How are top advisory firms handling the present-day challenges of constructing retirement income portfolios? During the Think Retirement Income Top RIA Roundtable in Boston on Thursday, three advisor experts sounded off in a discussion moderated by Investment Advisor Editor-in-Chief John Sullivan.
Wellesley Investment Advisors recommends convertible bonds to clients shell-shocked by loss of principal in fixed-income investments, said Michael Miller, the firm’s co-chief investment officer. He noted that these hybrid bonds, which can be converted into equity, tend to perform well in a rising-rate environment.
“If the goal is retirement income, we think making big bets is risky,” contended Bob Glovsky, vice chair of The Colony Group. “Instead of getting in and out, we would rather our clients stay well diversified. Our advice would be, ‘Yes, we’re going through a rough time, but bonds always come back. We’re planning for steady, consistent performance over the long term.’”
Managing for Income vs. Accumulation
Managing a portfolio for income comes down to a more conservative asset allocation, Glovsky said. “There aren’t many people who can get enough retirement income totally from interest, so they need to keep some in equities with the focus on total return.” Along with portfolio returns, the key factors are inflation and the client’s rate of spending. “What does the client want to have in retirement, and what are they willing to let go of?” he said. “The wild card for baby boomers is health care.”
Miller noted that the normal focus is on maintaining principal while drawing down funds needed for college, etc. Glovsky added that a sustainable withdrawal rate of 3% to 4% has increasingly replaced 4% as a rule of thumb.
The Bucket Approach
Chief Investment Officer Justin McNamara of McNamara Financial Services, delayed earlier by Boston traffic, jumped in to report that his firm keeps two to three years’ worth of retirement income in a cash bucket with the remainder in investments. “It reassures clients that they won’t have to sell if the market is down 10% or 15%,” he said. The client’s needs and available cash are reviewed periodically to see if the bucket needs replenishing.
“The bucket approach is a technique that clients feel most comfortable with,” Glovsky agreed. If some clients want to be more aggressive or conservative than average with their cash bucket, “it’s not going to make a big difference in returns.” However, Colony advisors do fight when clients call with what Glovsky calls “headline concerns.” “We say, ‘That’s short term.’ Clients ‘get it’ intellectually, even though it’s hard for them to change their behavior.”
Duration and Active vs. Passive
At the Colony Group, Glovsky reported, “Our managers are shortening their durations.” Wellesley’s bond duration is now “just shy of two years,” Miller said. McNamara commented that his firm “chose to diversify our bonds instead of focusing on duration targets.”
Acknowledging Charles Ellis’s argument for indexing during the previous session of the Think Retirement Income conference, which continues Friday, Glovsky observed, “We tell our clients indexing is great. But they still need financial planning; they need asset allocation and diversification.” Colony measures results with a “blended benchmark” formulated in the same ratio as the client’s portfolio.
Although about 75% of McNamara Financial Services’ investments are in ETFs, “we consider ourselves active managers in the sense that we deliver asset allocation,” Justin McNamara said. With a nod to Ellis’s point about high active management fees, he said, “We’re also focusing a lot on cost,” anticipating future returns in the low single digits.
Convertible bonds allow advisors to bring in yield without worrying about interest-rate risk or equity risk, Miller said. Praising convertibles for higher earning potential with less risk, he said they exemplify a key benefit of active management.
The Search for Alternatives
“It’s hard to find investments that don’t correlate” in developing a diversified portfolio, Glovsky noted. “But we can’t know who’s going to be the next winner or loser.”
“We’ve had a high bar for alternative investments,” McNamara added. “We buy only when we see value.”
Clients are more aware of the correlation problem since the market crash, Miller said. In his view, “alternative investments are a crucial edge in avoiding bear market losses.”
“Clients need education,” Glovsky emphasized. “They don’t get what a ‘long-short fund’ is. It’s a leap of faith. How do we earn that faith? With education.” Instead of hiding an alternative investment in a traditional category, he said, “we break it out and explain it.”
“We see clients aware of correlation issues,” McNamara agreed. “We’ve spent a lot more time on education minutiae in recent months” while diversifying bond investments.
About Your Fees…
Commenting on Justin McNamara’s report that his firm has stopped billing on cash because of its low returns, Glovsky argued, “Once you charge different fees, clients begin to work against their own best interests” by picking and choosing on price.
He foresees fee compression as Baby Boomers continue to withdraw their assets: “Our AUM is going to come down, and there aren’t enough Gen X and Gen Y assets to replace them.” Not only will Boomers’ wealth end up divided among their children, he went on, “but it’s unlikely that the kids will stay with you. The decumulation of baby boomers is going to be a time bomb for our industry.”
Motivated by a perception that the next generation is more fee-sensitive, McNamara said, his firm is moving to the retainer model with younger clients.
That may be the wave of the future. Glovsky pointed out, “As a planning technique, annuitization is a good way to replace a defined benefit plan. But this isn’t a great environment to annuitize.” It also doesn’t make sense for a fee-only advisor paid on assets under management — an indication that payment structure could be one of the most important changes for advisors intent on meeting the challenges of retirement income.
Check out Charles Ellis: The ‘Glory Days’ of Performance Investing Are Over on ThinkAdvisor.