Giving retirees a smoother return path in uncertain times

As fixed income takes a battering, portfolio manager says older investors need extra protection to mitigate risk

Giving retirees a smoother return path in uncertain times

A perfect storm is building for retirees. As the population ages, defined benefit pensions become less prevalent and COVID-19 compounds a low interest-rate environment, income is not such a sure-fire thing.

Chris McHaney, portfolio manager, BMO Global Asset Management, believes investors have to take more control of their retirement planning, utilizing their own investments and solutions that are specifically geared towards them. For retirees now, the situation has been accelerated by the global pandemic. Interest rates have gone down to essentially zero, there is little returns in fixed income and moving into the equity market means picking up more volatility.

McHaney said this presents a problem for the typical retiree who wants relatively safe investments and predictable return streams. The fixed-income market, of course, was their usual destination but that no longer looks as appealing.

“Potential volatility associated with fixed income is actually getting bigger,” he said. “Traditionally, this was a safe haven type of investment. But as interest rates continue to stay low, it’s not just the amount of debt that governments are issuing [that’s making things hard], the term of that debt is also getting longer and longer.”

On top of this, the recent Federal budget announced the return of a 50-year bond issuance, which features more volatility when interest rates change. The scenario is steering more investors into increasing equity exposure and risk in order to get the returns they're used. It's a move fraught with danger.

McHaney explained: “For an investor that’s saving over time, it's not as big of a deal. Volatility actually works in your favour if you're putting in your regular contributions. But in retirement years, when you're drawing from your savings, it works the exact opposite way. You need that smoother return path – the return associated with equities but the volatility associated with fixed income. This is obviously a real problem for retirees or for anyone that's a risk-averse type of investor.”

BMO believes, therefore, that as investors make this shift into riskier assets to get returns, they require an investment solution that pays explicit attention to the volatility they’re taking on and takes steps to mitigate it.

Its primary investment solutions are the BMO Retirement Portfolios, “low-risk” mutual funds that differentiate themselves from a traditional balanced fund (60-40 stocks and bonds). Within fixed income, they pay close attention to duration and the volatility associated with interest-rate, while on the equity side, they run a protective option overlay, using derivatives to reduce the overall risk of the equity portfolio to create a smoother return path.

McHaney said: “We’re giving away some upside in potential growth, but we're doing it in order to protect on the downside, as well as compress the range of potential outcomes. It uses derivatives within the regulatory framework of a traditional mutual fund, so we’re not taking leverage, we're actually reducing risk.”

He added that in the growth sleeve, they invest in low volatility equities, the so-called “boring stocks” like consumer staples and utilities. “It’s a solution that's purpose-built for retirees and for investors that want, again, a more traditional type of return stream, but don't want the volatility associated with moving into the equity market.

“We’re giving up a little bit of that upside in order to protect on the downside to create a smoother return path, and have investments that are geared specifically towards this market segment and this type of investor.”