This article appeared in Money Management December 16th, 2010

This article has been reproduced courtesy of Money Managment (16/12/10).Copyright © Reed Business Information. All material on this page is subject to copyright. All rights reserved. No part of this material may be reproduced, translated, transmitted, framed or stored in a retrieval system for public or private use without the written permission of the publisher.

My parents have had plenty ofstress in their lives. Runninga sheep/cattle farm on theusually dry plains near Hay

in southwestern New South Wales, myfather encountered the usual farmingchallenges including, but not limited to:drought (often), fire (occasionally) andfloods (very infrequently).

My mother, originally from Brisbane,arrived to somewhat sparse conditionsat the end of the 1950s. Before the 1960swere over she had seven children, (atone point, six of them under age six,including one with terminal leukaemia),helped out on the farm and later workedas a nurse at the local hospital (oftennight duty) to help put six childrenthrough Sydney boarding school. Thenthere was the stress that six, sometimesdifficult, children created.

Fortunately, since selling the farm andretiring in early 2002, they have had lessstress (at least financial) than most,including through the global financialcrisis (GFC). However, this is certainlynot because they had plenty of money.The proceeds of the farm sale would nothave covered the purchase of a two-bedroom terrace in inner Sydney.

Rather, this lack of financial stressreflects the simple way their financialaffairs have been organised (at leastfrom their perspective). And while I amnot suggesting their arrangements,described below, should be copied, I dothink they provide some valuableinsights into developing ‘low stress’ port-folios that truly work for retirees – ratherthan those that seem designed primari-ly to work for the financial servicesindustry.

Selling the farmBasically, my parents’ total assets follow-ing the sale of the farm in 2002 haveconsisted of two components (exclud-ing the purchase of a modest house inSouth Hay):

• Roughly half in cash accounts and termdeposits that they (mainly my mother)have controlled and managed; and

• The other half as members andtrustees of a DIY super fund/allocatedpension (of which I am also amember/trustee and oversee from aninvestment perspective).

The DIY fund has a growth-orientedasset mix with wide diversification andflexible asset allocation across conven-tional and alternative investments. The largest, core holding is an investmentin a growth oriented multi-asset, multi-manager fund. This is complemented by

some direct shares and specialistmanaged funds. This growth focus goesagainst the conventional wisdom forretirees, but it makes sense because the‘see-through’ allocation of the combinedcash/term deposit component and DIYgrowth component is reasonably conser-vative (and also because the two othermembers, which includes me, are accu-mulation members).

My parents provide no input into theinvestment makeup of the DIY fund, andin fact pay limited attention to how it isinvested. Their main focus has been thenon-super cash/term deposit compo-nent that has produced known, but low,income and with certainty of the capitalvalue. Having said this, the annual allo-cated pension payment has been vitalin topping up this component and/orassisting with expenses.

Between the 4-6 per cent per annuminterest earned on the cash/termdeposit component and the low teensper annum average total return on theDIY/growth component over the lasteight years, the combined return hasbeen in the high single digits, a verysatisfactory return given the periodcovered. Not being subject to adviser orplatform fees has also obviously helpedreturns, and these returns and arrange-ments have resulted in minimal if anypersonal tax.

This is not to say that it was all plainsailing. As with most portfolios someindividual investments held have donepoorly while some have done very well.The DIY fund return was negative infinancial years 2007-08 and 2008-09,with the worst of these minus 15 percent. There were also one or two anxiousphone calls in 2008 in particular but withthe comfort of the fixed value andpredictable income of the cash/termdeposit component they were muchmore relaxed than most investors at thistime. Of course, there were also the chal-lenges of obtaining reasonable interestrates investing in cash and term depositswhen official cash rates reached as lowas 3 per cent per annum in 2008.

The allocated pension payment ismade in June each year and my parentsessentially see their total balances onlyonce a year, even though I can providerough estimates at any time. Theysimply have no need or desire to checkdaily, weekly or monthly valuations orreceive frequent reports showing them.Full reports are produced by an externaladministrator once a year. They there-fore don’t see the greater volatility onthis component.

As a result of this overall strategy, myparents have not had to deal with many ofthe stressful and financially painful issuesthat many investors and retirees have hadto deal with in recent years. Specifically,they have not had to worry about.

• The high volatility of their total port-folio (if they did consolidate their invest-ments their worst financial year returnwould have been slightly more thanminus 5 per cent);

• Direct share holdings collapsing invalue (although they own some indirect-ly in the super fund);

• Geared or structured productarrangements imploding;

• Fund failures or funds suspendingredemption;

• Fraudulent funds;• Lack of income/cashflow; and• Lack of access to capital (they could

access to their entire portfolio quickly ifrequired).

The arrangements have thereforegone a long way to removing many ofthe stresses of investment but withoutabandoning a reasonably well diversi-fied portfolio necessary for the longerterm, especially to provide some protec-tion against inflation. Of course, someof this stress has been transferred to meand to managers that I delegate to, butthen that is our job.

Perhaps that highlights a key problemin this industry. The pressures and stress-es of investing are not being delegated to

16 — Money Management December 16, 2010 www.moneymanagement.com.au

Observer

Stress lessDominic McCormick looks at investmentportfolios for retirees and considers thebest ways to minimise stress.

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This article appeared in Money Management December 16th, 2010

This article has been reproduced courtesy of Money Managment (16/12/10).Copyright © Reed Business Information. All material on this page is subject to copyright. All rights reserved. No part of this material may be reproduced, translated, transmitted, framed or stored in a retrieval system for public or private use without the written permission of the publisher.

the right people. Clients are bearing thesestresses directly, and many planners arenot well placed to handle them either.

Bearing the riskThis is where I disagree with thosepromoting a risk profiling approachand then obtaining clients’ ‘informedconsent’ on the level of risk they aretaking. Apart from the flaws in thesimplistic view that a set asset alloca-tion that these approaches lead to isconstant risk anyway (it isn’t), manyclients don’t understand investmentrisk and never will – no matter howmany questionnaires or tests they areput through.

We therefore need to come up with

portfolios that reduce some of thatinvestment risk but in ways that makeclients comfortable and do not overlyinhibit them meeting their longer termre t u r n o b j e c t i v e s. My p a re n t s’approach is one that works very well,for them at least.

At one stage I was tempted toencourage my parents to invest someof their non-super cash/term depositsin a defensive multi-asset diversifiedunit trust. In hindsight I am glad I didnot. Not because of reduced returns –they would most l ikely have beenslightly ahead over the long term – butbecause the additional volatility in theinterim would have added stress thatthey didn’t need, and they were onlyever going to get a marginal benefit interms of extra return.

Critics might say what I have describedhere is an idealised arrangement thatcannot be replicated by an adviser andtheir clients. However, I think it highlightsseveral important points.

Firstly, perhaps we should be happy toallow some, but certainly not all, retireeclients themselves to partly or fullycontrol the relatively easy to manage andunderstand cash/term deposit compo-nent of their portfolios. This can makethem feel more in control in ways thatare not negative for the portfolio. It willalso more make them more prepared todelegate the more complex diversifiedgrowth component. As long as they stickto the low risk/very conservative end ofthe investment spectrum, there is oftenrelatively little value a financial planneror fund manager can add; and subjectingthis vital but usually low returningcomponent to adviser, manager andplatform fees will just make a big propor-tion of this return disappear. At the veryleast, fee structures need to reflect thisconcern.

Secondly, we need to get away fromthe desire to create portfolios that gener-ate a certain ‘income yield’ that the clientis supposed to live off. It is total returnand cash flow that matter, not yield. Thatcash flow can come from drawdowns ofthe cash/term deposits component andallocated pension payments/superdrawdowns as well as the interest andother income on investments held. Theone thing we learnt from the GFC is thatif investors/advisers go around obsessingabout yield, smart investment bankerswill manufacture it in expensive andflawed structures that ultimately disap-point investors. Just look at whathappened to listed property trusts andhigh yield funds.

Thirdly, we need to ask whether theindustry’s focus on the development ofplatforms with more and more bells andwhistles and improved reporting onclient investments is actually increasingclient and adviser stress and resulting inpoor investment decisions. While it isvery convenient and great for plannersbusinesses to be able to transact orproduce reports at any time is this reallyconstructive? Doesn’t it just encouragethe investor and adviser to overreact towhat is going on in parts of the portfo-lio and not keep a proper eye on the big

picture? Are the costs of frequent prettyreports justified or even necessary insome cases. Clearly my parents don’tseem to think so.

Finally, advisers should recognisesome of the more subtle benefits of usingwell-run multi-asset, multi-managerportfolios for at least the core of thediversified/ growth components of port-folios. Specifically, they can providerequired growth asset exposure, diverseand flexible asset allocation while someof the inherent volatility involved in indi-vidual components does not need to beoverly focused upon therefore making itmore likely clients will stick to the port-folio in the long term. Most of the severeproblems many investors faced in 2008that I listed above were totally or largelyavoided by investors in diversified multi-manager portfolios.

Reducing client stressThe primary role of a good financialplanner should be to arrange their client’sfinancial affairs in ways that reduce thatclient’s financial pressures and stresses.To do this adequately across a variety ofclient circumstances requires a generalistapproach with broad knowledge of invest-ments, insurance, social security, tax, andestate planning – but with access to theappropriate experts when required. Still itseems relatively few planning groups arestructured this way.

Instead, many continue to promotethemselves primarily as investment gurus,feeling they have to constantly report onand be seen to be on top of the client’sportfolio, which contains numerousinvestments to justify asset-based fees. Sothey spend their time and client reviewsgetting worked up about the poor recentperformance of a particular investmentand thinking of substituting it for some-thing else that has done well recently (andin doing so usually worsening overall

investment returns). All this close scruti-ny usually does is increase the stress forboth themselves and their clients.

Some planners think they can reducetheir clients’ financial stress by using guar-anteed and structured products. I disagree– the majority of these are a source for laterstress as poor returns, inflexible accessand high fees eventually take their toll.Most of these products need everythingto go perfectly to work well.

I do see a role for lifetime annuities aspart of the mix as long as they are compet-itively priced and they could partly replacethe cash/term deposit component. Theannuity debate is at least getting theindustry focused on the need to reduceand better manage retirees’ exposure tomarket risk (both real and perceived), toincrease certainty relating to their cash-flow and ultimately to make their finan-cial lives less stressful.

Still, I believe my parents’ arrange-ment shows that there are alternativeapproaches without using annuities withbetter returns and more flexibility (andlittle additional stress). That said, I amnot suggesting that their particulararrangement is feasible for all or evenmany retirees out there, particularlygiven my ability in this case to take a‘hands on’ role in the DIY fund. But I dothink it does provide some valuableinsights into the strategies, structuresand investment management arrange-ments that can help to lower the finan-cial stress of clients and still meet reason-able return objectives over time.

As the year winds down and I onceagain head down to the unusually green,and possibly flooded, plains of Hay forChristmas 2010, I will fortunately be ableto report that the DIY fund had a good2010 financial year and a good 2011financial year so far; that my parents stillhave considerably more money thanthey invested in 2002 despite takingannual allocated pension paymentssince – and not always the minimum;and that their eligibility for the agepension is still some time off.

My father will probably still joke thathe thinks it must be some form of Ponzischeme. And while there may still besome stresses and arguments aroundthe Christmas lunch table, the finan-cial issues and stresses of my retiredparents will not be one of them. Unfor-tunately, across Australia there will beplenty of other retirees where this willnot be the case.

The development of better, lowerstress portfolios that truly deliver forretirees will improve although not elim-inate this situation. However, to achievethis it is necessary for the industry to stepback and think about these issues firstand foremost, before it focuses on how itcan monetise clients’ assets and situa-tions to its own benefit. Who knows – wecould end up with many happier, lessstressed and wealthier clients and advis-ers all round. Isn’t this what clients areexpecting from professionals in thefinancial services industry?

Dominic McCormick is chief investmentofficer at Select Asset Management.

www.moneymanagement.com.au December 16, 2010 Money Management — 17

“Most of the severeproblems many investorsfaced in 2008 were totally orlargely avoided by investorsin diversified multi-manager portfolios. ”

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