Why is active management important when investing in retirement? Newton head of mixed assets investment Paul Flood considers the environment in which active thrives and why he thinks it is well suited to investing in life beyond work.

What is the purpose of active investment management?

The purpose of active management is to try and identify areas of opportunity and balance those with the risks for clients. Particularly for retirement, it is about trying to ensure the needs of savers are met throughout the rest of their lifetime. That means thinking about sequencing risk and trying to identify areas of stable and growing income to meet a client’s income needs in retirement.

What market conditions tend to suit active investment management best?

Active management tends to do best when fundamentals drive the returns of companies. That suits active management better than when returns are driven by macro events that are often unpredictable. When returns are less macro driven strong, resilient businesses start to show their colours versus those that have benefited from a rising tide floating all boats.

Active managers tend to perform well when dispersion, or the magnitude of moves between stocks, is high. Post pandemic, we have seen this as higher interest rates have put stress on companies without strong business models that were reliant on the availability and low cost of finance. In a capital constrained world this is more difficult, and it limits the ability of ‘zombie’ companies to continue competing.

Lower correlation across market returns is also good for active managers. It offers opportunities for diversification and an ability to reallocate capital across the cycle. When correlation is high, everything tends to move in the same direction at the same time and there's less opportunity for active managers to capitalise on divergent markets and asset classes. It has been good to see a normalisation in the bond markets, for instance, as this allows for a higher degree of diversification within portfolios, which can provide ballast and resiliency, particularly for those in retirement.

Lastly, while volatility is often associated with a rise in correlations within the equity market, it can provide opportunities for active managers if they can keep control of behavioural biases. It is at this point that asset prices can move a long way from their intrinsic value as fear pushes a lot of investors to sell. And while active management does less well in a highly correlated market, it tends to be more resilient in downturns, which can be important for those in retirement who want to reduce the likelihood of withdrawing capital when valuations are low.

When it comes to investing in retirement, why is active management important?

Historically, a lot of the narrative has been about de-risking clients as they approach retirement. But, people retire and still have a very long investment horizon so need their pensions to provide an income and keep up with inflation. And while it's okay to draw down on your savings in retirement, there is longevity risk to think about, and the view many grandparents have of wanting to leave something for future generations.

So, you have to think about investing to meet clients’ needs of income in retirement while balancing risk and reward. The risk is that you have to withdraw your savings in retirement to fund your lifestyle. But if you are withdrawing that from capital at a time of market volatility that can risk the value of the assets over the longer term – also known as sequencing risk. Seeing a big drawdown early in retirement can be detrimental to the ability of that retirement pot to continue to fund the income required over the longer term.

One way to address this is to pick the asset classes that are less likely to see big drawdowns. Another way is to think about using natural income. The reason that active managers are suited to achieving this is because the focus is on the confidence in a company being able to pay its dividend so that if we are in periods of capital drawdown then that income will continue to be paid even though the backdrop may be uncertain. It is precisely at these periods of economic uncertainty that the weaker companies tend to cut their dividends, which is exactly the opposite of what is need to help deliver an outcome in retirement.

What is the benefit of using a multi-asset strategy when investing in retirement?

Multi-asset can be beneficial in retirement because everybody has different objectives. We're here to provide solutions that aim to address different investment objectives. Some retirees will have large pots and can withstand higher capital volatility, so having a higher allocation to growth assets may be more appropriate. Others perhaps don't have such large savings pots and can stomach less of a capital drawdown. It's important to be able to distinguish and that's why we have a multi-asset range so that advisers and investors can select the portfolio that best meets their requirements.

In addition, some retirees may have an annuity able to cover their income requirements. For others who may be using their pension savings for drawdown or are more reliant on income, perhaps a multi-asset income fund that is focused on providing a stable and growing income over the longer term, is more appropriate. This could allow them to generate an income in retirement as well as perhaps leave something for future generations.

What is your macroeconomic outlook and how do you see active management fitting in with this?

The current macroeconomic backdrop looks better suited to active management and particularly multi-asset than we've seen over the past decade where low interest rates and quantitative easing (QE) largely drove the market. Today we see much more dispersion across and within markets, which provides us with opportunities to make significant asset allocation decisions that we haven't seen since the great financial crisis. Now that we've seen a normalisation in the bond markets, we're not only seeing an opportunity to add bonds into portfolios for diversification, but they're also offering attractive levels of return in our view. That provides a more attractive backdrop for the traditional 60/40 portfolio.

The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed.