SMSFundamentals | Jul 20 2021
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Why Focus On Equities For Retirement Income
Martin Currie Australia argues that a focus on equity-based investment solutions that solve a client’s income needs is more important than ever in a post covid world.
-Retirees requiring a reliable income stream to focus on the actual dollar income generated over time
-Retirement products need to be built with the characteristics of “sufficient income for life”
-Martin Currie expects income growth for high-quality Australian equities to return to strength as business recovers post-covid
By Mark Story
Equity specialist, Martin Currie Australia, rejects the notion commonly held by multi-asset retirement products that when retirees get to age 65 they should automatically move away from risky growth-style assets, and looks to covid to explain why.
For example, for retirees who relied on predictable dividends to live on the fallout from covid was disastrous. Based on Martin Currie’s numbers, in 2020 Australian equity investors experienced a -$27bn loss of income, while term deposit investors saw their yields fall by more than -75%.
What equity-based strategies should seek to address, concludes Martin Currie, is an over-reliance many self-funded retirees have to income as a percentage of their total returns.
Martin Currie Research Highlights The Need For A “Sufficient Income” Focus
Within a white paper titled: Investing in a sufficient retirement income in a post-covid world, Martin Currie highlights what was a clear disconnect between its understanding of sufficient income for retirees’ needs, and typical defensive retirement portfolios based on the total risk/total return theory.
Martin Currie’s analysis suggests that percentages are the wrong way to think about income in retirement. What is more important, the equity specialist argues, is for retirees who require a reliable income stream to focus on the actual dollar income generated over time, rather than a headline yield percentage, which is often their primary focus.
Given that it leads to a greater focus on growth assets in the retirement mix, Martin Currie also argues that the idea of income stability is a better substitute for the risk of impaired living standards for retirees than capital or total volatility as a standard risk measure.
Unsurprisingly, Martin Currie believes income stream volatility and growth are much more important as a measure of risk than capital volatility.
In summary, the equity specialist claims its research highlights why retirement products need to be built specifically to provide retirees with the characteristics of what it calls “sufficient income for life” and cites its recent history to prove the point.
For example, despite the short-term impacts of covid on the dividend-paying ability for Australian companies in 2020, Martin Currie claims its specifically designed retirement income strategies have performed in line with its income objectives. Equally important,Martin Currie maintains that its income focus has not been compromised by the effects of 2020.
Based on the feedback from investors, institutional clients, and financial advisers, Martin Currie realised that a source of retirement income needed to adhere to four key characteristics, which when combined deliver “sufficient income for life.”
These characteristics include a high and stable franked dollar income stream to support annual expenses and income growth for inflation protection. Then there’s capital growth to manage longevity risk – aka the risk of outliving your money – and diversified growth exposures to reduce income sequencing risk – aka the risk of occurring large losses when it is difficult to recoup them.
The Problem With Defensive Assets
Martin Currie notes the sufficient income focus differs significantly from the traditional accumulation phase investment objective of maximising capital growth based on the constraints of total risk and total return.
It became evident to the equity specialist as far back as 2010 that when defensive asset yields fell, the resulting income from a traditional defensive portfolio risked sending a retiree’s hard-earned capital into a downward spiral without any capital growth to top it up.
The equity specialist also recognised that the age pension was an insufficient safety net for a comfortable retirement.
For example, to earn $51,300 income, which the Association of Superannuation Funds of Australia (ASFA) suggests a couple aged 65 needs, at a 0.3% term deposit rate today, a portfolio of over $17 million is required. By comparison, a $500,000 portfolio in 2008, based on an 8% yield, would have met all a retiree’s income needs.
By investing in high-quality companies with strong balance sheets and earnings, Martin Currie attempted to minimise the income draw down as much as possible, ensuring the long-term income potential of the portfolio remained robust, during covid.
The equity specialist expects income growth for high-quality Australian equities to return to strength as business recovers in the post-covid period.
By deploying four key factors, Martin Currie created a portfolio that varies significantly from both traditional equities and other income-focused approaches. Firstly, to avoid income shock, the equity specialist built its income portfolios from stocks based on their ability to pay what it calls a forward-looking sustainable dividend.
Martin Currie’s analysts also screen for quality companies with less volatile income than the market. By using a non-benchmark portfolio construction approach, security and sector concentration risk is also limited to ensure a more stable income stream, while avoiding income shocks.
Fourthly, Martin Currie recognises the value of franking credits within its investment process and seeks to maximise the after-tax income for 0% taxpayers. This is done by actively selecting companies that both have a high rate of franking and pay sustainable dividends.
By deploying the above strategies, Martin Currie expects the next twelve-month income stream of its sufficient income for life-focused strategies to consistently remain higher and more stable than the peer strategies analysed. By comparison, Martin Currie notes defensive strategies are well below the required level of income.
In summary, the equity strategist concludes that by deploying a greater focus on stocks through the four abovementioned drivers, lower volatility capital growth can be achieved.
Having aligned its portfolio construction methodology with inflation drivers specifically for Australian retirees, Martin Currie does not believe retirees should look to global equities or global fixed income for most of their income requirements.
While offshore investments are often seen in traditional 70/30 and 30/70 balanced funds, the equity specialist believes foreign exchange risk, rather than adding diversification, introduces an additional unintended risk in the volatility of the income stream.
Given that broader Australian equities are not a particularly good mirror of the effect Australian inflation has on long-term retirement income requirements, Martin Currie has structured its portfolios to have better diversification across the domestic economy, in sectors such as consumer, financials, and real assets. As a result, income growth is more linked to retiree income needs.
Focus On High Dollar Income
Overall, Martin Currie believes that by focussing on providing high dollar income, rather than on capital returns, it has been able to provide better income outcomes. Also contributing to high levels of capital, both when paying out actual dividends and the ASFA standard, there is less need to draw down capital to provide a sufficient income.
From Martin Currie’s view, the same cannot be said about defensive assets or even a high yield approach that has impaired its capital despite a high headline income. While term deposits may have a stable capital base when only actual income is paid, Martin Currie reminds investors this income alone is woefully insufficient versus the AFSA standard.
The bottom line is if you are not invested in growth assets, you will quickly run down the value of capital, and this creates longevity risk. Similarly, by focusing on strategies that improve both growth and income, you can better meet the needs of income and capital protection.
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