Sun-Herald: Investing With Age

Sun-Herald/Sunday Age, March 2010

We’re all getting older. Australian society is in the midst of a landmark demographic shift, as the baby boomer generation enters retirement. That group – those born between 1946 and 1964 – accounted for two fifths of all employed Australians in 2007, according to the Australian Bureau of Statistics; now they’re gradually leaving the workforce.

From an investment perspective there are two ways of looking at this fact. On one hand, our ageing population has fostered a clutch of retirement income products designed to help money last in retirement: to combat, if you can put it that way, the chance that we’ll live longer. But on the other, ageing has become an investment theme in its own right. There are funds that draw their income from surrendered life insurance policies, funds based on retirement villages, funds that draw on the greying theme and lean their resources towards caravan builders and manufacturers of hearing implants. This article looks at both sides of the coin: retirement products, and age-themed investments.

On the retirement income side, the challenge is to preserve income, make it grow, and keep it accessible. “Retirees’ concerns are the provision of lifelong income and the security of their capital,” says Darren Johns, a certified financial planner at Align Financial in Sydney’s Northern Beaches. “They make a decision. Either they’re going to accept some investment risk, and potentially be rewarded for taking that risk; or they’re going to give their money to an institution and say: I’m happy or you to bear the risk in exchange for some kind of guarantee of steady income with limited potential for growth. Everybody’s different.”

One of the consequences of the global financial crisis is that the second camp Johns describes has grown considerably. Retirees with money in allocated pensions, which bear market risk, suffered badly through the crisis, seeing their retirement capital shrink dramatically, and although much of the losses have since been recouped, many are scarred by the experience.

In this environment, new products have focused on providing greater security. The two most well-known entrants have been Axa’s North product, and ING’s Money for Life. Axa North, which was actually launched pre-crisis in 2007, sought to bring capital protection to retirement products; it offers a range of investment options, with varying degrees of market exposure, and capital protection from five to 20 years. Galvanised by the financial crisis, it already has more than A$1.1 billion under administration – a strong start but no surprise to Axa which has offered a similar product in the US for 15 years. Over there, the market is worth US$1.4 trillion.

ING moved into the market in October 2009, and advanced the Axa approach by guaranteeing income for the whole of an investor’s life rather than a set term. It sets a protected income base on the first day (the amount you invested), which is used to determine your guaranteed income and the maximum you can withdraw each year under the terms of that guarantee. While the protected base can’t fall, it can rise, and is recalculated every two years.

“It gives you a combination of certainty and control,” says David Kan, executive director in the retirement and investment solutions group at ING. “You are certain your income won’t run out as long as you live; it won’t go down as markets go down. But you have full access to your capital at any time. And if you die, the capital returns to your beneficiary or estate, unlike a lifetime annuity.”

It is an open secret that Macquarie will be the next major name into this business. “We have made it reasonably clear we are interested in this space,” says Macquarie’s Andrew Robertson, head of a group called longevity solutions at the bank, though he declines to put a date to it.

“There is a real recognition that these things [guaranteed retirement income products] are going to become important,” he says. “What’s driving that recognition is what we call the sequence of returns.” What does he mean? Well, start out with $100 in an investment product with $10 a year in withdrawals, and assume that during your investment, there will be good and bad markets. It all balances out, right? Well, not exactly. If you get good returns early on, then bad ones later, you will see an increase in your balance and then a fall; you’ll be able to make your $10 a year withdrawals and still have something left in the account at the end of 10 years. But if you get the bad markets first, your balance drops early on, and your withdrawals mean there’s less capital to grow when markets rebound. In this instance you might run out after seven or eight years and have nothing left in the account. “This idea that it’s all about time spent in the market, not when you invest, has become a mantra that the industry is based around and everyone believes,” he says. “The problem is, it doesn’t work for accumulator saving products. Retirees are fundamentally exposed to these sequence-of-returns issues.” The only way to avoid it, he argues, is through a guaranteed product.

Consultants expect other providers to follow.”We feel that in a year’s time you would have a couple of other players,” says Nick Calill, principal and consulting actuary at Watson Wyatt. “These things are huge business, trillion dollar sellers in the US and Japan, so it’s natural that they will be rolled out here.”

However, nothing comes for free, and some financial advisors are alarmed by the level of fees involved in these products. Guarantees cost money, on top of the investment costs. Ultimately everyone will decide on the trade-off between fees and security. “The problem I have with some guaranteed super products is you pay a fairly heavy price for the guarantee, and if I pay a couple of extra per cent in fees it’s going to reduce my long term return,” says Paul Moran at Paul Moran Financial Planning in Carlton, Victoria. “It might be more stable with a guarantee attached to it but it does mean giving up a reasonable percentage of the return I’m likely to get.”

 Kan says ING’s research ahead of the launch showed that people would be comfortable with total fees around the 3% mark, including the guarantee, and that Money for Life matches that, at between 2.75% to 3.15% when purchased through a platform, and lower when bought through ING’s own platform, Select. “You do pay a fee for a guarantee, but we haven’t had feedback that it’s too high,” he says.

“There’s no product which is right for everyone,” says Calill. “Objectives will differ. One big one is the bequest motive: whether or not it’s a high priority to have money left over for the next generation. One of the stated advantages of not annuitizing is that you have access to your capital and if you die early there’s still something left.” So the pros and cons depend on what you wanted from a product in the first place. “You need to be careful to look at the fees you are paying, and there can be constraints that govern the extent to which you get your protection – if you draw more than a certain limit from these products you lose some of the protection they offer. They can be good, but not for everybody.”

Some planners report another knock-on effect of the financial crisis:  a return to fashion of boring old annuities. These guarantee you income for the rest of your life in a lifetime annuity, or for a set term in a term annuity. They are often index-linked to inflation, but have no exposure to markets and do not generally allow you to pull money out as and when you need it – plus, if you die earlier than expected, the money is lost and is not passed on to your dependents.

Frank Gayton is a financial planner who learned the hard way the value of these straightforward products when clients who had split their money between annuities and allocated pensions lost a huge chunk of their capital in the allocated pension and came back to him asking why he hadn’t put the lot in an annuity. “We are always very comfortable with annuities and they have really come back into our thinking,” he says. Available rates are attractive, he says: the week before speaking to the Sun Herald he did a quote for someone on $460,000 of savings who was able to lock in a rate of 7.03% on a 36 year term. “The global financial crisis has forced everyone to think that what efficient market theory tells us, doesn’t always happen that way,” he says.

He is not enticed by the ING/Axa school of capital protected, market exposure products. “It does sound very expensive to me,” he says. “The thing about a plain annuity is what you see is what you get.” Of major providers, Challenger has been a driver of this revival in annuities.

Aligned to this trend has been a return to what Johns calls “harder assets – holding a portfolio of cash and term deposits. I don’t know if it’s exclusive to the retirees market but I’ve had more inquiries about gold in the last 12 months than the last 12 years.” Generally speaking, when he looks at retirement income products, one of his main concerns is avoiding the plight of investors who are tied up in mortgage, income and structured funds that are still now allowing redemptions or withdrawals even a full year after most people consider the global financial crisis to have passed. “The king for retirees is liquidity,” he says.

How about the flipside – making money out of the ageing theme?

“A few years ago there was talk of launching funds which in the industry were known as zimmer frame funds: they invested in stocks such as mobility scooters, pharma and medications targeted to the elderly,” recalls Johns. “These were businesses which were directly involved in producing products or services for retirees or the elderly. I don’t know if it got any traction.” As a field of distinct managed funds, it didn’t, but the greying theme does inform the investment decisions of many fund managers who see growth ahead in companies in this area – be it Fleetwood, the caravan manufacturer, which is exposed to the trend of many people retiring and wanting to enjoy their free time travelling but on relatively modest financial means; Cochlear, which makes hearing implants; or international pharmaceutical companies like Roche or Novartis, which appear in many portfolios of Australia-based global equity funds.

Australian Unity is an example of a manager that has launched products based on a similar theme. It has offered three series of a product called the Retirement Village Investment Note between 2005 and 2009, the most recent of them providing around 8 to 8.5% per annum, secured by income from retirement villages. Adam Coughlan says Australian Unity sold about A$100 million of these types of products during that period. “Underpinning that is the demographic trend: retirement village income is very stable, underpinned by real property.” Products like these, with a fixed term of three, five or seven years and a rate of income that varies accordingly, do raise the suspicion of some planners wary of anything that limits liquidity, but they are an example of the use of the ageing theme to secure returns and build new offerings.

Another example was the ING Real Estate Community Living Group, formed by the stapling of two listed property trusts that among other things invested in aged care facilities. That, however, has not worked out. “It’s been an absolutely atrocious investment,” Moran says. “It’s had a 95% fall in value.” Partly this was the market but that doesn’t explain the extent of the losses. “It was caught up in the property trust collapse, but part of the problem is that these aged care facilities tend to be specialised properties. And if the aged care facility closes for whatever reason, you’ve got to find another to go in there.” Additionally, there’s something of a conflict at the heart of them, he says. “We feel there is a contradiction, or a natural tension, between the community desire for affordable aged care and the investor’s expectation of a profit.”

Nevertheless, tailoring a share portfolio to make the best of the ageing theme does make sense: as the chunk of Australia’s population that is in retirement grows, it’s natural that needs will increase for products targeting the elderly.

BOX: Life Settlements

If you’re getting on in years and have a life insurance policy you no longer really need, perhaps because the people who were your dependents no longer depend on you, you may have considered selling your policy back to the life office you bought it from, gaining a modest fee. But a new industry provides an alternative to people in that position, and has in turn used the policies to create a new investment class.

Life Settlements, a Victoria-based group, is so far the only Australian group to have attempted a model tried widely in the United States, known as viatical settlement. It buys up life insurance policies in the US; it collects when the original holders die; and the returns create the income for a fund sold in Australia.

There is a certain squeamishness in an investment class that delivers better returns the earlier people die, but the idea is actually quite entrenched in the US. As an investment, the theory is that it is reasonably stable and predictable and is uncorrelated to traditional financial markets. “It has this very interesting attribute of having a very low correlation to the rest of the market, but has aspects of being a bit like a bond in that it’s a financial instrument issued by a very highly rated credit entity – an insurance company – and you have a known cashflow at the end,” explains Stephen Knott, a director at Life Settlements. The US policies his firm buys are of a type called universal life, and they have a fixed benefit payable at the end with no unpredictable variation. “You have simply the uncertainty of the exact term,” he says – that is, how long someone lives.

Since that last point is unpredictable, funds like these tend to hold a minimum of about 200 policies to get diversification, “to manage the fact that although the various lives will have a predicted expectancy of X, the only thing you can be sure of is that it will not be exactly X.” There is, then, “a high degree of certainty of payment.” Life Settlements’ fund had 568 policies in it when the Sun Herald spoke to it, issued by 70 different insurance companies and equating to about US$1 billion of funds under management. Knott argues there are advantages to this compared to a bond, in that life policies are issued against reserves monitored by regulators and are legally distinct from a company’s assets, unlike a bond.

Life Settlements, like many others, hit problems in the financial crisis when it suspended redemptions as liquidity fell away. Knott presents this as an obligation under Australian law: “If we can’t satisfy ourselves we can sell assets at a reasonable price, we suspend until we can determine a reasonable price.” He says 50 to 60 mainstream mutual funds were in temporary suspension at the same time in a host of asset classes and that the problem was one of global market liquidity rather than anything specific about his company’s approach; redemptions reopened in March 2009. One change that came with the crisis is that the fund now hedges for currency movements, since that was playing havoc with investment returns, albeit sometimes very positively. The fund returned 14.57% for the 2009 calendar year.

The fund is sold to retail through platforms like BT, Macquarie, Oasis and Netwealth. Generally, though, the bulk of the funds have come from institutional investors to date.

Where does it fit in a portfolio? “We have a view on that: it is an alternative asset somewhere between your growth and defensive assets,” Knott says. “We’ve got institutions who say it’s a strange type of bond or a fixed interest type investment even though the return is not fixed.”

It’s notable, though, that nobody else has made much of an effort to enter this field. Andrew Robertson at Macquarie says he has been “staying across that market”, but “we are very aware of the fact that this has some significant reputation risks associated with it. I’m not sure we’re yet comfortable that the asset class is worked out. There is a risk of unscrupulous behaviour where people are cheated out of a policy that they shouldn’t be selling at that point in time.”

And planners generally are yet to be convinced. “There’s been an issue in the past with liquidity,” says Paul Moran. “In fact, you’re relying on people dying to create liquidity and to get a return. But I can understand there is a case to be made for them as an asset.”

And Calill, who looks at them more from the point of view of institutional investors, is similarly cautious. “From our clients’ point of view, it wasn’t immediately obvious that they should buy a product which would do better if people stopped living longer but worse if they lived for a long time.”