Veteran baby boomer adviser calls for profound fund industry rethink of 'total return'

Advice veteran Doug Brodie has called on the UK's Financial Conduct Authority and the wider fund industry to redefine risk classifications to better reflect income needs in the post-QE world.

In a letter to the regulator, the chief executive and founder of UK retirement income planning firm Chancery Lane urged it to amend its rulebook, differentiating between its definitions of income risk and capital risk.

Chancery Lane's experienced ‘baby boomer' team is focused solely on decumulation phase of retirement aimed at solving income challenges in a low interest rate era, including non-executive director William Todd, co-founder of Nutmeg; Bridget McIntyre, former UK chief executive of insurer RSA; Kim Lerche-Thomsen, ex-boss of Prudential Annuities; Steven Sharp, former executive marketing director at Marks & Spencer and Ian Manning, an IT consultant who worked at the Swiss CERN large hadron collider experiment.

Brodie (pictured above) claimed the industry "obsession" with total return was misleading and called on the fund management industry to move to risk definitions that demonstrate income risk and capital risk separately.

Observing that capital volatility of long-term assets masks the stability found through steady dividend streams, he said the broader funds industry is doing investors a disservice by not addressing this issue.

"There is no correlation between equity market risk to capital and stability of dividends. We need to stop just communicating total return payments and show Joe Public what the income will look like," he says.

He also argued the common assumption that high levels of equity exposure are unsuitable for pensioners is essentially flawed: "Telling an 80-year-old, who doesn't work, that they have to sit in fixed income and suffer the consequences of low-yielding assets is both illogical and unhelpful when there are other solutions."

Brodie added: "The whole industry can help itself by displaying the different elements or ingredients that make up the cake of a total return. If as a collective we carry on hiding income reliability behind the capital volatility, it's partly our own fault and no wonder that the regulator still regards everything being under the one risk banner."

The firm has just released its annual White Paper that carries out a comprehensive analysis of a number of investment strategies often used in retirement planning.

In particular, it proposes the following heuristics are re-examined for today's low interest economy:

• If equity income is to act as a bond proxy, then why is it deemed as high risk and unsuitable for pensioners? Its volatility must be evaluated separately.
• Why is the US-modelled 4% rule still used widely in the UK where it doesn't work as historical rates of inflation and equity returns are different? This is not comparing apples with apples.
• Why are models designed for institutional pension funds continually used for individual investors? Such funds have regular cash inflows to offset pension payments, and have multi-generational objectives. A crystallised private pension is different in that it has one pensioner and no premium income - plus a pensioner needs a precise income.
• Why are investment income statistics hidden by total return figures, thereby layering capital volatility over the top of income stability?

The Report analyses investment data spreadsheets - both forward and backward looking - supporting a number of popular strategies including: equities acting as so called bond proxies, mixed asset portfolios and investment trust dividend heroes.

Brodie said: "We have questioned for some time the industry's accepted definition of investment risk. Typically, risk is defined as volatility, the amount by which an asset moves in relation to its own historical value or to other assts. We believe that is wrong, misinterpreted and misleading. Why does the industry continue to hide annual income stability under capital volatility?

"As advisers on regulated investments, we would define risk as the likelihood that an investment will fail to do what an investor expects, measured as a percentage.

"Examining income sources in a zero % world leads only to equity and property, yet investment trusts reign supreme for reliability and predictability due to their reserves.

Our research analysed 31 mainstream investment trusts over the period since 1974, one of the most volatile periods in the equity and bond markets since 1929. In a nutshell, a dividend payment was never missed by any trust - 100% confidence level; the payment was the same or higher than the prior year in 97% of cases and in 89% of cases it was increased in every year."

He continued: "We think the simplicity of the natural income approach is more predictable, more valuable and - ultimately - more reassuring for investors, particularly those retired. It meets what is required by most pension drawdown investors - an income for life, rising each year to counter inflation, with a good degree of certainty.

"The one-time backbone of a retirement plan and our ‘hero' approach is the humble investment trust, with its ability to support dividend payment and balance sheet reserves which offer stable income to those who have waved farewell to their monthly salary. It may not be sexy, but it is definitely the ‘reliable boyfriend.'"