The risks with income targeting a retirement portfolio

Income-targeting retirement portfolios could struggle to measure ‘success’ well, says Parametric.

The Retirement Income Panel’s work over the past year should give superannuation funds all the motivation they need to decide what ‘success’ in funding pensions really means, according to a  research note by the global implementation specialist manager Parametric.  

Raewyn Williams, Head of Research (Australia) and Analyst Josh McKenzie, in a ResearchBite titled  “Income-Targeting in a Retirement Portfolio: too much, too little or just right?”, explore how superannuation funds deliver an adequate pension to retired members is a new frontier. 

“They are not shackled by legacy products, they’re not the focus of peer surveys or the APRA  heatmap. It is a rich ‘greenfield’-type opportunity to get back to the specific needs and sensitivities  of fund members and embrace problems not yet solved by the industry – truly, a licence to  innovate.” 

The authors argue that delivering an adequate pension to retired fund members requires funds to determine what an ’adequate’ yield on the Australian equities component of a retirement portfolio is and be willing to move beyond mechanical, accumulation-style approaches to yield benchmarking. 

“One benchmark to determine adequacy could be a portfolio’s yield equaling or exceeding the yield of the S&P/ASX 200 Index over a certain timeframe. 

“Franking credits also should be added to the equation because they provide significant value to retirees. Our research shows that franking credits on the S&P/ASX 200 are worth 1.5% annually to retirees and an active, franked dividend targeting strategy can add as much as 2% annually to retired fund members, albeit with a different risk profile. 

“A pension-focused Australian equity strategy without franking visibility and ‘smarts’ misses an important portfolio lever to meet its income targets. Can a super fund really answer credibly  whether the equity yield outcomes are ‘successful’ without including franking?” 

Williams and McKenzie say this market-cap benchmark approach to yield will appeal to many funds.  “It’s relatively simple to implement, reflects familiar performance and benchmark concepts and  showcases how a super fund’s thoughtful portfolio design can beat a ‘dumb beta’ equity portfolio  yield outcome.” 

They add that a more ambitious challenge funds could take up is to measure yield ’success’ through the prism of the member – not the fund. “For example, think about a fund with reasonable data or,  for some, a good feel about member preferences. Members who would otherwise invest their retirement savings outside super in, say, term deposits, ‘blue-chip’ Australian companies or a rental property really want to know this: whether their decision, instead, to let their super fund invest to generate retirement income has been a good one. So that could translate to benchmarking the yield on their super retirement portfolio against yields on term deposits, blue-chip stocks or rental properties.

To demonstrate the amount of innovation that is possible, Williams and McKenzie also discuss an array of benchmarks funds could use to gauge yield ‘success’ based on age pension entitlements,  salary replacement targets and ASFA’s dollar-based living standards for retirees. 

The authors conclude: “Our key message is that as super funds develop and implement their retirement portfolios, they can do better than simply migrate mechanical accumulation portfolio– style yield benchmarks that, in truth, may miss the mark for members.  

Super funds could think innovatively and define yield success in a way that more closely reflects what retired fund members would relate to and care about. The estimated 1.8 million members  moving into and through retirement in the next five years hope the opportunity to measure ‘success’  well in income-targeting retirement portfolios is one that super funds don’t miss.” 

Main Image Source: Kitefly by Shutterstock 

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About Parametric 

Parametric Portfolio Associates is registered as an investment adviser with the Securities and Exchange Commission.

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