In 2014, in one of the most radical changes to private pensions for a generation, the government announced, “pension freedom”, enabling anybody aged 55 and over to take the whole of their pension as a lump sum. And by 2021, people in the 55 to 59 age bracket will account for the highest percentage (some 7%) of the UK population, meaning that an unprecedented number of people are going to be living off their pension funds as a form of income.
Once upon a time, you could use your pension pot to purchase an annuity which would give you a meaningful and stable pension over your retirement. Unfortunately, falling gilt yields and interest rates over the past decade have completely changed the backdrop for annuity rates, causing many older people to defer their pensions.
The days of investing in a strategy of fixed-income securities delivering returns of 4% to 6% appear to be long gone, and with interest rates looking set to remain low for the foreseeable future, creating a meaningful income has become more challenging.
The same holds true for investors. The corollaries of nearly twenty years of crises (the dot-com crash, the 2007/2008 financial crisis, the euro crisis, Brexit and now Covid-19) are very loose monetary policies and a raft of stimulus packages the world over, putting significant downward pressure on interest rates and sovereign bond yields.
More recently, the leading central banks and governments have reintroduced quantitative easing and other stimulus measures as a means of protecting jobs and corporations while stimulating the global economy. Nevertheless, the UK is about to suffer its worst recession in 70 years. Income-seeking asset classes such as equities have been hit hard and – in a drive to protect balance sheets – dividends have been cut or suspended.
The UK has recently joined Germany, Japan and a number of other EU nations in selling debt with a negative yield. Indeed, last month the government issued its first ever negative three-year government bond (-0.003%). The result is that investors are now guaranteeing themselves a loss and actually paying the government for the privilege of holding these bonds.
All of this means that net gains among the participants in this fractured global economy are difficult to come by. If one party gains, then others often have to lose an equivalent amount. How then can we secure wins in a zero-sum game?
There are options – you just have to look carefully and cast your net a little wider. Obviously, quality businesses will continue to grow and pay respectable dividends, so they will still constitute a sound investment opportunity. But for the time being, you might need to shift your focus away from the traditional asset classes – like UK government bonds and equities for income – and look at alternative asset classes.
One such alternative asset class is infrastructure. Government-backed infrastructure projects in particular can offer long-term sustainable income, and many countries – including the UK – will need to adopt a fiscal expenditure strategy at some point that will involve them spending more money on areas such as transport systems, communication networks, hospitals, schools and large scale projects. These projects will provide investors with some healthy yields and income… and as an asset class, infrastructure has the advantage of not being overly correlated to equity and bond markets.
Another area currently providing opportunities is real assets: real estate, renewable and clean energies, as well as specialist infrastructure. These are appealing for four reasons: (i) the high income that they are capable of generating, (ii) the inflation protection that they have around them, (iii) their equity appreciation over the longer term and the fact that they are also lower-correlated to equity markets (iv) and finally – in some cases – their favourable tax treatments.
These are options – if you are looking for safe income streams. But if you’re looking for growth as well, you’ll need to opt for a mixture of new-world and reputable global leadership businesses. Companies that generate significant positive cash flows or earnings which increase much faster than inflation or the overall economy. Similarly, many of these businesses deliver attractive income through rising dividends. Identifying excellent businesses has become even more important, since many old-economy businesses have not embraced change and so have suffered as a result.
The numerous crises of the past twenty years have functioned as depressants on markets and assets, and apart from yet more quantitative easing and introducing negative interest rates, the monetary toolbox now seems pretty much empty. Furthermore, disruptive technologies – such as robots and automation – reduce the need for a paid workforce, constituting yet another non-inflationary factor. So, with the current debt mountain standing at some US$260 trillion globally and rising, and with interest rates and bond yields set to remain low for a long time, any meaningful rise in the inflation rate seems unlikely any time soon.
Today’s world is indeed very different to yesterday’s. But there is a positive side: global equity markets are still delivering healthy and acceptable returns. Income, however, has to be derived differently. The way to do it is to opt for a total-return strategy through a more resourceful and visionary asset allocation. Implementing such a strategy involves embracing change and investing in quality companies with strong balance sheets, healthy cash flow and rising dividends. It is contingent on being able to capture a changing world and benefiting from its rewards.
Usually, as we get older, our natural inclination is to take less risk and steer clear of volatility. But the truth is that the real gains are to be found in higher-risk assets.
There was a time when a standard rule of thumb was to “have your age in fixed income”. So if you were 60, you would have 60% of your money in fixed income, and 40% outside of that safe asset class. Now, that was fine if you passed away at 70 or 75. But now that people are living longer, if you down-risk your portfolio at 55 or 60, you could well have another 30 years during which you need your money to deliver income for your lifestyle. You therefore need to keep a much higher weighting in equities so as to guard against the risk of you running out of money before you die.
You cannot avoid volatility – it is part of life and you simply need to ride it out. And in fact, the longer your time horizon, the easier it will be to ride out those bumps in the road (financial crises, fluctuating inflation rates and interest rates and corporate profitability figures).
You can also learn to be less fearful of risk and diminish it by approaching experienced and highly qualified people for guidance and advice. Whether you decide to seek financial planning or investment guidance, the best investment you will make will be paying for the right advice from the right people so you can be assured of getting your desired outcome.