The arrival of efficient frontiers for retirees

Strategies

David Barrett & Luis Sarmiento
Wednesday 20 May 2015

The global financial crisis (GFC) has had a lasting impact on many retirees and their financial advisers. Large market corrections resulted in significant capital losses, hitting hardest those who had recently invested into the market and/or just retired.

The GFC led to greater recognition of another type of investment risk beyond those traditionally considered (which include, for example, interest rate risk, business risk, credit risk, legislative risk, call risk, inflation risk, liquidity risk, and systematic risk). Sequence of return risk has emerged as an issue for retirees, their advisers and superannuation trustees.

Broadly, sequence of return risk involves the risk that lower than average expected returns occur early in the anticipated investment term, and have a detrimental effect on the overall investment result.

Given that 94 per cent of Australian retirement savings are invested in account based pensions1, which presumably are exposed to a significant degree to market-linked assets, the issue of sequence of return risk is very relevant to the Australian retirement income system.

The strategic asset allocation decision (arguably the most important portfolio construction decision in terms of its impact on return variability over time)2 is generally based on traditional efficient frontier analysis. Traditional efficient frontier analysis involves mapping the universe of possible portfolios by expected return and risk, and identifying those portfolios which either minimise risk for a given level of expected return, or maximise expected return for a given level of risk. The question that has emerged since the GFC is: given that traditional efficient frontier analysis does not incorporate the impact of sequence of return risk, does it fail to adequately address retirees’ needs?

In this article we firstly demonstrate that sequence of return risk is real and a valid concern for retirees, and that its impact is magnified by increasing the level of drawdown from an investment portfolio. We will then examine the impact of drawdown levels on the traditional investment portfolio efficient frontier analysis, and offer a number of conclusions from that analysis. Finally, we’ll question the traditional concept of ‘risk’ - what is the actual ‘risk’ that retirees are most concerned with, and how does that affect our findings.

Download the full article

Share this

If you enjoyed reading this article, why not share it?

Simply copy and paste the text and include a link to the article. Please read the Expertise Articles Terms of Use before sharing.

Related articles


 

Subscribe to our monthly newsletter




We bring you technical updates, financial insights and industry expertise.

Thank you
There seems to be an error with your form

 *
 *
 *
The information you provide on this form will be retained by Macquarie and may, from time to time, be used to contact you about other products and services we feel would be of interest to you. If you do not wish to receive information of this nature or would like access to your personal information, please phone us on 1800 287 153. Please refer to our Privacy Policy for specific details.

Find out how we can help


If you'd like to speak to a specialist about how we can help build your business, get in touch.

Any information on this page in relation to mortgages has been prepared by Macquarie Securitisation Limited (MSL) Australian Credit Licence (ACL) 237863 ACN 003 297 336.

Unless stated otherwise, this information has been prepared by Macquarie Bank Limited ABN 46 008 583 542 AFSL and Australian Credit Licence 237502.

This information is provided for the use of licensed and accredited brokers and financial advisers only. In no circumstances is it to be used by a potential client for the purposes of making a decision about a financial product or class of products.

1 Post retirement market trends in Australia, Mercer, July 2014, as quoted in the Financial System Inquiry Final Report, page 120

2 Wallick, Shanahan, Tasopoulos and Yoon, The Global Case For Strategic Asset Allocation, July 2012

Macquarie Investment Management Limited (MIML) ABN 66 002 867 003 AFSL 237 492 is not an authorised deposit-taking institution for the purposes of the Banking Act (Cth) 1959, and MIML’s obligations do not represent deposits or other liabilities of Macquarie Bank Limited ABN 46 008 583 542. Macquarie Bank Limited does not guarantee or otherwise provide assurance in respect of the obligations of MIML.

This information is provided for the use of financial services professionals only. In no circumstances is it to be used by a potential investor or client for the purposes of making a decision about a financial product or class of products.

The information provided is not personal advice. It does not take into account the investment objectives, financial situation or needs of any particular investor and should not be relied upon as advice. Any examples are illustrations only and any similarities to any readers’ circumstances are purely coincidental.

While the information provided here is given in good faith and is believed to be accurate and reliable as at 23 February 2015, it is provided by MIML for information only. We will not be liable for any losses arising from reliance on this information.

MIML and Macquarie Bank Limited do not give, nor purport to give, any taxation advice. The application of taxation laws to each client depends on that client’s individual circumstances. Accordingly, clients should seek independent professional advice on taxation implications before making any decisions about a financial product or class of products.

Copyright 2015 Macquarie Investment Management Limited

Except for Macquarie Bank Limited ABN 46 008 583 542 AFSL and Australian Credit Licence 237502 (MBL), any Macquarie entity referred to on this page is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Cth). That entity’s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that entity, unless noted otherwise.

Important Information

Restricted to financial services professionals

This information on this website is provided for the use of financial services professionals only. In no circumstances is it to be used by a potential investor for the purposes of making a decision about a financial product or class of products.

In order to proceed, please confirm that you are a financial services professional by clicking 'I accept'.