The second quarter of 2021 ended with continued signs of positive recovery across global markets from the effects of the pandemic. Further progression on vaccine rollouts was a key factor in this, which cemented more confidence in consumer spending.
With lockdowns easing in most countries across the world, the increase in consumer spending has contributed to high levels of Consumer Price Inflation (CPI). Inflation rose to around 5% in the US and around 2.5% in the UK in June. The US central bank reviewed its monetary policy in June, announcing an earlier than expected increase in interest rates. This will help to curb the inflation arising due to the accelerating recovery and meet their medium to long term target of 2%.
The bond market had priced in this inflation hike at the beginning of the year through large sell off’s and it may have been expected that the market would react to the central bank announcement by selling off more bonds, further increasing yields. However, the quarter ended with yields on 10-year US treasuries falling slightly. There is thought that the market had already expected short term rates to increase sooner, also pricing this in at the beginning of the year. Equities performed well for another quarter as markets continued their recovery. This quarter saw growth stocks outperform value stocks, unwinding some of the lead seen in the first quarter of the year. Commodities were the highest performing asset in our multi asset strategy this quarter, which might have been expected in a low interest environment and as economies reopen.
Royal London Asset Management’s (RLAM) Multi Asset team had positioned for an inflationary quarter, where we were overweight equities , commodities and global high yields and underweight government bonds. This remains for Q3 and a tilt towards economies that are rapidly reopening has been placed, where RLAM hope to make some additional returns. The diversified nature of the Governed Range has also provided some level of immunity to extreme impacts resulting from market volatility over the year.
Although there are signs of global recovery, it’s worth noting that uncertainty remains. The threat of a third wave is likely to keep markets on their toes whilst the race for vaccination continues. The significant market volatility we’ve seen through the last year or so has highlighted the importance of tools like the drawdown governance service in supporting client conversations about the long-term sustainability of their income plans and investment choices. It may also highlight the need to re-evaluate client risk appetite and capacity for loss. Our risk profiling and income modelling tools mean we’re well placed to support our customers and advisers in this area.
Last quarter saw an additional update to the standard quarterly calibration, with a change to our Strategic Asset Allocations across the Governed Range. Only a quarterly model calibration is seen this time, where this update allows us to provide accurate estimations for income sustainability as the world changes and markets adapt.
Our model calibration updates this quarter have slightly reduced expectations of future returns for some assets, like UK and US equities and bonds. Customers are therefore likely to see a small fall in future expected fund values. Forward looking volatility looks unchanged in the short and long term for most assets this quarter.
Here’s a reminder of how the income sustainability scores are calculated on DGS:
These factors work together every quarter alongside the Moody Analytics assumptions to give customers an idea of whether their income sustainability is still on track or needs some attention.
Setting a reasonable income relative to the customer’s investments is one of the key aspects of investing through drawdown. Our financial planning tool is useful in helping model different income scenarios and help drive discussions when planning an income through retirement.
The underlying assumptions for the financial planning tool have also been updated this quarter.
We expect this quarter’s calibration to lower sustainability scores for some customers, reducing some of the increase in scores seen last quarter through our Strategic Asset Allocation (SAA) change. However, most customers will still be in a better position overall from the beginning of the year after the SAA update.
With a reduction in expected future returns for some assets from the model calibration, customers with longer income terms or higher income amounts may see lower scores. This applies to both our income for life (taking an income then purchasing an annuity) and income to age (taking an income to select age).
Our ‘houseview’ represents our current opinion on what would be a sustainable level of income for someone aged 65 just starting out in drawdown. Just starting out in drawdown is important here as the houseview doesn’t capture the impact of recent market turmoil on the value of pension savings and assumes that the individual is looking to use these savings to start drawdown over 25 years, investing in GRIP 3 with a yearly charge of 1%. We haven’t adjusted our view this quarter and continue to believe that 3.5% income over 25 years is highly sustainable.
Our current view is that a 3.5% withdrawal rate is highly sustainable.
This may seem low, but the value of the DGS is its ability to provide visualisation on the impact of not just current market conditions, but also fund performance and actual customer income levels on sustainability scores. Ideally, this means customers and advisers can responsibly adjust income levels to reflect the wider economic environment and ensure they maximise the likelihood of sustaining income throughout retirement or until annuity purchase.
|Nominal Income %|
All values calculated using a 1% AMC and using GOVERNED RETIREMENT INCOME PORTFOLIO 3
Key: 85%+ Highly sustainable 75 - 84% Quite sustainable 50 - 74% Barely sustainable 0-49% Not sustainable
Vaccine rollouts, inflation uncertainty and the impact on income sustainability scores.
Log in to our drawdown governance service now to see if your clients’ income sustainability scores have changed.
If you don’t already use the service, visit the drawdown governance service webpage to find out how it can help you track, discuss and manage the ongoing sustainability of your clients’ income.