The key is to make sure you have increased your capital to a point that allows you to enjoy your twilight years in comfort. Investors have traditionally achieved this by taking on more risk when they were younger and moving into safer assets such as bonds and cash as they grew older to protect their wealth and to receive a steady level of income.
And in the past, this would have worked. For example, you wouldn’t have wanted to be completely in equities at 65 when markets fell off a cliff in 2008.
However, while bonds used to be the safe place to be, rising yields and talk of pulling back from quantitative easing in the US have given the cautious staple an uncertain future.
Industry experts agree that bonds have been in a prolonged bull market for the past 30 years. On top of that, investors have been piling into the asset class for safety as risks surrounding the global economy intensified. This has led to bubble-like conditions forming in the asset class, according to a number of experts.
Then a new dynamic was thrown into the equation. In order to stimulate the economy, the world’s central banks have pursued a policy of ultra-low interest rates along with ultra-loose stimulus in the form of quantitative easing (QE).
QE mainly involves buying government bonds, forcing yields down further and further. Ten-year gilt yields had been as low as 1.7 per cent recently and are now at 2.5 per cent. To put that into perspective, they were close to 5 per cent in 2007.
The major risk surrounding fixed income now is that as the global economy improves, central banks may well step away from their QE programmes and will be forced to raise interest rates to curb inflation.
There is much debate among bond managers as to when this may happen. However, the fear is that if interest rates were to increase dramatically or government bonds were to be sold off aggressively, it could well cause the so-called bond bubble to burst as prices of traditional fixed income assets fell.
Therefore, with bond yields at rock-bottom and interest rates at such low levels, do the same rules about asset allocation still apply? Given the reasons mentioned above and the fact people are living longer, Bestinvest’s Jason Hollands (pictured) doesn’t think so.
"Many advisers used to operate on the maxim that you should hold your age in bonds, meaning that a 50 year old should be 50 per cent in fixed income and a 60 year old 60 per cent in fixed income and so on," Hollands said.
"Essentially, this is about the process of de-risking ahead of retirement and as your time horizon shortens. The trouble is that this pearl of wisdom emerged at a time when life expectancy was shorter than it is today."
"According to the OECD, in 1958 the average life expectancy post-retirement was 11.9 years for a UK male but by 2010 that had increased to 16.9 years and their projection is for it to rise to 17.7 years by 2020 – an almost 49 per cent growth in post-retirement life-span in 55 years."
"Combined with much lower bond yields and investment returns generally, that means there is a pitfall in de-risking too early on, as you may outlive your wealth."
"This is particularly problematic in the current environment, when bond prices have been distorted by QE and the risks of a reaction to a wind-down of central bank bond-buying are elevated."
"A formulaic rotation out of equities into bonds – sometimes called life-styling – over the next year or two could be very ill-timed," he added.
Hollands admits that raising risk exposure is a very difficult task; however, he says investors nearing retirement could be making an even more dangerous decision by buying bonds now.
"Of course, if you know you intend to purchase a pensions annuity in the next couple of years, de-risking may still be the right course of action – you don’t want to take a hit on the value of your portfolio from an equity correction on the eve of buying an annuity."
"However, bonds may not be the right option in the current environment. You might consider absolute return funds instead as a proxy for fixed income," he added.
The main attraction of absolute return funds is that they attempt to make money in all market conditions, using a diversified portfolio of equities, bonds, cash and alternative investment strategies such as derivatives.
One of the best-performing absolute return funds in recent years has been the five crown-rated, £504.6m Insight Absolute Insight portfolio.
The fund is headed up by the FE Alpha Manager duo of Reza Vishkai and Sonja Uys. It is actually made up of five funds, namely a UK equity market-neutral fund, a currency fund, a credit fund, an emerging markets fund and an absolute return equity fund.
According to FE Analytics, Insight Absolute Insight has made money in every calendar year since its launch in February 2007, except for 2008; however, it only lost 0.17 per cent in that year.
That cumulative performance means that Insight Absolute Insight has returned 33.46 per cent since its launch, while its benchmark – the Libor GBP 3m index – has returned 15.54 per cent.
Performance of fund vs index since Feb 2007
Source: FE Analytics
Insight Absolute Insight has an ongoing charges figure (OCF) of 1.32 per cent and requires a minimum investment of £5,000.
Hollands says there are also other options available for investors nearing retirement.
"Alternatively, increasing numbers of investors might consider pension drawdown as an alternative to purchasing an annuity instead," he said.
"With drawdown, you retain the pension portfolio and keep it invested, in return generating assets – probably more cautious in nature – but draw an income from the portfolio within the restraints of the Government Actuary's Department cap."
"Drawdown carries more uncertainty as the natural yield on the portfolio will rise or fall unlike the guaranteed income from an annuity, and the capital will fluctuate dependent on markets, but it does extend the timeframe of the portfolio and should therefore merit including exposure to higher-returning asset classes such as equity income," he added.
If investors are looking to an equity income manager to steer them through retirement, they will probably want one who has been there, seen it and done it all before.
One such man that immediately springs to mind is FE Alpha Manager Neil Woodford. He has managed his five crown-rated Invesco Perpetual High Income fund since its launch in 1988.
His track record speaks for itself. Over 15 years, the £14bn fund has returned 298.64 per cent while the IMA UK Equity Income sector and the FTSE All Share have returned 128.02 per cent and 96.53 per cent, respectively.
Performance of fund vs sector and index over 15yrs
Source: FE Analytics
The fund is yielding 3.31 per cent. It currently has a high weighting to large cap UK defensives such as AstraZeneca, GlaxoSmithKline and British American Tobacco.
Invesco Perpetual High Income requires a minimum investment of £500 and has an OCF of 1.69 per cent.
