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Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and sponsored by Canada Life. For today’s Soundbites, we’re talking about retirement investment solutions with Jack Delany, senior portfolio manager with the Multi-Asset Solutions team at Keyridge Asset Management — formerly Irish Life Investment Managers. We talked about the role of diversity in post-retirement planning, derivative-based strategies, and we started by asking what makes investing for retirement so different from wealth accumulation.

Jack Delany (JD): Investing for retirement will still have that core focus on risk and return, just like in the accumulation phase. But here, your objective is different. We need to take that risk-and-return focus and broaden it out. You want to ensure that you don’t outlive your savings. Retirees also have a number of additional considerations. They have things like an income need, the need for liquidity, inflation protection, estate planning and so on. A specific set of needs demands a dedicated solution. That’s a solution that not only acknowledges that these needs exist, but really tailors the asset mix to capture them.

Longevity risk

JD: Life expectancy has generally been on the rise across much of the world. In Canada, specifically, we can generally expect those coming to the point of retirement at age 65 to live to 86 on average. One of the key implications of living longer is that retirees are going to need their savings pots to last longer. And one way to mitigate longevity risk, or the risk of outliving your savings pot, is to generate a positive return on your investments. So, when it comes to retirement solutions, you’re typically still going to need those growth engines that deliver the potential for positive returns. It’s all about balancing that need for growth with some of the other needs of retirees, particularly when it comes to the risk side of things.

Sequencing risk

JD: On average, investor pot sizes will be at their largest at or around retirement. That’s something that we call the Retirement Risk Zone. Investors have done all their saving, they haven’t yet started their spending. So, if an investor’s portfolio suffers a large drawdown in the Retirement Risk Zone, it’s got two effects. Firstly, the monetary value of that drawdown, it’s larger than it otherwise would be because of the elevated portfolio value. Secondly — and crucially — the investors’ withdrawals will crystallize a portion of that drawdown because those withdrawn funds will be unable to participate in any future recovery. And that can be particularly detrimental for investors’ long-term outcomes after retirement. So, a core focus on drawdown management is going to be absolutely crucial. And these first two risks — longevity risk and sequencing risk — they’re effectively in contention with one another, right? Generating return means taking some risk. Taking some risk can result in drawdowns. So, again, getting that balance right between risk and return is absolutely critical, and it’s one of the key elements of successful retirement portfolio design. Diversification and strategy selection are going to be the vital tools here. And then, in terms of strategy selection, really looking for those strategies that can protect on the downside, while still giving growth potential that can be really important cornerstones in retirement solution design.

Income generation and inflation risk

JD: Given retirees’ need to take an income from their portfolios, a bias towards income-generating assets is generally prudent. A lot of research shows that there’s real behavioural benefits for retirees in having income strategies in their portfolio. They like knowing that there are assets in there that deliver an income stream. That could be combining something like a higher-yielding equity strategy alongside more traditional yield-generating assets, like in the fixed-income space. Inflation protection is another key difference from the accumulation phase. Retirees are fully dependent on their assets to help them with that inflation risk. Allocating some capital to assets that can protect against elevated or volatile inflation can help.

Derivative strategies

JD: A strategy I really like is an equity collar strategy or a calendar collar, specifically. This is a strategy that’s going to be long the equity market. It buys put options to mitigate some of that risk of market decline. It sells away some — but not all — of its upside potential to help pay for those put options. It’s a strategy that can deliver growth with downside mitigation, and then, depending on how you structure it, positive net income. Three really important features for retirees. Another interesting area is call overwriting or enhanced income equities. This is, again, where you go long equities. It gives you some growth potential. And then you sell some call options on those equities. Selling those call options generates income. These strategies could be structured to deliver an income yield of 4% to 6% for example, while the dividend yield on global equities is about 1.5% right now. So, when we compare this to a calendar collar strategy, call overwriting doesn’t have the same focus on downside protection, but it’s got a greater focus on income yield. It makes it another great tool in the arsenal of a diversified retirement solution.

And finally, what’s the key takeaway for Canadian financial advisors?

JD: My key message here, I would say, is retirement investing is different. Retirees have a unique set of needs, objectives and risks, and these really need a dedicated solution. It’s a solution where that alignment to retiree needs permeates all aspects of the fund design — from asset allocation right down to strategy selection. For me, solutions that achieve this are going to be really, really important in this growing segment of the market.

Well, those are today’s Soundbites, brought to you by Investment Executive and sponsored by Canada Life. Our thanks again to Jack Delany of Keyridge Asset Management. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

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