Sequencing and longevity risk drive need for diverse retirement strategies

With regulators ‘raising the bar’ on retirement planning, a paper from Lonsec Research and Ratings has urged advisers to place greater focus on sequencing and longevity risk as they navigate clients through the shifting landscape.

In October, ASIC released Report 818 outlining the next phase of oversight for the Australian retirement system, with a particular focus on outcomes and clear communication for members following the Retirement Income Covenant which came into effect 11 December 2024.

While this was largely targeting trustees, the Sequencing, Longevity and the Evolving Multi-Asset Toolkit by Lonsec Research and Ratings multi-asset manager Andrea Theouli suggested the interaction between sequencing and longevity risk is “reshaping how multi-asset portfolios are designed and evaluated”, impacting how advisers allocate client funds.

Sequencing risk is the danger the timing of withdrawals from a retirement account can have an investor's overall return while longevity risk is the risk that clients will live longer than anticipated.

Theouli said: "ASIC’s Report 818 reinforces the need for transparent communication noting that trustees and managers should explain how sequencing risk is addressed in product design, rather than simply warning members it exists.  

“Advisers too can add value by helping clients understand how features like defensive sleeves or staged drawdown strategies protect capital during vulnerable periods.”

When it comes to sequencing risk, Theouli said the order in which returns occur can “make or break retirement outcomes”. Namely, she argued a portfolio that sees early losses in the drawdown phase would see significantly different outcomes to an otherwise identical portfolio.

After facing two consecutive negative years in 2022 and 2023, a greater focus is now being placed on the retirement risk zone – the five years either side of retirement. As a result, Theouli explained that some lifecycle funds have opted to reduce growth exposure earlier and other turning to cashflow staging or smoothing overlays to cushion drawdowns.

As the retirement landscape shifts and longevity risk becomes an increasingly important factor in planning, Theouli explained that solutions blending “income, growth, defensiveness and flexibility in new ways” are filling this need for diversity.

These include, Lifecycle super options, multi-asset income funds, annuity-backed solutions, as well as separately managed accounts (SMAs) and ETFs.

While arguing that the focus isn’t necessarily on creating new products but on designing portfolios that better reflect the realities of retirement, Theouli also noted having a wider range of solutions available gives advisers and trustees more tools at their disposal.

She added: “It allows them to target sequencing and longevity risk more precisely; design portfolios suited to different retirement timeframes and adjust as circumstances change. Understanding how these components work together and using them effectively is key to delivering sustainable income and meeting the expectations of retirees and regulators.”

However, as advisers look to tackle these risks in their portfolio development, Theouli said designing retirement portfolios is ultimately an exercise in “balancing trade-offs" as some products may address one risk while exacerbating another.

This comes as multiple research reports highlight Australians’ fear of running out of funds in retirement. Most recently, Fidelity International’s latest report, The Longevity Revolution: Preparing for a New Reality, found that some 29 per cent of Australians over 50 could have a shortfall of at least a decade as a result of increasing life expectancy.

Likewise, Natixis Investment Managers’ Global Retirement Index, released in September, revealed that almost half (49 per cent) of Australians were concerned about not having enough money to enjoy their retirement as a result of inflation and the high cost of living putting negative pressure on overall household funds and their ability to save.