Month: December 2018

Flexicurity in Retirement Income Solutions – making finance useful again

/ Kiwi Investor / 9 Comments

Flexicurity is the concept that individuals need both security and flexibility when approaching retirement investment decisions.  See EDHEC-Risk Institute.

 

Annuities, although providing security, can be costly, they represent an irreversible investment decision, and often cannot contribute to inheritance and endowment objectives. Also, Annuities do not provide any upside potential.

Likewise, modern day investment products, from which there are many to choose from, provide flexibility yet not the security of replacement income in retirement.  Often these Products focus solely on managing capital risk at the expense of the objective of generating replacement income in retirement.  In short, as outlined by EDHEC-Risk, modern day Target Date Funds “provide flexibility but no security because of their lack of focus on generating minimum levels of replacement income in retirement.”

 

Therefore, a flexicure retirement solution is one that provides greater flexibility than an annuity and increased security in generating appropriate levels of replacement income in retirement than many modern day investment products do.

 

EDHEC offers a number enhancements to improve the outcomes of current investment products.

 

One such approach, and central to improving investment outcomes for the current generic Target Date Funds (TDF), is designing a more suitable investment solution in relation to the conservative allocation (e.g. cash and fixed income) within a TDF.  Such an enhancement would also eliminate the need for an annuity in the earlier years of retirement.

 

From this perspective, the conservative allocations within a TDF are risky when it comes to generating a secure and stable level of replacement income in retirement. These risks are not widely understood nor managed appropriately.

The conservative allocations with a TDF can be improved by being employed to better matching future cashflow and income requirements. While also focusing on reducing the risk of inflation eroding the purchasing power of future income.

This requires moving away from current market based shorter term investment portfolios and implementing a more customised investment solution.

The investment approach to do this is readily available now and is based on the concept of Liability Driven Investing applied by Insurance Companies.  Called Goal Based Investing for investment retirement solutions. #Goalbasedinvesting

The techniques and approaches are available and should be more readily used in developing a second generation of TDF (which can be accessed in some jurisdictions already).

This is relevant to improving the likely outcome for many in retirement. With this knowledge it would help make finance more useful again, in providing very real welfare benefits to society. #MakeFinanceUsefulAgain

 

For a better understanding of current crisis of global pension industry and introduction to Flexicure see this short EDHEC video and their very accessible research paper introducing_flexicure_gbi_retirement_solutions_1.

 

This is my last Post of the year.

Flexicure, is my word of the year! Hopefully, we will hear this being used further in relation to more Robust Investment Portfolios, particularly those promoted as Retirement Solutions.

As you know, my blog this year has had a heavy focus on retirement solutions and has drawn upon the analysis and framework of EDHEC-Risk Institute.

In addition, the thoughts of Professor Robert Merton have been important, particularly around placing a greater emphasis on replacement income in retirement as an investment objective and that volatility of replacement income is a better measure for investment risk for those investing for retirement.

I have also noted the limitation of Target Date Funds and how these can be improved e.g. with the introduction of Alternatives.

Nevertheless, the greatest enhancement would come from implementing a more targeted cashflow and income matching portfolio within the conservative allocations as discussed above.

 

Wishing you all the best for the festive season and a prosperous New Year.

 

 

Happy investing.

 

#MakeFinanceUsefulAgain

#flexicure

#goalbasedinvesting

 

Please see my Disclosure Statement

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

 

 

Recent Market volatility and end of year market and economic forecasts

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There are lots of economic and market forecasts at this time of the year. Many are easily accessed on the internet.

Does anyone care about these forecasts? Or do we place too much emphasis on these forecast? These topics are covered in a recent Institutional Investor article. Some good points are made.

 

The current market volatility is likely to be front of mind presently for many investors. Others may be seeing it as an opportunity.  What ever your view of 2019, a longer term perspective should always be maintained.

Either way, it has been a tough year to make money .

 

Most likely, your view of the current market volatility is closely tied to your forecast for 2019.

On this note, there are number of reasons to be “relaxed” about the current market volatility as outlined in the recent Think Advisor article.

 

Why should we be relaxed about the current bout of volatility? The most pertinent reasons from the article are as follows:

The US economy is still strong

US Economic growth accelerated in 2018 while the rest of world slowed. Global growth is expected to moderate in 2019 from the current pace in 2018.

Albeit, the US economy is still strong with unemployment at its lowest level since 1969, consumer and business confidence remains healthy, forward looking indicators are supportive of ongoing economic growth.

Although growth is slowing in Europe and China the environment remains supportive of ongoing economic expansion.

Global sharemarkets appear to have already adjusted for a more moderate level of global economic growth in 2019.

 

Stock Fundamentals are okay

Global corporate earnings are forecast grow over the next twelve months, supported by the economic backdrop outlined above.

As alluded to above, value has appeared in many global markets given recent declines.

 

Yield curve inversion

Markets are pre-occupied with the possibility of a US inverted yield curve. This appears overdone. Yield curve Inversion is when the yield (rate of interest) is lower on longer dated fixed interest securities compared to shorter dated securities. Under normal circumstance longer dated securities have a higher yield than shorter dated securities.

As highlighted previously  an inverted yield curve is a necessary but not sufficient pre-condition to recession. Not every yield curve inversion is followed by a recession .

There is also a considerable time lag between yield curve inversion and economic recession. A period of time in which sharemarkets have on average performed strongly.

Lastly, the traditional measure of yield curve inversion, 3 month yield vs 10 year yield, is not inverted!

 

Of the reasons provided in the article, the above are the most relevant and worthy of taking note of.

Nevertheless, global trade is a key source of the current market volatility and is likely to remain so for sometime.  Likewise it may take time for markets to gain comfort that global economic growth has stabilised at a lower rate of expansion. Therefore, continued market volatility is likely.

Alternatively, a pause in the US Federal Reserve raising short term interest rates would also likely provide a boost to global sharemarkets.

 

PIMCO, as recently reported, highlight that the risk of a recession in the US has climbed in 2019.

This prediction is made in the context that the US is nearing a decade long period of economic expansion, the longest period in its history without experiencing an economic recession (defined as two consecutive quarters of negative economic growth).

PIMCO note “The probability of a U.S. recession over the next 12 months has risen to about 30 percent recently and is thus higher than at any point in this nine-year-old expansion, Even so, the models are flashing orange rather than red.”

“The last few months have given us a sense of the types of risks that are out there, that both the economy and markets are going to face in 2019,” ….. “At a minimum, like we have seen this year, expect ongoing volatility and that’s true across all segments of the financial markets.”

 

Happy investing.

 

Please see my Disclosure Statement

  

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

It has been a tough Year to make Money

/ Kiwi Investor / 1 Comment

2018 has been a tough year in which to make money.

2018 is “The worst time to make money in the markets since 1972” according to a recent Bloomberg article.

“Things have not been this bad since Richard Nixon’s presidency”.

Research undertake by Ned Davis Research, who places markets into eight big asset classes, everything from bonds (Fixed Interest) to US and international stocks and commodities, not one of them is “on track to post a return this year of more than 5%, a phenomenon last observed in 1972”….

As they note, in terms of absolute loses, think Global Financial Crisis (GFC 2007/08), investors have incurred far worst returns in 2018, nevertheless, as far as breadth of asset classes failing to deliver upside returns, “2018 is starting to look historic.”

Nothing has worked this year.  Year to date: global equities are down, as are emerging markets, hedge fund indices, global commodities (even oil), International Credit, Global High Yield, US Fixed Interest, US Inflation Protected Bonds, while Global Aggregate Fixed Interest have eked out a small gain.  Investments into unlisted assets have been more rewarding.

 

“That’s all but unique in history. Normally when something falls, something else gains. Amid the financial catastrophe of 2008, Treasuries rallied (increased in value). In 1974, commodities were a bright spot. In 2002, it was REITs. In 2018, there’s nowhere to run.”

 

Outcomes are a little better if you are a New Zealand (NZ) based investor, Cash is on track to return around 2%, 6 month Term Deposits 3.5%, NZ Fixed Interest is up around 4%, and the NZ Sharemarket is currently up 3%.  Still they are all short of 5%.  Meanwhile the recent strength in the NZ dollar has detracted from offshore returns.

 

It has been a tough year, global equities reached all-time highs in January, fell heavily in February and March, only to recover up to October, with the US Sharemarket reaching a new historical high.

Since October yearly gains have been erased due to a number of factors, some, but not all, of these factors are briefly outlined below.

 

In short, as highlighted by a recent Barron’s article markets appear to be panicking over everything.

Recent market drivers in brief:

  • Primarily concern for Sharemarkets has been a reduction in global economic growth expectations. Global investor sentiment toward the pace of global economic growth in 2019 has become more cautious over recent months. Global sharemarkets have adjusted accordingly. Albeit, the sharmarket adjustment does appear to be overdone relative to the likely moderating in global growth in 2019, which has also  largely been anticipated.
  • Global Trade concerns continue to negatively impact global markets e.g. Australia and commodities, primarily the ongoing negotiations between the US and China are a source of market volatility and uncertainty.
  • Brexit more recently. The UK are going to have to pay a price for leaving the EU, why? too stop other countries ever considering leaving the EU as a viable option. Unfortunately, while Brexit is an important issue and will be a source of volatility, the negative consequences will largely sit with the UK rather than the rest of the world.
  • There has been considerable oil price volatility, the price of oil fell by over 20% in November.
  • There has also been uncertainty as to likely pace of increases in the Federal Funds Rate by the US Federal Reserve (US Central Bank).

 

Inverted Yield Curve

Lastly, markets have also latched onto the inversion of the US Yield curve.

Inversion is when the yield (rate of interest) is lower on longer dated fixed interest securities compared to shorter dated securities. Under normal circumstance longer dated securities have a higher yield than shorter dated securities.

An “inverted” yield curve has been useful, though not perfect, in predicting economic recession and equity bear markets (when sharemarkets fall in value of over 20%),

 

On this occasion the market has focused on the three year security versus the five year security.

Normally, the market focuses on the three month versus the 10 year security as the best predictor of economic recession.  For a further discussion see Risk of Economic Recession and Inverted Yield Curve and US Recession warning. An inverted yield curve is a necessary but not sufficient condition in predicting a recession, and there is often a lag.

 

As the Barron article highlights: “Since 1965, the three-year yield has been higher than the five-year on seven different occasions. In 1973, the stock market had already sunk into a recession. In the other six instances, the median distance to a recession was 25 months—or more than two years. The S&P 500 went on to gain a median 20% over the 24 months following such an inversion. “Historically, not only have returns tended to be very strong, but the bear market has generally been years away,”

 

Happy investing.

 

 

Please see my Disclosure Statement

 

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.