The importance of managing downside risk during retirement has never been more critical. Recent stock market volatility and inflation risks from tariffs have highlighted the phenomenon known as sequencing risk. Large withdrawals from a pension pot when fund values are depressed can significantly reduce the sustainability of income (sequencing risk). Trevor Greetham, Head of Multi Asset at Royal London Asset Management discusses the pitfalls and solutions advisers should be considering for their clients.
This article was featured in our Multi-asset Fund Insights 2025, looking at the latest thinking and analysis into what’s going on within this key market segment. Readers can check out the full publication here.
In the UK, flexible drawdown was introduced with pension freedoms in 2015, and the extended 2022 bear market in both global stocks and bonds was its first real test. Meanwhile, today’s higher bond yields mean annuities are a more competitive investment solution than they used to be, albeit with significantly less flexibility.
What Makes a Good Retirement Income Solution?
The asset management industry has had decades of experience designing and managing portfolios during the accumulation phase of saving. However, many providers aren’t yet addressing the distinct investment challenges faced by people withdrawing money from a pension pot to meet their retirement income needs. The management of downside risk is as important as the management of return in a successful retirement solution.
In the accumulation phase, the focus is on diversified portfolios that seek to maximise returns for a given level of risk, with risk defined as the volatility of returns. A portfolio with regular inflows is benefiting from ‘pound cost averaging’, with contributions invested when fund values are depressed showing the greatest long-term gains. As such, short-term volatility isn’t entirely a bad thing.
During retirement, income sustainability is the objective. An investor must keep an eye on returns, as a pension pot replenished by gains will last longer. Unfortunately, real growth-seeking assets like equities, commercial property, and commodities exhibit relatively high volatility and volatility becomes a danger when drawing an income. ‘Pound cost averaging’ becomes ‘pound cost ravaging’. Withdrawals made when fund values are depressed can significantly reduce the sustainability of income. Investment losses early in retirement, when the pension pot is large, can be especially damaging.
Potential Pitfalls of a Multi-Asset Approach Focused on Natural Income
The first reaction of the asset management industry when pension freedoms were announced was to launch multi-asset income funds. The idea was that you could live off the dividends, coupons, rents, and interest produced by a diversified portfolio of investments, leaving the capital to grow over time to support future income needs, or to pass on as an inheritance. In practice, for most pension pots’, natural income is unlikely to be high enough to meet spending needs. In addition, the whole idea of a pension for most people is to spend the capital they have accumulated over a working life rather than leaving it in place. Once you start dipping into capital, sequencing risk raises its head. The risk of losses is particularly acute going into a recession when equities can drop significantly in value – and it is at precisely these times that the higher-yielding bonds and alternatives prevalent in income portfolios can suffer credit losses and decreased liquidity.
Active Management Can Reduce Sequencing Risk
We believe active management can reduce sequencing risk and improve outcomes. Two elements to the investment process are required, both well aligned to retirement income needs:
- A volatility-capped core portfolio: An efficient mix of liquid investments to maximise long-term growth at a moderate level of volatility, with exposure to risky assets automatically reduced during periods of market turbulence to limit peak-to-trough losses.
- An active tactical overlay seeking to add value irrespective of market direction: A range of active strategies with a low correlation to the assets in the core portfolio, including strategies that tend to add more value going into and out of recessions.
The Impact of Recessions and Bear Markets on Retirement Income
There are very specific challenges to pension providers. How does your retirement solution aim to deal with sequencing risk in and around the several recessions that customers are likely to experience when drawing a retirement income? We’ve experienced some abnormally long business cycles since 1980, with low inflation allowing central banks to cut interest rates early and hike them late. Structural changes in recent years – including deglobalisation, a chronic underinvestment in commodity capacity, geopolitical risk, and populism – make more frequent inflationary overshoots more likely. This suggests we will see more frequent recessions, as central banks are forced to step in to create spare capacity in the economy and bring prices down.
It’s worth remembering that the average length of a full business cycle, based on US economic data since the 1860s, is about five years, with the average economic expansion lasting only three years. Business cycles may be getting shorter, but people are taking income earlier and living longer than they used to. Therefore, they might encounter half a dozen average length business cycles with the market turbulence linked to each recession potentially threatening the sustainability of their retirement income.
Lessons for Decumulation Solution Design
Retirement solutions need to focus on long-term growth and downside risk management in roughly equal measure. Multi-asset investing can improve the risk-return trade-off, limiting the worst outcomes, but passive investing or chasing assets offering high levels of natural income can leave retirees exposed to large losses in recessions.
Offerings for retirement investing are still in their infancy, but it is the urgent and unfinished business of pension freedoms. If we are in a more inflation-prone world, we should expect more years like 2022 with negative stock and bond returns coinciding with increased drawdown needs. Defined Contribution pensions created the freedom to choose your own investment strategy for accumulation, but with freedom comes responsibility. Flexible withdrawals take things one step further, asking retirees to choose both their investment strategy and their income withdrawal strategy in an uncertain world. If the asset management industry can minimise sequencing risk, it will make a meaningful contribution to the lives of millions of people gradually drawing down a pension pot to meet their retirement needs.
About Trevor Greetham
Trevor Greetham is an investment strategist and fund manager. Prior to joining Royal London in 2015, Trevor was Asset Allocation Director for Fidelity Worldwide Investment, where he was responsible for implementing tactical investment decisions across a wide range of institutional and retail funds. From 1995 to 2005, Trevor was Director of Asset Allocation for Merrill Lynch, advising fund manager clients on their multi asset investment strategy. Trevor qualified as an actuary with UK life assurer Provident Mutual and has a Master of Arts in Mathematics from Cambridge University.
