Asset Allocation Research for UK Advisers

Elston Consulting has designed the Elston Smoothed MPS solution that has been manufactured by Elston Portfolio Management for UK advisers. 

The full article is in Money Marketing

‘Income’ as an investment strategy should not be viewed as a catch-all. Drill down, and there are a variety of different strategies, each with their own outcome.

Shrinking a pot is different to growing a pot. And shrinking it in downmarkets can be dangerous without guardrails.  This is why we designed a “Managed Buckets” based approach for Retirement Portfolios.

[5 min read, read as pdf]
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• The US economy outperformed expectations
• The long-awaited pivot came through
• Portfolio resilience proved key

As we look forward to 2025, it is worth revisiting the themes and predictions of our 2024 outlook “turning the corner” to get a sense of what we anticipated at the time, how this informed our recommendations to UK adviser firms’ investment committees.  Asset class performance for 2024 is summarised in the chart above.  Our 2025 outlook is published separately.
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Steady as she slows
In 2024, we anticipated a gradual deceleration in the U.S. economy, with markets pricing in the likelihood of a slight recession. In the event, the U.S. economy surprised on the upside. Growth forecasts were upgraded from 1.15% at the start of the year to an impressive 2.6% by year-end. This revision supported robust equity market returns and served as a reminder of the resilience of U.S. economic fundamentals.  In summary, a resilient US economy defied expectations.
What did we recommend to our clients at the outset and during the year? We took a balanced view between accepting concentration risk (traditional S&P 500) and diversified (active, sector exposures).  We also recommended clients lean in to broader US equity corporate landscape via 1) Equal Weight and 2) US Small Caps exposures.
By contrast, the UK had that shrinking feeling as regards economic growth, and although out of a technical recession, we are not confident of its prospects relative to the US.

Pause before pivot
At the close of 2023, we were focused on the Federal Reserve’s pause in interest rate hikes, noting that a rate cut was a question of when, not if. While the consensus view was that the first cut would be announced by mid-2024, we anticipated that the timing would hinge on the performance and strength of the U.S. economy. Indeed, the economy’s resilience delayed the start of what we anticipate to be a rate-cutting cycle to September 2024, when the Federal Reserve finally delivered a significant 50-basis-point cut.
In fact, the eventual BoE Fed pivot came a month or two later than we had estimated at the start of the year, but we recommended our clients remain dynamic with regards to duration management.  We recommended clients go strongly overweight duration in June as a good time to extend duration ahead of BoE cuts, with Fed following suit, and we saw the additional duration deliver returns on the bond side of the portfolio before attention shifted to debt supply and the UK budget later in the year, which led us to recommending to move back to neutral.

The importance of portfolio resilience
Our focus on resilience proved vital when it came to navigating the key macro factors in 2024: Growth, Inflation and Interest Rates.
For Growth, anticipating a soft landing for the US economy, we highlighted the potential outperformance of cyclical sectors, and momentum, yield and size factors. In the event, momentum emerged as the best-performing factor, with yield and size also delivering strong returns. For Rates, we adjusted duration exposure mid-year to capture the effect of falling policy rates, aligning portfolios with a changing interest rate environment. For Inflation, which remained above target, the inclusion of liquid real assets (but to a lesser extent than in 2022) and shorter duration inflation-linked bonds, ensured continued portfolio resilience.  We continue to emphasise the importance of a diversified alternatives exposure from a correlation perspective, not just in name.
Our recommendation to consider Private Market Managers and Gold & Precious Metals paid off during the year – as these were the best performing asset classes for the year, outperforming world and US equities.

Political and Geopolitical risks
In a year of elections, we saw a change in government in the UK and in the US following Trump’s Presidential win.  Both have a greater impact on bond yields and currency dynamics than equity markets, in our view.
Geopolitical risks remain elevated with the Russia-Ukraine war continuing to grind, escalating conflict and contagion in the Middle East – all at tragic human cost.

Conclusion
Markets did indeed turn a corner in 2024, with economic growth, earnings and equity market returns outperforming expectations.  With 2024 in the rear-view mirror, it’s time to look ahead to 2025.  Our 2025 outlook is published separately.

Henry Cobbe, CFA
Head of Research, Elston Consulting

Investors should consider allocating three years’ worth of their income needs into money market funds, which “can be used as a liquid source of yield with near-nil volatility”. Setting aside such an ample buffer enables retired investors to put the rest of their wealth to work in higher risk investments to keep growing their pot.

Read the full article in Trustnet

For someone aged 65 with average life expectancy a bond fund isn’t enough to ensure portfolio durability. Over that term the biggest risk is inflation risk and it’s harder for nominal bonds to keep pace with inflation. Inflation-linked bonds bring in high interest rate sensitivity (duration). Whilst higher yields now make for a more interesting entry point, there’s plenty of solid yield available in high quality low cost index bond funds.

But to navigate the changing outlook within the bond market a managed bond fund should also be considered as a one stop diversified managed bond portfolio.

Most retirees will need a multi-asset retirement portfolio to last the course. Bonds alone are not enough.

Read the quote in Trustnet 

Henry Cobbe explores the challenges of building portfolios for retirement and also sizing "right" allocation to UK Equities.
Read the article / access the podcast

Key findings, and what advisers and policy owners should do next
Watch the replay of this CISI-endorsed CPD webinar

The long-awaited FCA thematic review of retirement income advice has finally been published, and Dear CEO letters sent. What are the key findings and what should adviser firms be putting in place to improve their proposition?​
Read the full article on FT Adviser

In this webinar, we are honoured to be joined by Sir Steve Webb, Partner at LCP and former Pensions Minister 2010-15 overseeing "Freedoms & Choice".  Steve will discuss his recently co-authored paper for LCP titled ""The Flex First, Fix Later" pension - is this this the future of retirement?" and earlier paper "Is there a right time to buy an annuity?"

Watch the replay of this CISI-endorsed CPD webinar

These rules of thumb stand the test of time.  Investor's Chronicle interviews Elston's Henry Cobbe.
Read in full

The conclusion of the Retirement Outcomes Review for non-advised customers is set out in the regulator’s Policy Statement PS19/21.

The key change is the introduction of mandatory highly governed investment pathways for non-advised drawdown (we prefer the term “Retirement Pathways”, for clarity) from February 2021.
In a nutshell Retirement Pathways is the new Stakeholder, but for decumulation, and with a soft price cap of 0.75% instead of 1.50%.

Whilst the policy changes impact non-advised providers, a “Dear CEO” letter was sent financial advisers in January this year announcing a review of the market for pensions and investment advice “Assessing Suitability 2” (AS2) with particular reference to retirement outcomes.

What are the key points of PS19/21?
The policy means that:

• direct to consumer providers must offer retirement pathways to their customers
• platforms that are both advisory and direct-to-consumer must offer retirement pathways to both their advised and non-advised customers
• advisers need to consider retirement pathways when assessing suitability for their clients considering drawdown

Retirement pathways will fundamentally change the landscape for retirement investing, so it’s worthwhile for advisers to ensure they are in the loop.
 
What is the point of this policy intervention?
The purpose of this policy intervention is to deliver better retirement outcomes for non-advised investors, who may not have the confidence to make robust and informed investment decisions.
Key protections include, but are not limited to: ensuring cash is not a default option, ensuring costs and charges are clear, reasonable and regularly communicated  ensuring investment strategies are appropriate through the introduction of default options for different objectives, and ensuring there is third party oversight of those default investment options either through an Independent Governance Committee (IGC) or a third-party Governance Advisory Arrangement (GAA).

If you are thinking that sounds a bit like the governance arrangements around automatic enrolment workplace pension schemes - you are right.  If you are also thinking it would have made sense to have those guidelines in place before or in conjunction with Pensions Freedom in 2014, you are also right!
 
What will d2c drawdown look like?
In the policy statement PS19/21, the regulator is requiring all d2c providers to offer mandatory investment pathways (Retirement Pathways) with effect from 1st February 2020.  Retirement pathways mean offering non-advised transaction or customers going into drawdown four investment options that align to four standardised objectives formulated by the regulator.

Providers must offer a single investment solution (a single fund, or a single fund from a suite of funds from the same solution such as target date funds) for each pathway.   These funds will be subject to intense scrutiny by the providers Investment Governance Committee in terms of appropriateness and value for money.
 
What are the standardised objectives?
The standardised objectives are intended to align to specific actions or intended actions that non-advisers may want to take.
The final wording for each standardised objective is below:

1. Option 1: I have no plans to touch my money in the next 5 years
2. Option 2: I plan to set up a guaranteed income (annuity) within the next 5 years
3. Option 3: I plan to start taking a long-term income within the next 5 years
4. Option 4: I plan to take my money within the next 5 years

Is there a price cap?
There is no price cap for Retirement Pathways.  However during the consultation, the regulator suggested that providers should be mindful of the fact that in automatic enrolment workplace pension schemes the Total Cost of Investing (a term which I define to be Platform/Admin Cost + Fund OCF + Fund Transaction Costs) is 0.75%.  This creates a fairly strong anchor within which d2c providers must operate.

Is that price cap achievable?
Yes: for example if we estimate a platform fee a for a d2c providers to be 0.30% for an investor with £100,000 at retirement, this leaves 0.45% budget for fund OCF plus transaction costs.  The price anchor indirectly forces providers down the road of offering multi-asset funds that are constructed with low-cost index funds.  And there’s nothing wrong with that - after all it’s the asset allocation that counts when it comes to delivering investment outcomes, not the type of fund.

What kind of funds align to the standardised objectives?
For investors expecting to purchase an annuity under one of the pathway options, we expect providers to offer funds that have similar asset exposures to what annuity providers hold to fund annuities.  That way, when investors purchase an annuity, there is a change in how an investors receives a payout (life-long guaranteed in exchange for surrendered capital), but not a change in the asset mix used to fund that annuity.  That way if annuity rates change, the assets the investor holds to purchase that annuity are the flip side of the same coin.

In the workplace pension world, there are pre-retirement funds that are designed to mirror annuity providers’ annuity matching portfolios.  We expect similar funds for the retail market, and are ready to construct “Annuity Conversion portfolios” should the demand arise. 

For the other three options, we expect that d2c providers will use multi-asset passive funds, with lower risk-return profile for investors starting to make near-term withdrawals and a medium-term risk-return profile for investors starting to make medium-term withdrawals.  Whilst “relative risk” traditional multi-asset passive funds could be one option for d2c providers, we expect Target Date Funds to have an important role to play in non-advised drawdown.
 
What does this mean for advisers?
Whilst the policy is aimed at direct-to-consumer providers, there have been consistent read-throughs for financial advisers from the outset.
Now that this is hardcoded into policy, we expect the forthcoming changes in the d2c market will create pressure on advisers in four different dimensions: comparison, cost, appropriateness and governance.

• Comparison: to evidence that the investment options they offer to customers in drawdown are of comparable appropriateness and value for money as what can be obtained in the Retirement Pathways non-advised market.  Indeed, there is talk that AS2 may result in the re-introduction of an RU64 style rule that makes comparisons to Retirement Pathways schemes mandatory, as with Stakeholder
• Cost: the cost of providing advice in retirement is not capped, and comes on top of the total cost of investing which is being anchored at 0.75%.  If advisers charge typically 0.50% to 1.00% we anticipate good value for money for advised clients in retirement will be a Total Cost of Ownership (a term I define for Advice plus Total Cost of Investing, defined above) of 1.25% to 1.75%.
• Appropriateness: whilst Target Date Funds have a key role to play in the non-advised market as a “one size fits all’ default strategy for different cohorts of investors, we believe that advisers can take a more nuanced approach to building a decumulation strategy.  Whereas Target Date Funds assume a single risk profile, and a single investment term starting from the year in the fund’s name, a managed portfolio approach, by contrast, enables a more granular approach to considering risk-return and time horizon.  This enables a more client-centric approach to retirement planning that can be more aligned to an investor’s “withdrawal profile”.  Finally because model portfolios are not unitised, they can be delivered at a lower cost than a multi-asset fund or target date fund. 
• Governance: just as d2c providers as manufacturers will have Product Governance obligations on the investment options they  facilitate for Retirement Pathways, advisers have Product Governance obligations on the investment options they select for their Centralised Retirement Proposition (CRP).  Every aspect of product governance should be considered with respect to CRPs, and again the decision as to whether to select funds or to delegate to managers should be viewed within this context.

 
Assessing Suitability 2
Assessing Suitability focused on CIPs in general but in an era where advisers’ responsibility was primarily for clients in the accumulation phase.

We believe Assessing Suitability 2 will focus on CRPs now that advisers’ responsibility includes clients in decumulation.

Helping clients invest for accumulation and decumulation requires a fundamentally different approach.
In accumulation, the focus is on attitude to risk, each client’s risk profile, and accumulation portfolios.

In decumulation, the focus should be on capacity for loss (not a volatility figure, but economic measures of shortfall risk, income replacement ratio and liability matching), each client’s withdrawal profile (amount of timing of withdrawals and their size relative to asset pool, and the degree of confidence in achieving a particular level of income durability), and decumulation portfolios (the investment engines that are designed to support term-specific withdrawals, rather than targeting long-term growth).
Retirement Pathways is transforming the investment approach for non-advised investors in decumulation.  Advisers need to position themselves accordingly.
 
The growing use of behavioural finance in policy interventions
Harnessing behavioural finance interventions that address behavioural biases, such structured choice architecture and default strategies, is a growing feature of regulatory policy.  It is based on the premise of investor “inertia” and is designed to provide protections for less confident and less engaged investors.
 
For this reason, investment strategies with built-in lifestyling, such as target date funds, have a growing role to play in the personal pensions market, as well as the workplace pensions market.
 
Needless to say, these highly governed pathway-type solutions then become a standard (in terms of design, appropriateness, and value for money) against which regulated advice can be compared and measured.
 
Key behavioural aspects and price points of policy interventions:

• Stakeholder Pensions (2001): default fund and “lifestyling” for gradual derisking towards retirement date, 1.50% hard price cap
• Workplace Pensions/Auto-Enrolment (2012): default fund, use of “lifestyling” or target date funds, 0.75% hard price cap
• Retirement Pathways (2021): structured choice architecture, single solution per each pathway, cash disallowed as a default option, 0.75% “soft” price cap* (investment solution only, non-advised)
• DB Pension Transfers (2020): consider recommending auto-enrolment workplace pension in the first instance (see 2 above) , 0.75% “soft” price cap** (investment solution only, excludes advice)

 
*Retirement Pathways: there is no price cap specified by the regulator.  My definition of a “soft” price cap is because there was a request by the regulator to providers to consider the comparative cost of auto-enrolment solutions when designing non-advised pathways.
**DB Pension Transfers: there is no price cap specified by the regulator.  My definition of a “soft” price cap is because, under PS20/6, it will become a requirement for advisers to consider and analyse a transfer to a workplace scheme, in the first instance, where the hard price cap of 0.75% does apply.

 

In this CPD module we look at assessing suitability for drawdown and explore sequencing risk, income risk and durability of withdrawal rates.

Watch this CISI-endorsed Elston CPD Webinar

• Understanding Target Date Funds
• Why a cohort-based approach makes sense
• The performance experience this year by cohort

 What are Target Date Funds?
Target Date Funds are multi-asset funds whose risk profile changes over time, becoming less risky on approach to, and after the target date in the fund’s name.
Investors, or their advisers, can use target date funds as an investment strategy that is purpose-built for retirement.  By selecting a fund whose target date matches a planned retirement year, investors get access to an accumulation-oriented investment strategy prior to the target date, and a decumulation-oriented strategy after the target date.  This makes target date funds a convenient “all-in one” fund which explains why they are often used as default funds within pension schemes, including NEST.
Why a cohort-based approach makes sense
It’s common sense that the risk capacity for an investor’s exposure to market risk is different at different stages of life and wealth levels.
For younger investors, where wealth levels are typically lower and time horizons are longer, there is a higher capacity for loss, hence a higher exposure to higher risk-return assets makes sense.
For older investors, where wealth levels are typically higher and time horizons are shorter, there is a lower capacity for loss, hence a lower exposure to higher risk-return assets makes sense.
If customers can be segmented by cohorts, it makes sense that investment strategy can be too.
What is the performance experience for different cohorts this year (time-weighted)?
The 2015-20 Target Date Fund from Architas experienced a moderate maximum monthly drawdown of -4.71% in March 2020.  By comparison, the 2020 Target Date Fund from Vanguard experienced a -6.66% drawdown.  This contrasts with -9.37% for the Elston 60/40 GBP Index, -10.94% for MSCI World, and -13.81% for the FTSE 100, all in GBP terms.
In this respect, investors who were in default decumulation strategies, with lower capacity for loss, saw better mitigation of downside risk relative to a traditional 60/40 “balanced” mandate.
Fig.1. YTD performance of UK Target Date Funds (GBP terms) for those retiring 2015-20.

 Source: Elston research, Bloomberg data
How Target Date Funds could fit in with policy evolution
Ensuring there is some form of in-built lifestyling is a longstanding feature of consumer protections for pensions investment since Stakeholder times.  Using behavioural finance in proposition design can provide a degree of consumer protection from poor outcomes for less confident, less engaged investors.  That’s why a growing number of regulatory interventions incorporate some form of built-in lifestyling.  Whilst this is complex to achieve from an administrative perspective, the fact that Target Date Funds deliver lifestyling within the multi-asset fund structure makes them a useful product type for default investment strategies.
Fig.3. Key behavioural aspects and price anchors of policy interventions