Structured products are an accident waiting to happen for many retirees, with the inflexible terms and conditions of many such products likely to have been tested by the sell-off earlier this year to leave investors exposed to losses, according to 7IM.Many structured products have terms whereby they can absorb some level of losses before the end investor starts to lose money.
The scale of the falls seen in 2020 – when markets shed as much as a third of their value – means there is a real chance that many products will now be “underwater”, says Matthew Yeates, Senior Investment Manager at 7IM.
“Structured products specifically would have been among the most volatile products to own through the period, and given the scale of the falls in markets we have seen, the drawdown across parts of the structured products market has been brutal,” he says.
Yeates says this is a major problem now for retirees who turned to structured products to provide them with an income. He is concerned that the size of the drawdown experienced by such products is unlikely to encourage investors to hold for the long term, especially when many are using structured products in retirement portfolios to cover short-term income needs.
“The key difference for investing in retirement is that investors only get one chance to get it right,” he says. “Using structured products or relying on natural income doesn’t cut it.
“Investment solutions for retirement should be built on solid foundations, and not expose investors to the worst of market falls when there is a correction. Unfortunately, defined income structured products usually do exactly that, which is just plain dangerous.
“This could be an accident waiting to happen for lots of retirees when they come to review their investments post the crisis and find that the capital they thought they had is now much lower.”
The solution to tackle this – and one that is more prevalent than ever given the headwinds facing markets – is to look for retirement propositions with a much more flexible mandate, and far greater diversification, Yeates says.
“Investors looking for a portfolio that maximises their chance of meeting their retirement spending needs should focus on the total return of portfolios, incorporating both capital returns and income,” he says.
Yeates says a total return mindset in retirement, albeit it one which makes provisions for short-term income needs, provides a better long-term solution that doesn’t need to be changed or “rescued” when markets tumble.
“We believe in a long-term, total return approach to retirement income. To allow us to take a long-term approach – we split investments into different pots that provide for short-term income needs, longer-term needs and a buffer to provide income when periods of volatility arise.
“We have rules in place to follow for rebalancing portfolios when markets are up or down. This approach allows us the flexibility to look across all types of investments, not just those with high levels of ‘natural’ income. In turn, it gives retirees the flexibility to work out how to spend their total return in retirement, without worrying that they’re getting a little less this year from dividends.”