Lessons from growth investing

Why flexibility? Because it allows your clients to take on investment risk. Flexibility is the key requirement to ensure success of the retirement plan – that is to say – a preparedness to adapt to conditions during retirement. With whatever comes out of the current FCA ‘Thematic Review of retirement income advice’, firms will need to ensure they can meet the required level of due diligence and research in this area.

We looked in some detail over the last couple of editions at the role of due diligence and research to support recommendations in general. Today, in a departure from our more typical format, we will look at the practical side of researching and evidencing the kind of investment strategies that advisers are increasingly recommending to their clients at retirement.

Each firm will have their own particular approach - to pulling together their Centralised Investment Proposition and their Centralised Retirement Proposition, working out their own contact strategy and how they formulate reports and evidence recommendations. But the basics are the same. When advising retirees, the key questions are - how much income is required, how much is available and how long will funds last?

The central contention here that if you have access to the kind of research available in Synaptic, then financial planning can be taken to the necessary level, where a framework for distribution of funds over the longterm can be set up and the highest level of evidencing and disclosure can be met.

Since Osborne’s pension freedoms and the abolition of compulsory purchase annuities, our customers have taken on a far more active role in the retirement plans of clients. The evidence points to the great job they are doing. The regulator is very nervous however, recognising the potential harm to clients should things go wrong, which is why Consumer Duty has become so prominent with its fiduciary principals. From a financial planning perspective this area is all encompassing, from client risk profiling to layered tax efficient strategies for the provision of income over the longterm.

With retirement funds there is no room for error or complacency. The opportunity to support a client’s financial security through retirement is a job of rare responsibility, and advisers must be sure of their approach and build in the necessary safeguards in respect of the strategy to ensure there is minimal risk of running out of funds. Hence the absolute importance of the quality of research, service and the stewardship offered by firms to clients through retirement.

The FCA, the risk ratings agencies (including Synaptic) and academics all share the same conviction that there is a shift in how advisers should approach investment risk as part of the transition from accumulation through drawdown, if the opportunity to replenish funds through savings is removed from the equation at retirement. This must mean that the advisers must balance the most important equation in financial planning - which is how to capture investment returns without compromising the integrity of the client’s financial plan, putting in place a strategy that is capable of working over decades.

We will look now at how research and due diligence can support such a strategy, and how the calculations can be presented to the client to ensure their buy in. The central role of research here is to demonstrate that if a client has flexibility and understands that there may be times in the retirement journey where adjustments may need to be made to spending to allow funds to replenish, then the returns from investment over the long term can be sought out without fear.

A well-structured retirement plan has the following attributes:
› Firstly, the plan should be simple and easy for the retiree to understand. Some thought needs to be given to how the plan will be managed in the latter stages, when the retiree’s faculties may be failing.
› Has sufficient margin been provided as a buffer to poor performance in the markets? Has stress testing provided enough headroom for a wide range of eventualities?
› Most advisers have customers who they feel are overly cautious. Another issue is to present the plan in such a way that the retiree understands that they can safely drawdown funds and live their best life.
› The role of investment is paramount. Markets can and do lose significant amounts of money in the short term, however forecasts of market returns can become more reliable over the longer term.
› In this day and age, firms have access to fantastic and robust investment vehicles from a range of asset managers. It is essential that firms use research to ensure that product, platform and portfolio arrangements represent value for money and provide the necessary level of reporting and service. Though still common, there is no need for clients to be paying 3% or more, ad valorem on their retirement funds when equal or superior custody can be set up for half that. The lost 1 or 2% will have an enormous impact over the long term if clients are losing the benefit of compounded growth.
› Another observable pitfall is where firms run (often expensive) discretionary portfolios that are not well constructed (cost or diversification) or are not properly aligned to the correct risk profile. Often eye catching, but esoteric and unreliable funds are chosen because they look good on a portfolio fact sheet, but they suffer damaging drawdowns in times of turbulence. Investment in portfolios which are regularly churned because of market conditions are almost certainly not correctly risk aligned and will almost certainly suffer from mistiming. We have seen this a lot over the pandemic market roller coaster. Well designed investments are designed to perform over the longterm, not require constant speculative adjustments.
› The rates available for annuities should always be considered, because there are times when they absolutely make sense, including consideration as to whether a portion of the client’s income should be annuitized. At the time of writing, at age of 65, 5% per annum can be bought, as a single life, escalating at RPI. 

An ‘at retirement’ case study

Here is a worked example of a retirement case, showing the various research elements provided by Synaptic.

Our couple are retiring at 65. He has £550k in DC pension, both are entitled to state pension, and she has an NHS pension which is worth £12,500 p/a. They also have £150k in ISA’s. Our couple have two children, so wish to ensure a legacy, and they have no outstanding debt having paid off their mortgage. Both he and she are Balanced investors according to their risk profile, as established through use of the integrated A2R questionnaire in Synaptic Pathways.

I wish to provide due diligence and research to satisfy the following two purposes:
1. Ensure that I provide the best advice and my expertise as an adviser is complemented by the quality of the arrangements I put in place and my ability to explain in detail to my clients what their retirement should look like.
2. I am fully compliance covered, with the minimum of additional work. This is no small undertaking in the age of Consumer Duty and MiFID II. I need all the relevant disclosure on costs and charges, as well as cashflow analysis and full financial planning support.

A range of research is conducted for this recommendation:

1. Define a portfolio that reflects my clients’ ESG preferences and convictions for use in the pension investments:

 

 

 

 

 

2. Switch from his legacy pension provider to modern platform with drawdown facility, reporting and contract enquiry to facilitate future reviews and modern charging. I need a critical yield and hurdle rate for compliance.

 

3. I need a forecast of returns from the pension to validate the plan and a detailed breakdown of costs for the first 12 months as per MIFID II requirements. The Synaptic system uses contract enquiry (manual input) to allow a review of the holding to be conducted at any time. Conducting reviews on this holding will only take minutes going forward.

Here is the summary of results page from my research. I can look at the impact of costs on growth and a full inflation analysis (using Moody’s stochastic methodology) from the display options:

 

The report includes cost analysis using 2 COBS approved methodologies: stochastic and deterministic. The former is more useful for financial planning (as it is probability based), the latter is good for cost analysis (RIY calculations, because it is linear).

Here you can see where the portfolio sits in the efficient frontier, as a balanced investment. We will be reusing the Moody’s calculated nominal growth rate of 7.68%.

4. 

 

5. Here is the ex-ante table, included in the report. The system knows all the costs – platform, product, portfolio, special deals and adviser charging. Note the costs are presenting as % and ££ for the first year. Also notice costs by line item including transaction costs for MiFID products.

 

6. The next piece of research is to demonstrate the viability of a 4% withdrawal from his pension pot (once the 25% tax free portion has been deducted). In the first graph, the 4% drawdown rate of £16,420 is used. The graph is calculated stochastically, to show the likely value of the fund after 30 years of drawdown. You can see that at this rate, the pot size is likely to grow. In fact, further ‘what if’ scenarios show that our ‘age of ruin’ only appears at an income level of around £31,000, around double the proposed level, so there is comfortable headroom. The calculations are stochastic, using the Moody’s engine, so represent the expected, or average results from the simulation. The graph also includes the ‘best and worst’ results, measured from the 5th and 95th percentile of the stochastic simulation.

7. Our clients’ ISA savings have been invested in money markets and balanced multi-asset portfolio with BNY Mellon. These finds are intended to provide additional spend in the early years when holidays and improvements to the home are expected, that may require funding in excess of our income provision. It is easy to supply the due diligence for this holding using Synaptic Pathways and set up the holding ready for future reviews using the ‘convert to holding’ button (top right of screen):

8. I can then use Synaptic Pathways integration with Webline to quote (and e-apply) for an annuity from my panel, purchased with the 25% cash free element of his pension, to value of £137,500. I can secure £5,505 p/a from L&G, with RPI escalation:

9. The final screen from the retirement income cashflow tool shows how the different elements of the plan hang together, contributing to the annual target of taxable income. All income is inflation protected, or in the case of the pension funds, is expected to grow at a rate in excess of inflation.

Summary

› The research that has supported the financial planning exercise for our customers has enabled a blend of ‘safety first strategies’, including purchase of annuity alongside investment growth strategies (pension and ISA savings).
› The stochastic calculations that the Synaptic tool has been able to provide as part of the research are all probability based and indicate a high degree of success.
› Each element of the plan is supported by detailed reports detailing the custody arrangements and underlying investments, offering proof of suitability and evidence of costs (MiFID II). They are fully complaint illustrations incorporating Moody’s stochastic forecasts.
› The plans are now set up in Synaptic Pathways as holdings which can be updated and reported on at review with minimal effort for the firm and maximum compliance. Furthermore, all of the elements will roll through the retirement period, potentially with little need for adjustment. As the term progresses, the adviser can help the couple with additional spending, gifts or other planning objectives.

So, what of the need for flexibility? The adviser needs to explain to the clients that the investment portion of the plan must be carefully monitored to ensure that the drawdown amount does not lead to significant depletion of funds. If a lower rate can be used in the event of market down turns, then funds will replenish and the legacy value of the pension will be assured, providing options for care funding in later life.

Without good research and flexibility, a probability-based approach is less safe and more difficult to manage.

If your firm is considering how it conducts due diligence in respect or retirement income, please get in touch for a demo or a trial of the new Synaptic Pathways suite.

Get in touch

www.synaptic.co.uk
0800 783 4477
hello@synaptic.co.uk