For investors heading towards retirement and anxious to ensure their pension or other investments become less vulnerable to the vagaries of the stock market as the big day approaches, one option is to make use of investment 'lifestyling' or 'lifecycle' products.
It's a fairly simple idea. Your money goes into a multi-asset fund of funds, initially in an equity-biased portfolio. Over the final 10 years or so before the target date, it is progressively shifted out of equities (where market swings could mean potential losses that cannot be recouped in the remaining time available) and into less volatile assets including bonds and property. The whole process is scheduled so as to produce a largely fixed interest and cash-based portfolio by the time it's finally needed. All of which seems pretty sensible at first glance – but also raises a number of important questions and potential problems.
The idea of lifestyling is commonplace among pension fund managers, and many group pension schemes provide an automatically lifestyled fund as a default position for scheme members who have not actively chosen funds.
But private investors can also opt for this outcome-oriented approach. The main player in the UK market is Fidelity, which offers a range of Target funds comprising a portfolio of Fidelity funds, with end dates at five-year intervals running from 2010 up to 2030. These are no promises of guaranteed returns – simply a pre-ordained 'glide path' for asset switching, which the fund manager has very limited discretion to adjust in light of wider market conditions.
Rob Fisher, head of UK personal investments at Fidelity, says that the range has attracted around £70m in the UK since launch in 2003. "Retirement is the biggest single goal, with most people holding them in an Isa, though they could form part of a Sipp fund," he explains. But they may also be used to cover a mortgage shortfall, or school fees – anything where there's a clear target date. Often they are used as a risk-controlled core holding to a portfolio.
Pros and cons
Financial advisers view these funds with mixed feelings. Their big strength, according to Tom McPhail, head of pensions at Hargreaves Lansdown, is that they ensure that investors who would otherwise have stayed in high-volatility assets are protected against the risk of adverse market moves. Moreover, as Mr McPhail explains: "The gradually increasing bond exposure then mirrors the annuity purchase at retirement, thereby de-risking any movements in annuity rates."
Steve Laird, director of Carrington Wealth Management, also highlights the broad structure of the funds. "Even using just one of these funds offers an investor great diversification and hence helps to reduce capital risk," he points out. However, similar diversity could be achieved through a conventional multi-asset fund without lifestyling characteristics.
Essentially, these funds remove the need for investors with a specific set timeframe to worry about asset allocation decisions. But as Rob Fisher acknowledges, investors really need a basic grasp of the importance of protecting their assets as their timeframe dwindles, in order to bother with such funds in the first place. Less well-informed investors – who would arguably be less likely to think about such matters and therefore stand to benefit most from an automated approach – may simply not see the point.
Beyond those benefits, there are other considerations. The biggest problem, as Adrian Lowcock, investment adviser at broker Bestinvest, observes, is that: "Lifestyling funds are just too simplistic."
For a start neither manager nor investor has significant control over the timing of the automated process, even if market conditions are working against a particular asset switch. "In some volatile conditions such as 2008 and 2009, when markets fell dramatically and then rallied with equal vigour, investors locked into an automated selling programme could have suffered the worst of both worlds, selling into investment losses and then missing out on the recovery," says Mr McPhail.
Secondly, some advisers question the need for people approaching retirement to start pulling out of equities 10 years beforehand as a matter of course, without taking into account issues such as age, attitude to risk and future requirements. "For instance, if a retiring client needs income to supplement pensions, then a good equity income fund would be likely to offer a better and less volatile income than a cash lump sum in a deposit account," suggests Mr Laird.
The assumption is basically that at the target date the money will be required in cash form to buy an annuity. But increasing numbers of people are now finding they don't retire on the date they forecast 10 years ago; and a more flexible approach to retirement dates will become more commonplace over the coming years.
"People are also increasingly taking retirement benefits in a more flexible format," adds Mark Osland, director at independent financial adviser (IFA) Formula Ltd. That might involve moving onto income drawdown rather than buying an annuity, or mixing and matching the two. In such circumstances, they need exposure to equities with the potential for growth, rather than fixed interest or cash alone.
There's a further danger, of complacency, adds Mr Lowcock. "The investor believes everything is sorted, and does not assess the performance or balance of his portfolio or pension. Indeed, it's easy to see the superficial attraction for investors who want to 'buy and forget'."
Asset allocation
But there is general agreement that a more sensible plan for anyone who can afford asset allocation and investment advice from an IFA is to construct a mixed portfolio on the basis of their risk profile, age, timescale and goals for the money, and then manage it on a manual basis.
Even on group pension funds, it's possible to switch off the lifestyling function and take a more active role in asset allocation, says Mr Osland. "The problem is that many people do not get involved with their pension investment, but we do encourage clients that way."
An interesting alternative available through IFAs is F&C's range of four defensive, cautious, balanced and growth Lifestyle multi-asset, multi-manager funds. There is no target date involved; instead, the IFA assesses the client's risk profile on an annual basis using a psychometric test from Distribution Technology, to ensure they are still in the right fund or switch funds if necessary.
"Broadly, people's attitude to risk is pretty consistent, though it may be shaken in the eye of a market storm, as happened last year; but they may, for example, lose their job or get divorced, and that could change their risk profile from one year to the next," explains F&C head of UK retail Dean Cheeseman.
The F&C team, although mindful of Distribution Technology's model asset allocation portfolios for each fund, has the freedom to exploit short-term opportunities in market capitalisation or movements. "At the moment, for instance, we're taking directional positions on the upward trend of the market by shifting the balances in the funds towards more aggressive equity managers," explains Mr Cheeseman.
Ultimately, if you can afford a more bespoke approach to asset readjustment, it's probably a better bet; but fixed-term lifestyling funds could help to protect those with small investment pots from the worst of an unfortunately timed market crash.
