A recent article in the Journal of Portfolio Management argued that longevity is the greatest risk to returns. It also argued that investors should be moving along the risk horizon towards unconstrained portfolios.
There were some aspects that I agreed with – I agree that portfolios should at the core be focussed on lowest cost allocation vehicles- but I disagreed with much of the following:
the rock-bottom interest rates of the past few years have forced risk-averse fixed-income investors to find ways of generating income without taking on too much volatility: as a result, many have turned to unconstrained, multi-asset strategies….The single biggest challenge facing investors remains how to pay for longer lives. Achieving that goal will require some adjustments—moving into nontraditional strategies, letting go of benchmarks, and, for many investors, taking on a higher level of risk throughout their investment horizon—both by holding higher levels of equity and, in many cases, through investments in alternative asset classes.
The biggest challenge is the low prospective returns from all asset classes and the much higher than historical risks to those returns. Moving out along the risk spectrum throughout their investment horizon effectively entails reducing liquidity and certainty of return over the key short to medium time horizon of the portfolio. It would also likely increase costs, especially at the short end of the horizon where once upon a time direct allocations to lower risk government bonds would have provided yield and capital security. This needs to be planned for….
So the portfolio is increasing long term allocations to enhance long return at the cost of greater short term risk. This essentially means that individuals are going to be more highly exposed to short term expenditure deficits…taking more risk to enhance returns means taking greater short term risk to returns…short term financial security has to take the hit. I am not so sure that I am confortable with this.
Longevity needs to be planned for and for many it may require a downward adjustment of expenditure over lifetimes. But if overly optimistic return assumptions are used to model expected withdrawal rates it will not matter what your investment strategy or your adjusted expenditure profiles are. I am concerned that people are seeing low IRs on the one hand and normal expected cash flows on risky assets on the other. I also express concern that longevity risk may be the lure towards higher cost more remunerative more complex structures for the sake of chasing return while the tide is in the asset manager’s favour.