On a quiet Easter Monday, the U.K. saw the biggest change to its pension system in almost a century. From April 6, people were no longer required to convert their pension savings into annuities upon retirement. In response, investment managers are scrambling to offer alternative products to fill the gap left by rapidly declining annuity purchases.
Individual investors had started reacting to this new pension freedom as soon as it was announced by George Osborne, the chancellor of the Exchequer, in March 2014. Workers due to retire before April 2015 delayed converting their pension savings to take advantage of the greater flexibility. At the insurer Aviva, for example, annuity sales were down 60 percent in the first quarter of 2015 from a year earlier. Investment managers blame the drop in annuity sales partly on low rates stemming from continuing easy monetary policy, and a desire for stronger investment returns to maintain a high standard of living in retirement. Given these challenges, the great virtue of annuities — certainty of lifetime income — is losing its luster.
Seeking ways to compensate for the falls in annuity business, many insurers are turning to multiasset products. The Aviva Investors Multi-Strategy Target Income Fund, launched in December, attracts £4 million ($6.1 million) to £6 million a week, says Paul Moody, head of global consultant relations at Aviva Investors, the £246 billion investment management arm of Aviva, in London. “It’s up to £200 million, which has somewhat taken us aback,” he says. “Normally, we would expect six months to a year before we get any traction, but demand for income is high.”
Standard Life Investments, the asset management arm of Edinburgh-based savings provider Standard Life, another traditional annuity provider, is equally enthusiastic about multiasset products. “Typically, the primary issue for retired people is ‘we want to make sure our money lasts for as long as we live, we want a return that will fund our retirement, and we want it in a form that we understand,’” says David Bint, London-based multiasset investment specialist at the £246 billion-in-assets firm. “We think the best way of achieving this is through a multiasset approach,” Bint adds.“It is a much better investment than passive equity.”
Bint’s conviction about the unsuitability of passive equity is based on research into the so-called probability of ruin. This may sound like the name of a thrash metal band, but in fact it is a calculation of the chances that different strategies will end with the investor running out of money. After studying both historical and simulated sets of returns, Standard Life Investments has calculated a 10 percent risk that passive equity investors would use up all their funds within 12 years if they started by taking 6 percent of their initial pension savings each year as income and increased this amount by inflation every year. For multiasset growth funds it takes 16 years to face a 10 percent risk of running out of money. These considerations are especially important given that such investment strategies are replacing annuities, with their zero probability of ruin.
The key to multiasset funds’ durability is their diversification, which reduces volatility. Bint cites Standard Life Investments’ Enhanced-Diversification Growth Fund, which aims to provide the same return as the equity market with just two thirds of the volatility.
Standard Life’s fund differs from annuities in that it does not pay out regular income. Bint argues that funds do not need to pay income because investors can generate it simply by selling units in the fund. The Aviva Investors Target Income Fund, on the other hand, mimics the smooth process of annuity payments much more closely than most income products. It targets an income of 4 percentage points above cash, paid monthly. Such monthly income payments are relatively rare for a multiasset fund, notes Moody, but he points to its high inflows. “People like the equal monthly transactions,” he says. The income is generated from stock dividends, bond coupon payments and forms of financial engineering such as selling call options on the equities.
Jupiter Asset Management, a £34.7 billion London-based manager, is well placed to take advantage of the new regulations because it has no legacy annuity business and enjoys a strong retail brand. The firm similarly sees a big role for multiasset funds, though it thinks that bond-based income funds can also provide a substitute for annuities. Charlie Crole, head of global professional client services at Jupiter, describes his firm’s £129 million Strategic Reserve Fund as a multiasset product “that we are pushing rather more to the fore than before.”
Crole maintains, however, that the days of annuities aren’t over. “I believe a lot of people will still buy annuities, because they provide security,” he says. “I personally would consider spending some of my savings on an annuity.”
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