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How can I optimise my investment strategy as I near retirement?

Luke Cummings, Harvest Lane Asset Management

Those nearing retirement do not have time to wait for the market to recover, but how can investors avoid being left in the lurch? 

With my dad having recently retired, my mum planning to do so imminently, and an aunt and uncle having just done the same, the investing needs of those who’ve just retired are very close to home.

With retirees specifically in mind, it became clear to my co-founders and I that in a post-GFC world, generating returns of 8 per cent or more per annum wasn’t going to be as easy as it once was. Where once upon a time, an investor could have expected to earn 8 per cent per annum in the relative safety of a term deposit, in the new world the going rate for a term deposit would be a quarter of that and for most investors, that simply wasn’t going to be enough. Very few investors or their financial advisers would have assumed a return anywhere near 2 per cent when calculating the level of funds that would be required to support a comfortable retirement.

If investors want returns akin to what they’d previously become accustomed to, they need to take on more risk, and in some instances a lot more risk. Our view was and remains that this course of action may be bearable for a younger investor who can ride out the inevitable bumps in the road that this entails, but could be financial suicide for a retired individual.


What retired investors (or those nearing retirement) need from their investments

Firstly, investors in or nearing retirement are generally no longer earning significant sums from working or soon won’t be, and therefore need to ensure that their capital is managed relatively conservatively. The last thing this type of investor needs is a large loss of capital resulting from excessively risky investments. This is largely because it is so difficult to recover these losses over a short period of time. A loss of 25 per cent of starting capital requires a subsequent gain of 33.3 per cent on capital remaining just to get back to even.

Unfortunately, in the current economic climate, it is easy to argue that the valuations of all major assets –equities, properties and bonds – are not particularly attractive. Combine this with the highly unusual economic environment – ultra-low interest rates and record levels of indebtedness – and it is not difficult to imagine sharp falls in the prices of these assets in the years ahead. Given that most investors and most managed funds have an inherent long bias, should such a fall eventuate, it would have a significant negative impact on the value of investor portfolios, thereby failing to meet our first criteria of capital losses being kept to a minimum.

Secondly, I’ve observed that most investors (despite what they might say) don’t tend to tolerate excessive volatility in their investments. Understandably, sharp price movements make many investors nervous, older investors in particular. In some cases, this discomfort may see investors selling investments and crystallising losses at exactly the wrong time, which only makes things worse. The volatility of the equity market and most equity market products are often too high for investors at this stage of their lives. Therefore, these investors need investment offerings which have lower volatility and are less ‘stressful’. Worrying daily about the value of an investment portfolio is no way to spend your retirement.

While the first two criteria deal with risk, retired or soon-to-be retired investors need to earn a meaningful positive return on their investments the majority of the time in order to support their lifestyle in retirement. Many investments, particularly in the current climate, simply don’t and won’t achieve a sufficiently high return. Mainstream equity and property offerings may achieve reasonable performance over the very long term, but suffer from a significant risk of not achieving adequate returns over time frames which matter i.e. the short and medium term.

What should a retired investor to do?

Each investor, and their set of circumstances, is unique, so while I can’t speak for all investors, I can talk about what I believe would be suitable for retired investors, including all of my family members who I mentioned earlier.

Firstly, look for managers with a deliberate focus on avoiding large downside risks, who achieve returns without having typical market dependencies, who are absolute return orientated, meaning they aim to make money at all times, irrespective of whether the market goes up or down. Every position should be considered and sized according to how much it can lose if things don’t work out in absolute terms, and not relative to an irrelevant benchmark like the stock’s weighting in the ASX 200. The results of individual investments are generally independent of the results of others in a portfolio. This means that if the market falls, a portfolio won’t routinely fall with it or to the same degree, and furthermore, a bad result for one of the stocks in a portfolio should have no bearing on any of the other stocks held.

Secondly, manage volatility to ensure it is much lower than that of the equity market and well within the tolerance of investors. While this means you won’t skyrocket upwards in a hurry, more importantly you won’t routinely suffer from sharp price movements downwards.

In doing so, investors can grow investor capital conservatively, without being exposed to the risks of heavy market falls or the same dependencies inherent in many other share market investments.

Ensuring your investment fund’s and manager’s interests are aligned with your own

Beyond having a strategy that helps investors to meet their objectives, we think it is important that any investment manager can demonstrate that they are ‘fair dinkum’ about what they do. Potential investors shouldn’t hesitate to ask them to prove it.

I don’t think it is fair for an investment manager to profit from their investors if they don’t make them money. Some managers are only paid a fee if a fund achieves positive performance in excess of the RBA cash rate i.e. it needs to add real value and absolute returns for our investors before they pay a cent. While this doesn’t occur in the vast majority of the industry, I believe that this is the way it should be, and hope that eventually more managers will structure their business in this way.

Secondly, you should look for a manager who invests capital alongside their investors. This is what managers do if they expect your fund to consistently make money for your investors, but it’s surprising how few managers actually do so, to the extent that some managers do not invest in their own funds at all.

When it comes to ensuring your manager’s interests are aligned with your own, there are two questions that all investors (retirees or otherwise) should be asking. Firstly, ask about the fee structure, with the obvious preference to pay only for performance. Secondly, ask about the extent to which the manager is ‘eating their own cooking’ by investing in their own fund.

In combination, having an aligned investment strategy (based on the criteria outlined earlier) and an aligned investment manager can produce impressive results for older investors. In contrast, a misaligned investment strategy or investment manager can make for a retirement that is less assured, and far more risky and stressful than it needs to be.

Luke Cummings, chief investment officer and managing director, Harvest Lane Asset Management

How can I optimise my investment strategy as I near retirement?
Luke Cummings, Harvest Lane Asset Management
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