Bhavin Shah continues Newton Investment Management's series of DC columns with a look at how schemes can meet the challenges of providing income in a low interest rate world
We are, on the whole, living longer and healthier lives. In 1960, 5.0% of the world's population was older than 65. By 2017, that proportion had risen to 8.7%. The World Bank estimates that by 2050 15.8% of the world's population will be over 65. In the UK, the statistics are even more alarming, with this age group expected to represent over a quarter of the population1. Ageing global populations have increased the burden on governments' health and retirement budgets, and as a result are limiting provisions. The private sector is also reducing pension support for current workers. This, in turn, has increased the onus on individuals to plan for their retirement. An important component of this planning is the defined contribution (DC) scheme, and how members' assets should be invested to meet changing requirements as demographics evolve.
Indeed, if we are living longer, we may need to work longer, which may in turn extend our investment time horizon. This should mean we have the ability to take on more risk in pursuit of growth to fund our longer retirement. However, it is widely believed that investment returns will be lower for longer, owing to growing debt burdens across nations, low interest rates and challenging demographic trends in developed economies. Therefore, a passive approach to equity investment (which could offer an overly optimistic projection of future returns) may not provide the long-term performance needed to meet future retirees' income requirements.
Furthermore, the investments in a DC scheme need to be flexible enough to provide stable total returns to fund lifestyles during retirement. The time horizon for investments post-retirement is also potentially longer, and with more people opting not to take an annuity owing to low interest rates, it will be crucial for DC schemes to provide members with effective ways to draw down while not depleting capital. It is therefore imperative to focus on investment solutions that will provide stable and growing incomes while providing attractive total returns.
Delivering such incomes from investments is clearly a challenge in today's low interest rate world. One way to achieve this could be via a flexible and transparent investment strategy that uses the full spectrum of the investment universe. This would include traditional asset classes such as equities and bonds, but also alternative investments such as infrastructure, renewables and property. In a world that has been distorted by extraordinary monetary policy, and where asset prices and economic growth have arguably been dislocated, it is important to focus on fundamental value, and on knowing what you own and why you own it. This, coupled with a sufficiently long investment horizon, could provide the recipe for sustainable long-term returns to help individuals to fund a longer and healthier retirement.
By Bhavin Shah, portfolio manager, multi-asset team, Newton Investment Management
1 Source: August 2018 Bernstein report - Age of the aged