Pension freedoms fund choices still playing catch up

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With two years under our belts since the introduction of pensions freedoms, we’ve seen changes in how clients take retirement income – most notable of which is the huge increase in the number of savers who now opt for drawdown.

With so many more retirees staying invested, and providers developing new retirement income strategies, patterns have emerged in terms of the fund choices advisers and their clients are making. One dominant theme we’re noticing is that advisers are sticking with the funds they know, favouring established portfolios designed for long-term saving, over new market entrants focussed on income generation.

A shrinking annuity market

With annuity rates at historic lows, it’s no surprise that annuities plunged in popularity after the new rules came into force. Drawdown accounted for only 15% of retirement income sales in quarter three 2013, but grew to 46% by quarter three last year.

As for the speculation that there would be large numbers of retirees seizing the new government-given ability to cash in their pension savings, we haven’t seen the ‘dash to cash’ that some expected, and the average size of fully withdrawn savings pots is on the small side, at approximately £14,000. 


With large swathes of clients forgoing income certainty in favour of greater flexibility and the prospect of better returns, which asset classes are this new wave of investors choosing?

Retirees holding strategies designed for long-term growth

To understand the trends at play, we looked at where our income drawdown investors are investing. The largest flows over the past year were into multi-asset strategies (45%), with equities second (18%), bonds third (15%) and equity income fourth (12%). Interestingly, this doesn’t differ dramatically to how our non-drawdown savers invest, even though many of these are younger savers who are investing for longer time periods. Managing risk and returns is taking priority even if this strategy is not designed for short-term income needs.


However, where investors are using multi-asset strategies to fund their retirement income, we are finding that they are reducing risk.

Within the multi-asset category, we see risk profiles reduce in retirement. Looking at a sample selection of six multi-asset fund ranges, we see a slight dialling down in risk between retired investors and the broader picture.


Most drawdown investors are investing in funds that match Distribution Technology’s risk levels three or four, while across the Aegon book as a whole our investors mainly sit in risk levels four or five. This conservative approach, using diversification to manage the balance between risk and return could be effective in the absence of better alternatives. That said, there is a risk inherent in using funds that measure success in terms of long-term growth as vehicles to provide regular near-term income payments.

We also see a shift from equities to equity income – with Neil Woodford’s fund dominating the cashflow figures in the equity income sector.

We draw a few important conclusions from this data:

  • The market is still adjusting to pension freedoms.
  • Advisers favour established brand names and fund managers over newer funds, even where these offer a more tailored approach.
  • There are very few drawdown-specific investments with a long-term track record.

Income withdrawals may prove unsustainable

Of course, the key objective of any retirement investment strategy is to provide an income for retirees for the duration of their retirement. While there are now a number of funds on the market which claim to offer higher rates of income, research Aegon commissioned from Evalue suggests the sustainable income rate is around 3.2% over a 30 year retirement period and a ‘moderate’ risk appetite based on the asset mix shown below. If the client lives for 35 years, this figure drops to below 3%.


The drawdown market feels somewhat out of step with this sort of research. Over-optimistic drawdown investors have experienced broadly positive markets in the two years since the new rules were introduced, but it remains to be seen whether the higher of the income rates being taken by some investors will survive a market downturn.

Were markets to turn negative we might start to see income rates reduce, or more retirees underpinning part of their income with a guaranteed product.

Current strategies not designed for market shocks

To date, it seems that advisers and their clients are dealing maturely with the challenges of pension freedoms in an immature market and we can see some clear trends emerging:

  • Most drawdown investors are sticking with a multi-asset approach to investing.
  • As they move into the retirement phase they’re dialling down risk, but remain in funds that have long-term investment targets, rather than prioritising short-term income needs.
  • Equity income funds, while popular, are not seen as the drawdown solution we might have expected, with a few notable exceptions.
  • High income withdrawal rates may appear sustainable in growth markets but may prove unsustainable in falling markets.
  • To date, no clear front-runners have yet emerged in terms of tailored drawdown solutions.

Most are sticking with familiar strategies and respected brand names while they see how this market evolves. These are working for now but they haven’t yet been tested by a Dotcom or credit crunch-style shock. The simple fact is no single strategy stands out in the data – there is no accepted wisdom a client could safely adopt, and advisers can once again create real value for an expanding list of clients, helping them create long-term, sustainable income using an ever wider range of fund options.

Distribution Technology’s risk ratings are based on their own assumptions, which differ from Aegon’s and may differ from other providers’ risk ratings.

This article is based on our understanding of the current and historical position of the market(s) and shouldn’t be interpreted as recommendations or advice.