A lack of transparency around income risk ratings of UK multi-asset funds and portfolios used for income drawdown poses a significant challenge for advisers in assessing suitability, warns EV.
According to the financial software provider, firms will find it difficult to meet the requirements of the FCA’s recent Retirement Income Advice Thematic Review which calls upon firms to undertake greater due diligence on the solutions they recommend.
In a review of 170,000 funds and portfolios in the UK retail space, EV found that most multi-asset funds and portfolios used for income drawdown fail to cover the full risk spectrum and a large proportion of retirees, particularly those with cautious to medium-risk profiles, are exposed to excessive risk.
In addition, EV found many funds and portfolios are inefficient at generating income and are more for wealth accumulation. It said efficiency of funds and portfolios in delivering income also varies significantly, with some funds offering over 10% more income for the same level of risk.
According to EV, funds and portfolios often struggle to efficiently deliver fixed and inflation-protected income generation due to differing requirements for constructing efficient portfolios. Lastly, the firm said the prevailing method of risk rating for income solutions focuses on investment volatility, which it said was an inappropriate measure for income sustainability.
Bruce Moss, founder of EV, said: “The FCA’s thematic review of retirement income advice majors on the need for advisers to ensure the risk suitability of their recommendations. Although there are some risk questionnaires designed to measure attitude to income risk, little appears to have been done to map the output from the questionnaire to suitable income drawdown solutions in a reliable and transparent way.
“Capital volatility appears to be used as the measure of risk. This is wrong as capital volatility does not correspond to most retirees’ objective of income sustainability, nor does it take any account of inflation risk, which is one of the biggest risks faced in retirement. The lack of transparency over how investment solutions for drawdown are risk-rated and mapped poses a huge problem for advisers who want to undertake some due diligence following the FCA’s review.”
Moss said to create efficient funds and portfolios for drawing an income, risk needs to be assessed correctly and a robust definition of income risk allows advisers to ensure the risk suitability of their recommendations for decumulation.
EV has developed a suitability process for income, where asset allocations can be optimised to create a frontier for income, allowing the relative efficiency of funds at delivering income to be measured.
“While a risk suitability process is well-established for accumulation, according to the FCA’s thematic review, there is little evidence of a consistent approach for decumulation. EV’s income risk suitability process is completely transparent, aligned with retiree objectives for either fixed and inflation-protected income and mirrors our risk suitability process for accumulation,” added Moss.
