Putting DC funds into illiquids can be like putting a square peg in a round hole, with the daily danger that DC members can ask for their money back at one day’s notice.
For anything but large listed equities, that entails the risk of a dreaded fire sale, and assets being quickly disposed of at a fraction of the value once attributed to them.
LTAFs deploy two techniques to get round this. Their main line of defence is a series of measures to slow the withdrawal process, like minimum holding periods and lengthy notice requirements.
But they also have been given the power to borrow, so to a limited extent withdrawals can be facilitated by the LTAF taking on debt and postponing the sale of illiquid stock until an opportune moment arises.
LTAFs found favour with nearly a quarter (24 per cent) of representatives of leading occupational pension schemes, master trusts, platform providers, IGCs, asset managers, pension consultants, member organisations, insurers and official institutions, who attended the DC-focused conference I spoke at earlier this summer.
LTAFs came equal first in a non-scientific poll of the audience in which I asked the audience to vote on one of the six options I presented for delivering greater DC savings performance.
Blending retirement income and drawdown
Indeed, the only other option that grabbed just as many votes in my poll (24 per cent) was blending income drawdown and annuity.
This innovation for optimising retirement income is gaining ground, with several major adviser platforms and discretionary fund managers launching blended retirement options over the past couple of years.
Sometimes called secure lifetime income, blending annuity and drawdown income offers the option to swap out low-performing corporate bond holdings in income drawdown portfolios, for example, into an annuity.
The adviser then applies their risk-rating process to the whole portfolio of annuity and drawdown combined, which noting the absolute security of the annuity will recommend a slightly higher risk for the drawdown investments. This can make diversification into more illiquid investments, for longer, a safer option.
Longer pathways needed
For the non-advised DC member, investment pathways will be offered to steer would-be retirees to adjust their investment mix as they prepare for decumulation.
Pathways help pension holders to confirm what they will be doing over the next five years. The provider should then offer a suitable investment mix for each of the four pathways.
I have always argued that it is not just about the first five years after starting decumulation, but considering what is happening after that. Let’s take a look at this below:
First five years | Beyond year five |
Option 1: I have no plans to touch my money in the next five years. | Any of the four options are possible in the next five years. |
Option 2: I plan to use my money to set up a guaranteed income within the next five years. | No need to plan further, the annuity purchase has set the consumer up for the rest of their retirement. |
Option 3: I plan to start taking my money as a long-term income within the next five years. | After some years of income drawdown, many consumers will decide to buy an annuity, finding annuity rates better once they are older. |
Option 4: I plan to take out all my money out within the next five years. | This consumer may have gone, or they may have seen the light and found a better way to raise the cash they needed, preserving their tax-favoured pension vehicle for longer than originally anticipated. |
So, although the FCA expects that the central focus in determining asset allocation is that first five years, it would be no bad thing to have one eye on the longer term.
