Case study: A new way to climb the retirement mountain

People spend a lifetime saving for retirement but getting there is only half the battle.

"It's like climbing Everest," says Contrarian Group financial planner Damian Liddell. "Everyone is so focused on getting to the top, but 80-90 per cent of deaths are on the way down. It's the same with retirement planning."

Pre-retirees face two major issues. Their retirement savings are reaching a peak, leaving them highly exposed to volatility and extended market downturns. Yet they still need to generate returns well above the level generated by 'safe' assets such as bonds and cash.

"Most clients just want a modest return of 5-7 per cent with the least amount of risk. That's easier said than done with interest rates now so low – everyone has been forced up the risk spectrum. It's working for now but eventually it's going to get ugly – I've seen it all before."

Most of Liddell's pre-retiree clients were invested evenly between growth and defensive assets before the initial COVID-19 crisis in early-2020, which protected them from the worst of the downfall. While some major 70:30 'balanced' super fund portfolios fell by more than 25 per cent, Liddell's declined by less than half that before fully recovering.

"A 20 per cent fall can really knock them around," he says. "Their emotions are going to take over and they're probably going to get out of the market at the wrong time. Everyone knows they shouldn’t run for the exits but when fear takes over, people panic."

Some large super funds reported flows of 3-4 per cent into cash as older investors with large balances sold over the March 2020 quarter, according to the RBA.¹ One medium-sized fund recorded 8 per cent outflows to cash.

In the last 18 months, Liddell says he's won about half a dozen new clients that fell into the same trap. They sold their shares when the market had already fallen, only to miss out on one of the sharpest rebounds in history.

While equity markets have since climbed back to record highs, the outlook remains uncertain as the world continues to grapple with the fallout from the coronavirus pandemic.

“The COVID-19 induced sell-off was a significant market drawdown but the market recovered in the blink of any eye and has lulled people into thinking they’ve got what it takes to ride things out. My experience is most people don’t, particularly retirees."

It's one reason why Liddell has added Milliman's SmartShield separately managed accounts to his range of client tools. The SmartShield Moderate, Balanced, Growth and High Growth portfolios all include a built-in futures-based systematic risk management strategy to smooth market volatility and provide some downside protection if markets fall.

"I’m not saying investors should shun growth assets completely. But rather, they need to invest with room for error or have a Plan B. Better still, I think SmartShield gives them Plan A and B."

Liddell uses the SmartShield High Growth portfolio as part of a core-satellite approach. The High Growth portfolio is comprised of 90 per cent passively managed growth assets, which are most at risk of volatility and a market downturn.

Liddell then uses other actively managed funds for his clients' bond exposure.

The built-in risk management strategy within the SmartShield portfolio has allowed him to raise the overall proportion of growth assets in his pre-retiree client portfolios to about 60 per cent from 50 per cent.

"The protection gives us some comfort that we can take on a bit more risk. I stress to people that with SmartShield, we're not taking risk completely off the table – it's not a full guarantee. But that concept of giving up some of the upside to protect the downside really seems to resonate with people."

It gives Liddell the ability to reshape the risk-return curve, melding it into a better fit for the specific needs of pre-retirees. His clients can also take an extra level of comfort knowing they have extra protection if the current strong market conditions reverse just as they approach retirement.

"I think it was Mark Twain that said, which sums things up quite well at the moment: ‘It’s not what you don’t know that will get you into trouble. It’s what you know for sure, that just ain't so.”

You can check the potential benefits of downside protection on your own client portfolios by using Milliman's SmartShield digital portfolio simulator at: https://advice.milliman.com/en/insight/The-SmartShield-digital-portfolio-simulator.

For more information about Milliman’s SmartShield Managed Accounts, please email [email protected].

¹What Did 2020 Reveal About Liquidity Challenges Facing Superannuation Funds? Retrieved from https://www.rba.gov.au/publications/fsr/2021/apr/pdf/box-c-what-did-2020-reveal-about-liquidity-challenges-facing-superannuation-funds.pdf

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