Prudential - Blending solutions to provide more income stability
29 June 2020
Overview
The recent stock market volatility & economic uncertainty caused by Coronavirus means that financial advisers should be on the front foot when it comes to providing support and advice to their drawdown clients.
It’s likely that some advisers have already started to bring forward client reviews so they can assess how the client is feeling, does drawdown still meet their objectives, does it still fit with the client’s attitude to risk and capacity for loss threshold? Many clients will have exceeded their capacity for loss threshold, which could mean a rethink of their current investment strategy.
Clients will also need a review of their current income strategy. Maybe this needs to change because their consumption has and will continue to fall in lockdown and for some time thereafter. Or maybe post-crash it’s established that the current income is no longer sustainable, or perhaps a combination of both.
Much has been written that the flexibility provided by no limits for drawdown income creates a problem for advisers in determining what is a sustainable withdrawal for clients. Sustainability of income is a concern for clients, advisers and the regulator alike and the recent market events has potentially compounded this problem.
Going forward & continuing in drawdown there are a number of risks that clients need to avoid. Insufficient returns, sequencing of return risk, taking too much income and timing risk being some of the main ones. All of which are exaggerated by market volatility.
Some of the solutions available to offset these drawdown risks are listed below, alongside their limitations
| Possible Remedies...? | Limitations |
| Draw from cash | When interest rates were higher this was a simple way to protect from reverse pound cost averaging in the early years. Interest rates today make this unattractive. |
| Take the natural income from the fund | Funds must be matched to the clients’ attitude to risk and also the actual income paid may not reflect clients’ requirements. Going forward will there be sufficient dividends in this period of economic uncertainty? |
| Time the market, take income from the right assets at the right time |
Costs of advice/process prohibitive for some investors. Size of portfolios and depth of asset diversification could be difficult to achieve for some clients. |
| Safe withdrawal rate | Much has been written about safe withdrawal rates. Every client is different, so how can there be a one size fits all for clients? Will returns in the future replicate the past? |
| The Bucket approach | This often still needs a weighting to cash The cost of advice/process can be prohibitive for some investors. Size of portfolios and depth of asset diversification could be difficult for some clients. |
| Smoothing of returns | May lag performance in a strong rising market, and returns over the longer term are still governed by underlying asset performance |
Smoothing returns
Smoothing returns and asset diversification potentially assist with providing more stable returns for investors. This is especially important for clients looking to reduce risk as they approach retirement or wanting additional security when they start drawing a sustainable income later in life.
The PruFund range of funds aims to grow your client’s money over the medium to long term (5 to 10 years or more), whilst protecting them from some of the short term ups and downs of direct stock market investments by using an established smoothing process. This means that while they won’t benefit from the full upside of any short term stockmarket rises they won’t suffer from the full effects of any downfalls either.
Using Prudential’s TIP allows investors and advisers to choose PruFund as a blending solution providing the benefits of a smoothed investment return alongside other asset classes without having to move away from a flexible pension wrapper such as a SIPP.
So what is a TIP and why are people using them?
A TIP is a single premium investment for trustees of UK registered pension schemes. It offers investors in pension schemes, usually SIPPs or SSASs, access to a range of wider investments that might not be available from a traditional provider.
Where are they being used with Prudential?
The Prudential TIP will allow investors access to a variety of pension funds including the range of PruFunds, whilst allowing the investor to remain in their current plan without the need to enforce a pension switch or transfer. The following explore why PruFund is being used so widely.
Income producer – Traditional drawdown portfolios weighted their asset allocations heavily towards cash, thus allowing income withdrawals to come from this as a stable alternative investment to the rest of the portfolio. This would avoid the risk of cashing in units at the wrong time from other asset classes. The difficulty with this strategy is cash has very low returns at present. However, advisers have the option of considering ‘smoothed’ investments to provide income for clients. By investing in a Prudential TIP investor can withdraw up to 7.5% of the original amount invested each year, though clearly withdrawals at this level are likely to reduce the value of the TIP over time. Prudential provides access to a Retirement Modeller on our adviser website, which allows scenarios to be modelled for clients.
Portfolio stabiliser – Advisers and investors are looking to provide diversification to portfolios for clients. Having a well-managed, highly diversified investment that has its returns smoothed means PruFund can often offer an alternative that could be uncorrelated to the clients’ other investments.
Death Benefits – Often legacy planning is an important consideration for clients when considering pension transfers. Investing in a TIP through a modern SIPP contract allows clients to notionally earmark some of the fund to provide flexible death benefit options to their beneficiaries.
Using TIP with blending & buckets – By combining PruFund with other asset classes some advisers are looking to manage market volatility and provide a drawdown investment experience to match the clients’ individual objectives. Often the portfolio is split with an element in cash to provide short term stability & immediate income needs. Then a proportion is invested in PruFund for the medium to longer term and then on top of that an allocation of funds is invested in a bespoke long-term strategy to potentially generate some Alpha. Often in these situations advisers have appointed a discretionary fund manager to utilise their investment expertise to complement the client’s other investments and help meet their objectives.
So in summary, if you have clients invested in SSASs or SIPPs and they want further information on
- Reducing exposure to volatility
- Taking income from their pensions
- Passing on death benefits
The PruFund range of funds all invest in Prudential’s With-Profits Fund, which is one of the largest with-profits funds in the UK. However, there are differences across the range of PruFund funds in their objectives and mix of assets, and how PruFund delivers returns to investors when compared to other With-Profits business, which means the returns received by investors will vary by fund choice.
Please remember that past performance is not a reliable indicator of future performance.
The value of an investment can go down as well as up, so your clients could get back less than they put in. This article is just for UK Advisers.
