Market recovery from the pandemic continued over the quarter. Although the number of COVID cases rose in the UK over Q3, deaths were reduced with the help of the continued vaccination programme. This, combined with the easing of lockdowns from the beginning of the year, meant market activity almost reached pre-pandemic levels in the UK and above these levels in the US.
Equity performance was positive, although this may have been suppressed in the UK and US due to supply chain constraints and uncertainty around the Chinese real estate sector. Commodities had another strong quarter, partly driven by the increase in demand for the wholesale gas market. Commodities continue to be one of the best performing assets this year.
Expectations of inflation caused some turbulence to bond markets this quarter. After the Bank of England signalled earlier than expected increases to inflation, UK 10-year gilt yields rose to levels not seen since March 2020. This impacted global bond markets, all seeing increases in bond yields this quarter. UK annuity rates didn’t show much change, although may see rises if the level of bond yields remain or continue to increase.
Royal London Asset Management’s (RLAM) Multi Asset team retained their overweight position in equities and commodities over Q3. Going into Q4, the team have taken some profits gained from the strong equity and commodity performance this year and de-risked slightly into more cash-based strategies. 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 while 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 range of pension tools mean we’re well placed to support you and your clients in this area.
Our model calibration updates this quarter have slightly increased expectations of future returns for most assets in the short term. Reduced expected returns are seen for index linked bonds after Moody’s Analytics changed the way they model inflation. This sees inflation more aligned with economic forecasts.
Uncertainties over the quarter from supply chain constraints and inflation has likely caused some increase to the forward-looking volatility of both equities and bonds from the calibration this quarter.
Here’s a reminder of how the income sustainability scores are calculated:
These factors work together every quarter alongside the Moody Analytics' assumptions to give you and your clients an idea of whether their income sustainability is still on track or needs some attention.
Setting a reasonable income relative to your clients investments is one of the key aspects of investing through drawdown. Our financial planning tool is useful in helping model different income scenarios and helping drive discussions when planning an income through retirement.
The underlying assumptions for the financial planning tool have also been updated this quarter.
This quarter’s calibration shows similar or slightly higher income sustainability scores for some clients, mostly down to the positive market performance.
With no real change to UK annuity rates, the buying power for income for life (taking an income then buying an annuity) clients haven’t changed. This means income for life and income to age (taking an income to a selected age) have seen similar movements in scores this quarter.
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 client income levels on sustainability scores. Ideally, this means you and your clients 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
Hello everyone, my name is Ryan Medlock, Senior Investment Development Manager from the Investment Solutions team here at Royal London and once again I’m joined by my colleague Mayer Raichura. Mayer, pleasure to be catching up with you again.
And welcome to all of you again for joining us on this podcast today for our quarterly round up on what’s happened in the markets, and how this has impacted the sustainability scores within our Drawdown Governance Service and most importantly what that means for your clients.
Lots of great stuff to get through today so let’s jump straight into it. Mayer, why don’t we start by looking at what’s happened in the markets over the last quarter? And I guess it’d be particularly interesting for listeners to hear about your views on inflation.
No problem Ryan. So, if we look at Q3, we’ve continued to experience the post-pandemic market rebound which has provided more economic growth. Market activity is now pretty much back to pre-pandemic levels in the US and not much further behind in the UK. Although there are still a number of key uncertainties heading into the winter – things like supply chain issues, virus risk and as you say – expectations of inflation.
The uncertainty around inflation and the struggling Chinese real estate sector may have suppressed equity performance a little this quarter relative to other quarters, although UK and US equity ended the quarter performing positively. The energy sector came out as clear winners with the recovery in crude oil. It’s worth mentioning that Commodities had another strong quarter, being one of the best performing asset classes, and its returned a performance of around 30% YTD.
Thanks Mayer. We’ve obviously seen rising inflation and the subsequent concern around monetary policies which caused further sell offs in bond markets his quarter. That actually triggered a drop in price for 10-year government bonds across global markets. What was the catalyst there?
Well this happened after both the Fed and the BoE indicated some reaction to inflationary pressures in August. 10 year US treasuries rose to around 1.55%, the highest since June. UK 10 year gilts yields rose above 1% for the first time since March 2020. Annuity rates in the UK remained largely unchanged from last quarter although could be expected to increase in the short term particularly if yields remain at current or higher levels.
OK thanks Mayer, lets talk about the tactical positioning within the Governed Range – a couple of changes made over the quarter. Can you tell us what these are?
Certainly Ryan, so over Q3 the multi asset team have reduced equity exposure to gain from some of the performance seen over the year. Going into Q4, they have continued this trend and taken a cut of further profits made from equities and commodities this year and de-risked to more cash-based strategies.
And is it worth touching on the model calibration we use before we get onto talking about income sustainability scores?
Definitely - our model calibration this quarter has shown a small change in increases to expected returns across most asset classes. Moody’s Analytics made an inflation change to better reflect longer term expectations. This comes as a model enhancement and highlights the benefits of using our Drawdown Governance Service tool.
OK, so that leads us on very nicely to the scores. What are the changes?
Well as always, a change in the scores depends on three different factors broadly:
The combined of these three factors will give us a view of how scores may have moved. So lets take fund values first.
As we know, fund values will depend on the asset mix of the individual, but broadly those with higher equity exposure are likely to have performed slightly better this Q, over those exposed to bonds.
The diversification in the Governed Range means bond exposure is a mixture of index linked and non linked bonds so this somewhat helps to protect against inflation as it has done this Q right?
Yeah, you’re right. The poor performance of bonds this quarter has been offset by the positive performance of our inflation linked bonds. Overall, our default Retirement Portfolio GRIP3 showed around 2% performance gain over the quarter which will slightly help with scores.
OK, great so lets move on to the second of those factors, the change in Moody’s assumptions.
Yeah, so there have been small increases in the expected return assumptions across most asset classes will also help with scores slightly. The changes have been made mostly to the shorter term, so not much impact may be seen by investors on a nominal basis. As I mentioned earlier, Moody’s have made a model enhancement this quarter too, which adjusts their CPI assumption. What this means is that on a real basis, customers might see an increase to their scores.
I know previous inflation assumptions were on what was called a 'market implied' basis for the first few years of a projection and then transitioned to a more long-term economic view of inflation. Can you give us a bit more insight into that?
Of course. So as you say, inflation assumptions on previous quarters have followed a ‘Market implied’ basis for the first few years of a projection which then blend into a longer term consensus view of inflation. This quarter the enhancement changes this assumption from ‘market implied’ to also align with economic forecasts in the first few years.
So by ‘market implied’ we mean a basis that is derived from the difference between nominal and index linked bond prices. This is good in some ways as in the short term assumptions align to what has happened in the market over the Q to nominal and index linked bonds.
In other ways, volatility around bond prices could cause regular changes to CPI assumptions quarter on quarter, which could impact scores. Moody’s also believe that by using a ‘market implied’ basis, you are relying on the supply and demand of bonds made by different market participants, which might differ from the consensus view on inflation. This change is to align with economic forecasts, and means reducing the assumption slightly over a full projection period.
Now in order to do this, Moody’s have used numerous inflation forecasts from global sources and forecasts published by Moody’s economists’ team to determine this new basis, which they believe is more accurate and stable representation of inflation.
This is something to cheer about right, particularly during an uncertain inflationary environment?
Definitely. This just shows the benefits of using our DGS tool and highlights how our tools are calibrated and continuously improved to provide a more accurate outcome for our retirement customers.
OK, so lets move onto the third and final factor; a change in income taken by individuals…
A change in income levels will affect scores for individuals as always. For example, if an individual decides to take more income this quarter, it will reduce their chance of sustaining their pot i.e. have a lower score.
With only a small change to scores seen from market and model calibrations this quarter, a small increase in taking income might unwind some of the impact seen.
Perfect, so what’s the overall outcome for scores?
Those individuals who retain the same income levels should see a small increase or similar scores from last Q in nominal terms. The inflation enhancement this quarter should slightly increase scores for most investors in real terms.
With not much change in annuity rates over the Q, the difference in scores between our Income for life and Income to Age investors may be pretty minimal.
Thanks Mayer, it’s been great talking to you. Thanks Ryan. And thank you all for listening to us this quarter. We’ll speak again soon.
If you have any questions about DGS or need help on how the income sustainability scores are calculated, please contact the Pensions Proposition team.
For questions about our campaign or support material, please contact the Pensions Marketing mailbox.