With retirees being given a wide range of options to withdraw and/or invest or reinvest their pension funds, advisers now need to consider many more factors to ensure the right selection is made for their clients, based on their individual circumstances. This case study by independent financial researcher Defaqto addresses some of those new challenges.


Despite the rise in the use of drawdown products, many adviser clients still require the comfort of a secure income for their retirement. This is particularly important now, where the retirement years are extending, as life expectancy has increased and so has the clients’ need to sustain both income and capital with their retirement funds.


In the past, clients approaching retirement had basically two choices. They could either stay invested, usually with the majority of their fund in the stock market, or use one of these two very similar strategies: 1) de-risking their investments (switching to lower-risk assets) or 2) lifestyling.


The advantage of staying invested is that exposure is maintained to equities, which have historically provided the best returns over the long term. However, equities have also been one of the most volatile asset classes and have seen some big falls in recent years.


Even if the fund is diversified, it may not be protected from a market shock. In the dotcom crash, for example, while equities fell heavily, the other main asset classes provided positive returns, so diversified funds would have fallen a lot less.


Following the recent credit crisis, though, almost all asset classes declined in value, apart from high-quality government bonds. In this case, even a well-diversified portfolio would have suffered big losses.


When de-risking/lifestyling, the risk of a fund suffering from any market shocks is reduced as the fund is moved out of equities and into fixed interest. There are, however, a few disadvantages to this approach: Missing out on the growth potential of equities, market-timing, and being dependent on retirement at a certain date.


A newer option for clients approaching retirement is where a fund manager implements a ‘targeted volatility’ approach, with the portfolio’s exposure to risky assets being automatically adjusted as risk levels fluctuate. The resulting fund performance should be smoother, with less peaks and troughs, while still maintaining the potential for healthy returns. However, although clients are much more protected from big market falls, they will also miss out on very large gains in the market.


Patrick Norwood, Insight Analyst – Funds at Defaqto, says:


“When putting together a retirement solution for a client, it is important for an adviser to analyse carefully the underlying investment options and what they do for returns and the protection of the client’s funds. The focus of this case study is on the final option above - funds which aim to deliver decent returns while providing capital protection.”