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Speed Dating

Summary

Following on from our last blog on Active Share (‘Hyper-Active Share’), another two word, although not new, phrase has received a fair amount of media attention recently; ‘Target Date’. This refers to funds that typically have an end date year that corresponds to your expected year of retirement; that year being the target date.

Following on from our last blog on Active Share (‘Hyper-Active Share’), another two word, although not new, phrase has received a fair amount of media attention recently; ‘Target Date’. This refers to funds that typically have an end date year that corresponds to your expected year of retirement; that year being the target date.
The composition of the fund will be dictated by the duration between now and the retirement date.  If your retirement date is in the next five years, you would expect a high proportion of low risk assets in that fund.  This would normally be bonds but in the current environment where bond yields have been suppressed by unprecedented quantitative easing, bonds might not be the low risk assets that they have been. In addition the typical construct of target date funds is via passive instruments.
So what happens at retirement?  Given changes in pension fund flexibility, the removal of the need for annuities and the resulting fall in demand for them, what happens to that pool of money at retirement?  Having spent the latter half of the 1990s working for a well-known US asset manager, I’m quite familiar with target date funds and the US defined contribution (401k) pension industry.
In the US, the birthplace of target date funds, the debate has moved on to looking beyond retirement for individuals’ investment horizons.  The issue has been named ‘to or through’. In other words do you invest to retirement or through it perhaps to some sort of life expectancy?
In England and Wales life expectancy at age 65 is a further 18.6 years for men and 21.1 years for women according to the Office for National Statistics.  Even when the retirement age rises to 67, that’s still a long way to go and fund your retirement.  In other words, if you’re approaching retirement, in your 65th year and you’re a man, statistically you are expected to live until you are 83; 86 if you are a woman.
Given current low yield levels across most asset classes, investors may well opt for a mixture of income and drawdown.  The preference might be for pure income either from a debt, equity, multi-asset balanced or portfolio but investors should beware of chasing yield to acquire the desired income stream.  The tail shouldn’t wag the dog and investors should think twice before buying investment risks they are unused to or may be uncomfortable with holding.  We have seen evidence of investors taking on greater credit risk to gain yield.  The next change in UK rates is likely to be up and the question is more about when than if.  Gilt yields and credits priced off them will need to reflect a gradual change to a more normal interest rate environment which may lead to increased price volatility.  Investors looking at equity income as a different way to achieve a given yield level should also be confident that any direct equities they own or the fund they’ve invested in doesn’t target a yield or dividend pay-out that is unsustainable.
Investors might want to consider a multi-asset solution like the T. Bailey Dynamic Fund which can be found in the Investment Association (IA) Mixed Investment 20-60% shares sector.  It is not confined to one asset class nor does it target a yield although it has an income share class.  But it does aim to deliver a return over UK consumer price inflation of 3% and has delivered that since its inception.  That might be a reasonable outcome for someone seeking to preserve capital in their later years and needing to mix capital drawdown and income.
With equities in many markets at or close to historic highs and some with valuations above their historic averages, passive index investing might not be as preferable as investing in a portfolio of active managers whose portfolio construction is index-agnostic.
So maybe don’t rush to invest to your end retirement date, this isn’t speed (target) dating, consider the longer term investment horizon too.

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