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How to build a retirement income portfolio

13 December 2014

JP Morgan’s Jasper Berens sets out how he believes investors should balance risk and return to create income from their pension.

By Daniel Lanyon,

Reporter, FE Trustnet

For most investors the slice of their portfolio intended to provide an income during retirement will be their largest in terms of value but also the most complicated to construct. 

For the first time the average UK citizen is set to spend approximately as much time in work as they are in retirement thanks to the forecasted continuing increase in life expectancy. 

Balancing risk and return with the passage of time can be very difficult and with the shake-up to pension rules announced this year allowing greatly flexibility and removing the need to buy an annuity, investors are arguably more at risk of running out of money if they make the wrong choices. 

Jasper Berens, head of UK funds at JP Morgan Asset Management, says the central challenge of managing your own pension is that there is a “myriad of factors shaping your future”. 

“Some of these you have total control over, such as your rate of saving and spending or how much risk you take with your investments. On other factors, you have some degree of control, such as the duration and earnings level of your employment and your own longevity,” he said. 

However, he adds there are some things over which investors have no control, such as market returns and policies governing taxation, savings and entitlements. 

“Saving is important and so is diversification, as a balanced portfolio is better poised to generate returns in all types of market environments. We know that the best and the worst performing asset classes can vary widely in any given year, but over the long term, a portfolio that is diversified across equities and bonds can help to dampen volatility, providing a smoother ride.” 

This has been particularly the case this year with the performance of many assets classes doing a lot better or a lot worse than most expected. 

For example, a widely held view at the beginning of the year was that bonds would underperform, particularly government debt, and that equities would continue their upward travel. However, bonds have generally done well with index linked gilts the best performing sector this year and UK smaller companies the worst. 



Source: FE Analytics


When building a retirement income portfolio, Berens recommends investors think about the various outcomes they want to achieve rather than just the assets they think they need exposure to.

He stresses that “a huge amount of personal considerations” need to be taken into account when structuring a retirement income stream, but says he favours an approach that he likens to a triangle.

“Starting from the base of the triangle, you move up the spectrum of risk and return to the top. The bottom and largest portion of the triangle comprises your needs – the basic assets that that are going to cover your regular expenses.”

He says sources of income for the bottom of the triangle should come from state or defined contribution pensions, short-term bonds or cash savings. 

“Moving on to the middle of the triangle, this part is your wants, comprised of your desires to pursue a lifestyle in retirement, such as travel.  Sources of income in the middle of the triangle tend to come from investments in equities or fixed income,” he explained.

“As you reach the top of the triangle, representing the smallest part, you reach the legacy considerations, where you might be considering assets to leave to your children. This income, unlikely to ever be drawdown for paying expenses, can be sourced from more high risk investments or structured in trusts.”  

Berens says he prefers multi-asset funds, where managers generally hold a mixture of bonds and equities and to a lesser extent property, currencies and alternatives, for retirement portfolios.

These funds can offer the potential to build and preserve wealth, beat inflation and reduce the risk of outliving your assets.

Multi-asset income funds, for example, diversify risk and attempt to make income more sustainable, without the costly guarantees involved with annuity products. They are flexible and tend to be tax efficient. Importantly, they are also a cost effective solution.

Four IMA peer groups house multi-asset funds – the IMA Mixed Investment 0%-35%, IMA Mixed Investment 20%-60%, the IMA Mixed Investment 40%-85% sectors and the IMA Flexible sectors, with the percentages corresponding to the proportion of portfolios that are held in equities.

The graph below shows what a higher weighting to equities has meant for the returns of the average fund in each sector over the past seven years. The average fund in the IMA UK All Companies sector has beaten all four.

Performance of sectors over 7yrs



Source: FE Analytics

A higher exposure to equities also meant that when markets are falling the losses have been greater. This is important for investors who rate capital preservation over capital growth.


Also volatility tends to be lower the more you move away from equities, with the average fund’s volatility in the IMA Mixed Investment 0%-35% sector less than a quarter of that of the IMA UK All Companies sector over the same period.

Of course, which fund is best for an investor depends on their circumstances. Berens says most savers would do well to seek advice on their details of their portfolio and points out that when it comes to investing, moving earlier rather than later is best.

Berens said: “Structuring a suitable retirement income stream is different for everyone. So it is important to keep in mind that these models are only rough guidelines – they wouldn’t work for all individuals.  In fact, the vast majority of people can definitely benefit from seeking some form of advice when planning their retirement income.

“That said, what is the same for everyone is the desperate need to start retirement savings earlier and to do it more consistently. The numbers speak for themselves on the power of compounding over time, and they are too important to ignore.”

 
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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.