What are you trying to achieve from your investments?
The question of asset allocation is key for retirees, and it is for this reason that we at FIIG have spent so much time over the last couple of years focusing on it for our clients both in The Wire and when speaking to them one-on-one. Since the onset of the GFC, markets, and equity markets in particular, have shown considerable volatility and while an investor with 20 or more years to retirement may be able to ride out such volatility, investors close to, or already in retirement do not have the same luxury of time to recover.
For investors who need to provide themselves with a regular income in retirement, these dips in equity markets (or cuts to share dividends), may cause them to eat into their capital base to fund their expenses, and for investors already in retirement, there are limited opportunities to rebuild their capital base.
For this reason, investors in retirement should be re-evaluating their asset allocation, with a focus on moving away from riskier, volatile markets like equities and property, and moving more of their allocation towards defensive, less volatile asset classes like fixed income.
A key driver of levels of allocation, and style of assets investors should hold is, “what are you trying to achieve from your investments in retirement?
As a retiree, are you really looking for growth? What is really important to you at retirement age? Do you really want your portfolio to double over the next 20 years or do you want your portfolio to provide a steady income? For most retiree’s their investments must provide their “salary”, so this, the provision of salary, should be their key focus.
Paying yourself a salary
With continued volatility in equity and property returns and the increasing proportion of Australia’s population either in retirement or approaching retirement, investors have sought investments which provide more cashflow certainty so that they may pay themselves an income from their retirement savings.
At the same time, investors want to maximise the salary they are paying themselves. While fixed income investments by their nature provide a regular income, investors are still often looking for a higher salary. This has led to the re-emergence of a product once considered a little old fashioned, the annuity.
What is an annuity?
An annuity is a series of regular future cashflows, due and payable to the investor in return for the purchase price paid.
As annuities return regular cashflows they are usually classed as fixed interest investments. This is because on the surface, they are not unlike a fixed rate mortgage, where the annuity investor is the equivalent of the lending bank. The investor, in return for purchasing the annuity, receives a regular repayment that comprises an interest and principal repayment, until the principal balance is zero.
By repaying both interest and principal, an investor is able to receive an increased ‘salary’ from their investment, with the trade off being the repayment of the principal portion over time. For investors seeking a higher return, and who are less worried about re-investing the principal at maturity, an annuity may be a welcome addition to their fixed income portfolio.
Indexed annuity bonds vs Retail annuities
While only life insurance companies can issue retail annuity products, some bond issuers issue Indexed annuity bonds (IABs). These are effectively an amortising loan with the interest indexed to CPI. The regular interest repayments to investors are adjusted with reference to the inflation rate thus protecting the real value of the investors’ income payments over time.
IABs will often provide returns superior to retail annuity; offerings as all of your investment return is returned to you, the IAB provider isnt keeping significant amounts of your return to pay for advertising, administration, commissions, APRA capital standards etc. Whilst some retail annuity providers highlight their no fee structure, in reality the actual returns they are paying are quite low, and you can be sure the returns they’re earning by investing your money is considerably higher, while there may be no ‘fee’, the provider definitely makes a profit.
By directly owning an IAB you also have the added flexibility of being able to exit your investment if something does happen and you need to access your money. IABs can be sold quickly and without incurring any fees. Traditional annuities aren’t designed for people with emergencies, and if you wish to break the annuity and take some money out, you will be hit with a fee, if you are able to redeem the funds at all.
Who issues IABs?
As most companies in Australia choose to issue ‘bullet’ loans (like an interest only loan) rather than amortising loans, IABs tend to be somewhat scarce; however they are well suited to projects with definitive time lines.
We have previously covered a number of public-private partnerships including Praeco, the (Department of Defence Headquarters development) and Southbank (the Southbank Educational Precinct in Brisbane) and Royal Womens Hospital, all of which exist for a pre-determined timeframe, and as such are well suited to the characteristics of an amortising debt profile. All of these PPPs offer IABs in their funding structure and offer strong CPI linked returns.
Conclusion
For investors looking for a higher regular income with protection against inflation, we feel the IABs with investment grade ratings, government backed revenue streams and low risk business profiles, offer a compelling investment opportunity.
Please contact your FIIG Representative on 1800 01 01 81 if you think an annuity may be right for you.
Disclaimer
The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced, distributed or to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.
FIIG Securities Limited (‘FIIG’) provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not make a market in the securities or products that may be referred to in this document.
The credit analyst certifies that all of the views expressed in this document accurately reflects their views about the companies and securities referred to in this document and that their remuneration is not directly or indirectly related to the views of the credit analyst. FIIG, its directors, representatives, employees or related parties may have an interest in any companies and entitles, and may earn revenue from the sale or purchase of any financial product, referred to in this document or any advice. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG.