These are:
- Systemic risks: Data security, changes in fashion, disruptive technologies, terrorism, and political intervention.
- Management risks: Controls failures, complacency, dissatisfied customers, consumer safety and compensation.
Moreover, there are certain themes each year that keep the investment team awake at night - these, too, have to be managed, as the following graphic suggests.
For Mr Morris, the study's findings showed how difficult it really was to run a low-risk portfolio that would allow for decent drawdowns, without true diversification.
He explains: "Due to the difficulty in finding low risk assets with a yield close to the holy grail of 4 per cent, many fund managers have diversified away from typical fixed interest assets.
"Some are taking additional risk. This often isn’t suitable for income-seeking investors, who tend to be more cautious. They may well come unstuck, especially with volatility making a return and interest rates expected to rise."
Sequencing risk
True diversification is important for any portfolio, but when it comes to income-generating portfolios in particular, Mr Norwood believes reducing volatility is "especially important", when the client is factored into the equation.
"This is because income portfolios are normally used in the decumulation phase of the investment lifecycle, such as during retirement.
"In this phase, money is being taken from the fund regularly. As a result, if the portfolio were to suffer a large drawdown, there is not the chance to make all of the money back through market rises in later years - which there would be during the accumulation stage."
These risks are known as pound-cost ravaging, or sequencing risk, and can have a deleterious effect on an income portfolio, especially in retirement, as the following graphs from Royal London illustrate.
The case study accompanying the below graph is that of a man called George, who is 65, and has a £100,000 pension pot. He requires £5,000 annual income from the portfolio - so no problems there regarding his annual allowance.
Source: Royal London/Lipper
The horizontal red line indicates the average annualised return of the portfolio since 1975. The purple bars show the performance of the market each year.
Had George retired in 1975, and taken income every year at £5,000 a year, he would have seen great investment growth and no deleterious effects on his portfolio.
However, if George had retired in 2000, his fund would have seen a 40 per cent loss in the first three years; coupled with the effect of taking income, the damage to his portfolio would have been immense - and it is very difficult to recover from such a loss.
As the Royal London factsheet on pound-cost ravaging comments: "A diversified portfolio can help to smooth out the ups and downs of the market and reduce the effect of market falls, but it’s also important that the portfolio is designed with income provision in mind. And this means using the right risk target."
