether it goes any further than a collection of Max Bygraves records. When it comes to enjoying life, today’s older consumers are just that –
14
IFA Magazine NOVEMBER 2014
consumers. Except that the scope for enjoyment and variety has probably closed in on them a bit. They’re well cared for, on the whole. Or, at least, they are if they’ve managed to build and maintain a sufficiently good investment pile during their lifetimes. At the risk of stating the obvious, the proof of the savings pudding is quite literally in the eating – and the heating and lighting too. If clients haven’t reached that stage of affluence by the time they need the income in their old age,
Tomorrow’s
pensioners just aren’t taking
enough risk to secure themselves a properly funded
retirement
then we as advisers have failed them. Being able to spend your hard-earned savings, and conserve your dignity and your independence, is what the whole business has always been about.
Capital Drawdown, Tax and Other Issues In one interesting respect, the objective of an income investment in old age might be quite different from the aims that apply to other age groups. Having spent a lifetime accumulating capital, it becomes rather hard to fault the logic of spending some of it. You can’t take it with you, after all. We’re not talking so much here about spending the kids’ inheritance on a Ferrari – the so-called Ski Generation are another subject entirely. Rather, it’s about accepting the opportunity for some reasonable degree of capital erosion in advanced age, for the sake of a higher income. There are income funds out there that will do exactly this. And why not? The maths and the logic of capital erosion aren’t so very different from what an annuity provider’s actuaries would expect to take in their stride – with the added bonus that the client doesn’t lose the balance upon death. It might also be appropriate to re-examine the client’s tax situation during this period. The chances are that the very elderly – and the notso-elderly, too – will be paying lower marginal tax rates on a lower income than they used to, and therefore that the balance of their investments may need checking to ensure that everything is still appropriately judged. There may not necessarily be much merit in preferring income over capital, or vice versa, if you don’t qualify for the right tax breaks. Health, Mobility & Care Needs We are, of course, in no need of reminding that the ‘second childishness’ part of the Bard’s quote still hits the mark as much as it ever used to. There are currently 850,000 people in the UK with diagnosed dementia, of whom 95% are 65 or over, and the Alzheimer’s Society
says that they and their families are still bearing most of the cost: around £17.4bn a year, compared with £8.8bn of state expenditure. The Society says it expects to see the numbers rising 1,143,000 by 2025 and 2,093,000 by 2050.
850,000 PEOPLE IN THE UK WITH DEMENTIA, Of Whom 95% are 65 or over
It’ll all have to be budgeted for. And, ideally, planned for. Funding for future old age care, whether at home or in an institution, is a prime example of “can’t risk a failure” - right up there with the children’s school fees and the deposit for a first home. As for other age-related illnesses, which account for significantly more cost than dementia, we can safely expect that the cost will rise exponentially as life spans extend and as the sophistication of treatment and care continues to grow. We would be naïve if we expected the welfare state to pick up the tab for all this – and, although it’s highly likely that the wealthiest would be first in line to lose benefits, the prospective future for those with no savings or assets at all is going to be a lot more grey, and with a lot fewer options.
the client’s decisions are correctly judged for the stage of life at which he or she finds themselves. And getting it right starts with a realistic appraisal of the planning realities. As we’ve seen, income investing is a deceptively broad church, with any number of available strategies and approaches to risk - but wherever safety and capital preservation are desirable, the sector has consistently shown its worth, and will continue to do so. IFA
Ultimately, Its About Choice And that’s ultimately what wealth accumulation is about. Money won’t always buy you happiness, but it buys you choices that other people won’t have. Possibly the most important message that an adviser can get across to his clients, at any stage in life. Certainly, the issue of financial safety becomes more urgent as the time horizon shortens – the risk preference in old age will always be on the conservative side, and rightly so – but there are other times in life when the same considerations don’t apply. The adviser’s job is to ensure that
NOVEMBER 2014 IFA Magazine
15
Going Beyond Fixed Interest
Ben Edwards Co-Manager, Blackrock Corporate Bond Fund
The UK corporate bond market and corporate bond markets in general are still hugely inefficient - they don’t operate the way equity markets do.
16
IFA Magazine NOVEMBER 2014
The co-manager of the BlackRock Corporate Bond Fund says he bases his investment philosophy on providing his clients with a very flexible approach. And it seems to be paying off. Edwards and his comanager Simon Blundell have been running the fund since May 2012 and October 2011 respectively, and under their stewardship the fund has blossomed. Originally launched in the mid1990s the fund has seen strong recent asset growth and is now close to £350m* and is currently rated by the Synthetic risk and Reward Indicator as a category three risk. (One being the lowest risk and seven being the highest). The secret, Edwards says, is that the managers like to accentuate the positives and keep things simple. “The fund was repositioned in the third quarter of 2011 with a very simple remit - which was to deliver corporate bonds to investors in a more efficient way.” “The UK corporate bond market and corporate bond markets in general are still hugely inefficient - they don’t operate the way equity markets do. They are filled with illiquidity, which
can be a positive as well as a negative. That’s because it means that the prices can move independently of fundamentals - and therefore, if we can take a long term view, we can capitalise on that.” “I need to get a return,” he says – “otherwise investors won’t enjoy the experience with the fund. But I think that what tends to be missing from the fixed income market is the risk-adjusted returns.” That’s where the team’s particular skills come in, he says. “If we look at our returns, we are clearly trying to target a top quarterly performance over a holding period of let’s say three years. We want to be in that top echelon of performers.” Who ought to be holding the fund? Edwards doesn’t try to flannel the question. “Should a 20-year-old be invested in a corporate bond fund? Probably not. But should we all be scaling up into these kind of investments throughout our career? I’d say yes, maybe we should.” “Stability and income and diversification are still the hallmarks of sensibly built portfolios, and this should be part of an investor’s approach.”
*Source: BlackRock as at 31 October 2014.