Smoothing out the bumps for post-retirees

6 March 2012

| By Tim Stewart |

Risk parity funds could provide members a 'smoother ride' in the post-retirement phase, according to Towers Watson.

In a report titled 'Strategies to improve post-retirement investing', Towers Watson pointed to the dilemma faced by members in the post-retirement phase as they consider the trade-off between stability and high real returns.

Due to longevity risk, there is a higher 'risk of ruin' (ie, the danger of running out of money) for post-retirees if they have a low exposure to growth assets, according to the report.

However, high exposures to growth assets can lead to a 'bumpy ride', causing members to switch to more defensive options during volatile periods.

Risk parity funds swap the concentration of risk in equities with other types of risk. This is achieved by using leverage - typically through the use of derivatives - to increase the risk and return of lower-risk assets like bonds.

"The overall result is a portfolio that is actually less risky than one which is overly reliant on a single asset class such as equities," said the report.

Risk parity funds offer a similar return to typical 'growth' funds with a 70/30 equity/bonds split, but they have a different risk premia, according to Towers Watson.

Historical analysis also shows that risk parity funds have been less prone to severe 'drawdowns' than portfolios dominated by equity market risk, according to the report.

Another strategy advocated by Towers Watson to create a 'smoother ride' for post-retirees are 'multi-asset' funds that employ a more active or dynamic approach to managing asset allocation.

These types of funds have a real return target, such as CPI+ 5, but have no static of fixed strategic asset allocation.

"The fund manager seeks to obtain exposure to those asset classes or risk premia that offer the best value at any point in time, and to avoid the most overpriced assets," said the report.