It's no exaggeration to say that retirement is one of the most significant trends in the world right now. We probably do not need to spend too much time discussing the demographic challenge, given the excellent overview we have just heard. However, demographic changes are clearly affecting how we invest, work, save, and retire.
In many countries, large sections of the population are becoming increasingly reliant on defined contribution (DC) assets to fund their retirement. This is certainly true in Australia and the United States, and it is increasingly the case in the United Kingdom. In fact, 60% of retirees in the UK today rely, at least in part, on their DC arrangements. If we are not there already, we soon will be, with the first cohort of UK retirees being entirely dependent on their DC assets for retirement income.
For individuals who have spent their working lives exposed to investment risk through DC arrangements, retirement brings a new set of questions. How should I invest? How much can I spend? Will my money last? These challenges go beyond individuals and affect society as a whole. What happens when large numbers of retirees cannot retire comfortably or outlive their savings? Who bears the cost? How does society function, and what are the implications for economic growth?
There is some positive news. Governments are beginning to take action to address these challenges. In Australia, superannuation schemes are expected to provide retirement income strategies. In the UK, the upcoming Pensions Bill will require DC schemes to offer at least one default decumulation strategy, with a focus on generating retirement income.
So what makes retirement different? The obvious answer is that, for the first time, workers will no longer receive a regular salary. This creates difficult questions with potentially complex answers. Can I afford to retire? Will I run out of money? Can I improve my pension? What if my circumstances change?
The challenge of retirement investing, particularly during decumulation, is one of the most difficult problems in finance. A key issue is sequencing risk, the risk of being forced to sell assets to generate retirement income at the worst possible time in the market. This leaves retirees facing two imperfect choices. On one hand, they can purchase an annuity, securing income for life but sacrificing flexibility. On the other hand, they can enter drawdown, retaining access to growth markets and customization, but taking on the complexity of managing one of the most important financial decisions of their lives without necessarily having the tools to do so effectively.
Over the past two years, we set ourselves the goal of developing an investment framework that removes these compromises for retirees. We asked whether it was possible to create a framework in which retirees never have to worry about running out of money, have confidence in how much they can spend, retain flexibility if their circumstances change, and still gain access to growth markets to improve retirement outcomes over increasingly long retirement horizons.
We are pleased to say that we have developed a solution that we believe fulfills these ambitions. The solution is currently being tested with the market, and today we will walk through the framework and its investment implications.
To solve the challenge of providing income for life, we began with a familiar product: the annuity. Annuities provide reliable income for life, but they come with significant trade-offs. They remove flexibility if circumstances change, can limit access to capital for family needs, and eliminate future upside potential since the income level is fixed at purchase. Despite these drawbacks, annuities remain a powerful tool.
Rather than purchasing an annuity immediately at retirement, we believe annuitization should occur later in life. This removes uncertainty about lifespan while creating a flexible period between retirement and late-stage annuitization. This "flex then fix" model is gaining traction across the industry because it balances flexibility and security.
From an investment perspective, this approach provides a defined investment horizon and a clear objective. During the flexible period, assets must generate sustainable retirement income while preserving enough capital to purchase a later-life annuity. Ideally, the income provided by that annuity should be broadly consistent with the income received during the flex period, avoiding a sharp reduction in retirement income.
We also considered the needs of pension providers, trustees, master trusts, and governance committees. While they seek strong member outcomes, they must also manage practical realities. With hundreds of thousands or even millions of members, each entering retirement under different circumstances, the challenge is delivering customization without creating excessive operational complexity.
To keep the solution simple, we developed two core strategies. Both are highly liquid, operate within the same retirement framework, aim to provide sustainable income during the flex period, and preserve sufficient capital for late-stage annuitization. However, they differ in their objectives. The first prioritizes stability, while the second aims to maximize retirement income through exposure to growth markets while still managing risk carefully.
The stability-focused strategy is built around a portfolio of high-quality bonds. By applying cashflow-driven investment techniques commonly used in defined benefit pension schemes, bond maturities can be aligned with future retirement cashflow needs. This effectively removes sequencing risk because assets mature into the required cashflows rather than being sold during market stress. A portfolio of gilts can also be used to hedge annuity rates, reducing uncertainty around the eventual annuity purchase. As a result, retirees receive predictable pension payments without needing to sell assets at unfavorable times.
For retirees seeking higher income, the growth-focused strategy follows the same retirement framework but aims to create higher sustainable distributions during the flex period and accumulate a larger pool of capital for purchasing a larger annuity later. Public equity markets provide an obvious source of growth, but market conditions at retirement can have a significant impact on outcomes.
To address this, the strategy combines growth assets with risk management techniques such as downside protection using equity options and annuity-rate hedging. Historical analysis across different retirement periods, including the dot-com crash and the Global Financial Crisis, demonstrated that these protections can significantly improve outcomes. By limiting the impact of severe market drawdowns and managing annuity pricing risk, retirees can maintain more stable income while preserving the potential benefits of long-term market growth.
The key objective is not financial alchemy, but better risk management. By identifying the primary risks to retirement outcomes and applying techniques long used in mature defined benefit schemes, it is possible to improve the likelihood of successful retirement outcomes.
In summary, the framework seeks to remove the compromises that retirees often face. It aims to ensure they do not run out of money, provides confidence in spending throughout retirement, preserves flexibility by avoiding irreversible early decisions, and maintains access to growth assets that can improve long-term pension outcomes. This is achieved through a combination of cashflow matching, downside protection, annuity-rate hedging, and continued exposure to growth markets. Together, these tools help address sequencing risk, improve retirement security, and support better outcomes for retirees.
