06 Apr 2020

Impala Bonds: Defending the financial health of drawdown clients from Covid-19

As the coronavirus pandemic wreaks havoc, looking after the financial health of clients in drawdown is a matter of urgency.  

This article is intended for Professional Advisers only

 

Leave it to the market pundits to debate whether the coronavirus pandemic is a black swan, a grey swan, a grey rhino or a hound from hell. Financial Advisers have more pressing and less philosophical matters to deal with as markets plummet and volatility returns with a vengeance: defending clients in drawdown from the impact of what is unarguably a clear and present danger to their wealth in retirement.

 

Chancellor Rishi Sunak has unveiled the biggest monetary and fiscal stimulus to the economy in history, but his largesse in supporting employees and the self-employed does not extend to those in retirement. They will need to rely on their Centralised Retirement Propositions for that and these are now being stress-tested as never before.

Seeking to preserve financial health is also very important during these strange days.

Rightly, there has been a huge focus on the protection and preservation of life as coronavirus wreaks havoc across society. However, seeking to preserve financial health is also very important during these strange days.

 

For that reason, it is now more important than ever to consider whether your clients’ retirement solution can withstand the current bear market conditions, provide them with greater certainty of income during this cliff-edge down-turn, and enable them to participate early in any recovery and potential future bull market.

 

Just as government advice is to change your normal behaviour by practising social distancing and self-isolation, so too is it vitally important for Advisers to help clients adjust their drawdown strategy. The urgency of this shift is underlined by research from AJ Bell showing that the majority of retirees in drawdown are making 4%-5% withdrawals from their funds. This is beyond what was generally accepted as a safe withdrawal rate of 4% prior to recent events.

Research from AJ Bell showing that the majority of retirees in drawdown are making 4%-5% withdrawals from their funds

Clients who opted for an old-fashioned annuity are in clover, for the time being, since their guaranteed-for-life income is completely independent of the roller coaster ride of the stock market.

 

But for those clients in drawdown there is the dreaded knowledge that taking money from their drawdown fund when it has been hit by stock market falls makes it much harder to recover later. Sequence risk is the bogeyman here.

 

However, good financial strategies are always designed to solve particular problems in terms of minimising risk and maximising returns in particular circumstances. There is no cure at the moment for coronavirus but, fortunately, there is a solution that provides greater certainty of income in the portfolios of clients in drawdown, the very people who are the most exposed to market risk as volatility reaches unprecedented levels and dividend income becomes less reliable.

There is no cure at the moment for coronavirus but, fortunately, there is a solution that provides greater certainty of income in the portfolios of clients in drawdown

Investec Wealth & Investment's new Targeted Drawdown Strategy (TDS) is a very timely solution to the current bear market challenge facing clients in drawdown. Effectively, it serves as a form of financial health vaccination by providing a welcome degree of certainty on the fixed income drawdown element of portfolios while ensuring that clients retain access to, and control of, their pension funds.

 

It delivers this through our innovative approach to portfolio structuring based on our use of Impala Bonds. These are investment grade, zero-coupon bonds which we are in the unique position of being able to offer to private investors.

 

The predetermined Gross Redemption figure means that the maturity value of the bonds is known from the outset. That means they are not subject to the same degree of market volatility, if they are held for full term, and offer a predictable return. Impala Bonds also offer a greater Gross Redemption Yield than simply holding cash with interest, especially attractive in the aftermath of the Bank of England’s decision to slash the base rate to a record low of 0.1%.

Investec Impala Bonds also offer a greater Gross Redemption Yield than simply holding cash with interest

The strategy is potentially a financial lifeline for clients approaching, or already in, early retirement who have looked on with mounting concern as stock markets tumbled. This is  especially true for those holding cash. The extent to which the strategy is appropriate will depend on the individual client’s circumstances and attitude to risk since locking in the greater certainty of Impala returns – albeit still subject to default and credit risk - obviously precludes potential for benefiting from any rebound growth in the stock market.

 

In the space of a month, from 20th February to 19th March, the FTSE 250 plummeted more than 40% while the Dow Jones sank by 36% over the same period, losing all the gains it had made during the course of the Trump presidency.

There is clearly risk attached to taking money out of a portfolio so using any available cash would be the best option.

The Chicago BOE Volatility Index, known as the VIX or the Fear Index, is the best predictor of market volatility and it has been hitting all-time highs in the last fortnight. With such literally off-the-chart spikes in the graphs, there is clearly risk attached to taking money out of a portfolio so using any available cash would be the best option.

 

The market rallies have been pronounced too. On 12th March the FTSE 100 had its biggest single day fall since Black Monday in 1987, worse than any fall in the Financial Crash of 2008. Then, just 12 days later, it rose by 9.1%, its second-biggest single day gain ever.

 

The sheer scale of the volatility can be seen in the fact that the market-wide circuit breakers, designed to prevent panic-trading, have been triggered four times in March. Since they were introduced in the late 1980s, they had only been used once before, during the Financial Crash.

The scale of the volatility can be seen in the fact that the market-wide circuit breakers, designed to prevent panic-trading, have been triggered four times in March

Nevertheless, all the major indices are now deep in bear territory. Everyone knew that the end of the credit cycle was approaching, but coronavirus has precipitated, accelerated and exacerbated that trend.

 

Investec’s Impala Bonds currently provide an annual Yield to Maturity of between 2.58% and 2.93% compared with a return on cash of 0% or 0.31% on UK Ten Year Gilts. In other words, they are delivering an investment return on the income generating element of clients’ portfolios.

 

Since the income requirement is being achieved by a smaller allocation within the portfolio, that leaves a larger proportion (typically 80%-85%) to invest for growth in equities, funds and alternatives (‘set aside’ as some providers are calling it).

Crucially, existing clients already in drawdown can be easily migrated to TDS.

Not only does this strategy mitigate any further sequencing risk, it allows for active management to select those stocks, funds and alternatives that offer the best growth potential for your clients’ portfolios, reflect their attitude to risk whilst maintaining the level of value in the overall portfolio when markets start to move into positive territory. Active managers can also seek to optimise the timings of those investments based on careful volatility analysis.

 

Crucially, existing clients already in drawdown can be easily migrated to TDS.

 

The good news is that both Black Monday and the 2008 Financial Crisis were followed by long bull markets although it took time for valuations to recover all the losses in the crash.

 

However, the prospects are even better for clients using TDS. They will have the comfort and security of knowing that their income is preserved at the time when they need it most, utilising a smaller proportion of the portfolio. So gaining the potential for the remainder to enjoy faster recovery in their portfolio values thanks to ‘set aside’.

 

Whether it was a black swan or a grey rhino that caused the bear market, it should definitely be an Impala that provides the greater certainty around clients’ retirement income. 

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