2020 Vision: Eyeing the Best Funds at Retirement

By Andrew Morris, Product Specialist 

Should an income-focused fund be the first choice for clients at retirement or would a growth fund where you sell off units to obtain income prove a better option?

The answer is that there are pros and cons to both solutions. With income funds, the biggest pro is that capital is not eroded by withdrawals as it instead utilises dividends for the clients’ income. Because of how they are designed, income funds can often offer yields higher than the likes of a sustainable withdrawal rate and are more aligned to other options such as, guaranteed income, without having to dig into the investors’ pots.

These pros might seem like a “no brainer” for clients requiring an income, but sometimes they are outweighed by the cons. The most important cons given today’s market environment are: a) that income is not consistent and b) the ongoing lower yielding environment means that income funds are having to look further afield in order to match historical returns.

Most income funds typically aim for a level of yield of around 4%. However, while over the course of 12 months a fund may meet and, for some, even surpass that level, it does not mean the end clients receive 0.33% every month (4%/12). If they pay out the bulk or all of their dividends each month and don’t hold much back (when dividends are lower/higher than expected or unpaid/special dividends paid) then the monthly dividend payment will not be the same as the previous month. As each of the shares, bonds or alternatives pay dividends at different times and at different amounts, this can have a knock-on effect to monthly dividend payments.

An example below shows dividends paid from funds available with data from Morningstar. 

To put into context, month-by-month payments can vary and this poses challenges with budgeting, for example, and adds another layer of uncertainty especially when the monthly payment is meant to be the clients’ main source of income.

This brings me to the second con for income funds – volatility and standard deviation risk. Historically speaking, income funds have been able to deliver high yields with lower risk simply because lower risk assets were offering higher yields. Before the global financial crisis, for example, government bonds were paying 3-4% alone, with high yield bonds and equities paying a premium on top of that. So, for a client looking for a month-to-month 4-5% yield, their investment could be led by low risk assets with a steady stream of income. This is much more difficult to achieve today with government bonds paying record low yields and, as a result, fund managers are moving into riskier territories in their hunt for yield.

Chasing yield can expose clients to risk that is greater than what they are normally comfortable with and when focusing on dividends could also potentially expose the underlying capital to larger loses. An example below shows the average standard deviation of monthly income paying funds with a yield over 4% compared to the average yield. While the 12-month yield has been relatively stable, the standard deviation has increased. This illustrates how investors are taking on more risk and accepting more volatility in their investment in order to continue to receive the same yield.   

An alternative view on income

Canada Life Investments has vast experience in managing fixed income, property and UK equity assets. Although active investment managers, we have always taken a conservative approach and focused on lower risk holdings. Our Diversified Monthly Income Fund was designed to offset the biggest cons for income-focused funds. Unlike most monthly income funds within the market, our focus on dividends is consistency rather than “more is good”. Each month we look to pay a target dividend that stays constant throughout the year, paying a discretionary quarterly dividend as well as an annual dividend when excess income is built up. This way we are able to better manage clients’ level of uncertainty related to income budget without them having to cancel off units.

Our second step focuses on quality investments. By having a base criteria for all investments, we remove the desire to chase yield by undertaking fundamental credit analysis and identifying companies offering more favourable yields – but with strong balance sheets that can withstand a potential downturn. This enables us to construct a portfolio that aims to deliver a sustainable income stream with limited fluctuation in capital values and to stick to a process where risk can be further managed.  

Important information

Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.

* Source: Canada Life Investments, data obtained from Morningstar as at 01/12/2019, based on all monthly paying income funds within the IA Mixed Investment 20%-60% Shares sector.

The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com.

Data Source - © 2019 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

Canada Life Investments is the brand for investment management activities undertaken by Canada Life Asset Management Limited, Canada Life Limited and Canada Life European Real Estate Limited. Canada Life Asset Management Limited (no. 03846821), Canada Life Limited (no.00973271) and Canada Life European Real Estate Limited (no. 03846823) are all registered in England and the registered office for all three entities is Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Canada Life Asset Management is authorised and regulated by the Financial Conduct Authority. Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

CLI01550 Expiry 31/01/2021

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