The Verve Group and Brooks Macdonald recently launched a whitepaper on Centralised Retirement Propositions (or, as we like to call it Centralised Retirement Philosophies - CRPs). There’s lots of focus on record keeping and advice processes and rightly so, but what can you do about the investment side of the philosophy?
Advisers often find themselves questioning, 'Do I need to re-write my Centralised Investment Proposition (CIP) for my CRP?’. So, it may come as a pleasant surprise to know – the short answer is no, the investment strategies used for accumulation can also be applied to decumulation. The key is however, as per pretty much everything else in the whitepaper, it’s all about documentation, processes and how the provision of a regular income is managed as part of those processes to ensure suitability, consistency and (hopefully) a stable long-term income.
So, what options are available to provide a regular income from growth-oriented investments? I wanted to put the spotlight on the bucketing strategy (you may have heard this called pots, cascading or waterfall) for those who may be considering it; what it aims to achieve and whether it could be suitable for your firm.
This technique of running money in retirement is where the client's retirement assets (needn’t all be within a pension wrapper) are split into ‘buckets’ of varying levels of risk and time horizons. The thinking behind this approach is that a strong level of long-term growth is achievable (within the whitepaper, Brooks Macdonald suggests a seven-year minimum time horizon for access on the growth bucket, based on evidence that there has only been one discrete seven-year period where UK equities have not delivered a positive return) with one or more lower-risk (in terms of volatility) buckets to cover off the clients’ short term (less than seven years) income needs.
The aim of the game is to reduce sequencing risk, which is when multiple encashments are made from a growth-oriented portfolio in a falling marketing - rather than a natural income yielding portfolio or a strategy with built-in downside protection. To continue to meet the client's income in monetary terms, more units must be sold at lower and lower prices, drastically limiting the potential for recovery as the remaining units must "work harder” (I am sorry) in percentage terms to recover to prior levels. A bucketing strategy can be implemented to help avoid this eventuality, where only cash and lower-risk investments need to be leant on for the clients spending, and thus giving plenty of time for the growth bucket to recover before being tapped again to top up the lower risk bucket(s).
There are no rules on the number of buckets or how it is implemented, as long as your process is fully documented, and the implementation is consistent across all relevant people within your firm.
The most popular are three-bucket cascades:
The investment strategies to support that are likely already available to you as part of your CIP and it will just be a matter of padding out your processes and documentation with regards to how they are adapted for decumulation. The bucketing strategy is also style-agnostic, meaning it can be underpinned by active, passive, or sustainable investment philosophies (or even a blend of them all) meaning you don’t need to alter your house view to accommodate a decumulation-specific range of investments. Do bear in mind that running a bucketing strategy will take you an awful lot more time in terms of administration and regular reviews to manage, which is something you may have to account for in the service level provided and charging for those clients.
Something else to consider is platform / provider functionality - specifically, whether they can support multiple portfolios within a wrapper (which a surprising number of platforms still don’t!). While it is possible to implement a multi-bucket strategy in separate wrappers, using ISAs and Investment Bonds for example, these will bring additional tax considerations (and admin!) when moving money between them.
The bucketing strategy is also of little use for smaller retirement funds where too much of the client’s funds need to be allocated to the consolidation / instant access buckets and resulting in the growth aspect of the strategy having to take on excessive risk to chase high potential returns to the point where the potential losses become more likely and more severe. In addition, the level of charging for your own time to run a Bucketing strategy may prove to be a poor-value proposition with the fees eating away at their retirement funds faster than any value-add that the process could provide.
Alasdair Wilson, Investment Specialist, The Verve Group.