Kevin Frisby from LCP, JLT Investment Consulting's Allan Lindsay, Axa IM's Yoram Lustig, HR Trustees' Giles Payne, Aon Hewitt's Ryan Taylor and Bruce White of LGIM discuss how schemes can invest in DGFs in the post-Budget environment, in the final instalment of a four-part panel discussion.
Ryan Taylor: The definition of drawdown is now effectively rewritten. It is no longer what you and I would have known six months ago, pre-April. It is now someone who has their pension fund and is going to say, ‘I want a bit of money today. I do not want anything else. Then I will come back in six months.’
They do not want income funds, because they are not taking an income; they just want something that is going to be ticking the boxes, no surprises. The type of investment strategy we are talking about kind of fits into that solution.
Kevin Frisby: I agree. I do not think there is any sort of sharp change when you hit retirement. There is no cliff edge in terms of the type of investment you need. It does not have to have a focus on income. I think traditionally we have thought, ‘Let us have a multi-asset fund and let us just spend the income.’ However, if it is relatively liquid you can just consume it at the rate that you want to.
Giles Payne: It becomes important how you structure the fund containing illiquid assets in that sort of environment. The illiquid assets will not need to be sold into the market in normal circumstances. It becomes a pricing issue so that you ensure people are getting fair value whether they are buying or selling units.
Frisby: This is where the DGFs have probably missed a trick. They have kept themselves highly liquid. I think they should be trying to find a way to harvest an illiquidity premium if possible.
They are not doing that at the moment. This is especially the case in the defined contribution space. They are hung up about it – ‘I have to have daily liquidity otherwise I am not going to get on platforms’. However, everybody knows that you do not need daily liquidity.
Allan Lindsay: I think the design of the post-retirement part needs developing. Some of the rules that surround it probably need to be loosened up to make it work.
I think people are familiar with the idea of buying an annuity and the certainty that this creates. The illiquid bucket will probably have to be sold, not in target dates, but in vintages. You would have a 2014 illiquid bucket that could be expected to last 25 years. That sits at the bottom. Then you have this liquid bit which will need to be low-volatility, because at the end of the day, in five or six years’ time, it will not be a surprise to find people on their smart phone paying for things using their pension pot.
Payne: It goes back to this illiquidity. It is illiquid in the market. It does not have to be illiquid to the member if the manager is not going to sell it. It is a pricing issue for fair transfer between members.
Frisby: We do not think people will necessarily use that pot and just draw down and exhaust their savings. I think at some point they may use the rump of that and buy an annuity, which means they still want liquidity for that flexibility.
You will no longer have to buy an annuity at any point in time. I would suggest you buy it when it is cheaper. Therefore, the last thing you want is an annuity-matching fund. You want an annuity-mismatching fund. You want something that will hold its value when annuity prices come down. You can then opportunistically switch.
Lindsay: If you look to the future there is no reason why, when you are looking at your pension, you cannot set parameters for purchasing an annuity. If the market offered you a pension that satisfied your criteria, then it could be purchased immediately as you would have already given your authority for the purchase.
Taylor: The definition of retirement has changed. I therefore think the decision will be delayed. I think there will still be a requirement. Annuity sales are down 50 per cent. However, I think that reduction is it; it is just a moment in time. Whether it is age 75, 80 or whatever, people will get to a stage where they go, ‘I just cannot deal with this any more. I cannot deal with watching my fund and doing this and that. Just give me my income in retirement and I am out of here.’
Lindsay: I think people will buy annuities. But I do not think they will do it in the current way. They will also not buy as many of them. Additionally, I think people might start asking for the idea of a five-year annuity, or similar. Individuals will have their own predictions about their life expectancy.
Bruce White: There was not much of a cultural appreciation of annuities in Australia. Therefore, relying on high-dividend yield bank stocks and cash is seen as a good strategy when cash is not at 0.5 per cent.
There is a risk generally with any sort of DC system that whatever the default is, will become what most people do.
Members with large pots will leave the system and get good quality advice. Very small amounts might be cashed out. It is therefore people in the middle who the default strategy should be designed around; they are likely to go into some kind of drawdown.
Frisby: I think to a certain extent it depends on the trustees or whoever is designing the plan. For some of them, the trustees might say, ‘At retirement, we do not want to make any provision.’
The trustees have to decide, ‘Are we going to provide a facility for these individuals for the next 30 years to have drawdown within our scheme?’ There is obviously a huge cost-drag from that. Or are we going to say, when you retire, ‘Thank you very much. You go into the open market and then you are on your own.’
