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Retirement income investors using a diversified portfolio need 1.) capital growth to keep up with inflation and reduce longevity risk, 2.) lower volatility to sustain portfolio life by moderating drawdown effects, and 3.) current income to help mitigate untimely capital withdrawals and supplement withdrawal rates. It’s a trifecta of retirement income considerations (Figure 1).

Figure 1: Trifecta of Retirement Income Considerations

Unfortunately, these considerations are not always compatible, but you can begin harmonizing them for your participants with the right plan options. We believe defensive equity solutions – especially those with an income orientation – are distinctive in their potential to simultaneously address these objectives.

Adding Portfolio Resiliency

Equities are typically the most significant contributor to portfolio volatility. Dampening that volatility can go a long way to managing today's retirement-income challenge. Defensive equity funds seek to do just that, and some offer an income-orientation that helps supplement withdrawal strategies.

“We believe defensive equity solutions – especially those with an income orientation – are distinctive in their potential to simultaneously address these objectives.”

These funds come in various names: low volatility, managed volatility, minimum variance, low beta, and variable beta. Low and minimum volatility strategies generally seek to match returns for cap-weighted benchmarks with much less volatility. In comparison, variable beta and managed volatility strategies try to beat cap-weighted benchmark returns with less volatility. However, all defensive equity strategies seek long-term growth and volatility reduction, offering participants a way to balance the trade-off between market and longevity risk.

Growth with Lower Volatility

Reducing equity volatility is potentially significant for defensive equity strategies – up to 40% lower volatility than cap-weighted indexes. Figure 2 demonstrates the impact of incrementally replacing allocations to a cap-weighted equity index with low-volatility or variable-beta strategies. Even moderate tilts toward defensive equity strategies have the potential of reducing volatility by 15% or more. And because lower volatility improves compounding, returns are potentially higher as well.

Figure 2 Defensive Equities and Lower Volatility

Drawdown Mitigation

Lower volatility is essential, but lowering it when you need it most is paramount. As we've seen, capital market drawdowns can force lower withdrawal rates and adversely impact lifestyles. Defensive equity strategies potentially mitigate sequence-of-returns risk in the precarious years around one's retirement date.

Figure 3 illustrates the magnitude of two significant equity market drawdowns. You can see how a hypothetical defensive equity strategy might have cushioned the blow of sequence-of-returns risk, with shallower drawdowns throughout the cycle.

Figure 3 Defensive Equities and Sequence Risk Reduction

Income Supplement

Yields are already low today and they could go lower; nonetheless, dividend-paying equities – which have stabilized in recent years – will always have the potential to supplement portfolio income objectives. To illustrate their importance, we offer a simple hypothetical example of how dividends can support withdrawal rates (Figure 4).

The MSCI World High Yield Dividend Index offered a 4.3% yield as of June 30, 2020. After an assumption for dividend cuts and management fees, investors might capture a 2.5-3.0% yield – that’s 60-75% of the way toward a typical 4% withdrawal rate. Your participants would only need another 1-1.5% of income, which might come from capital withdrawals.

Figure 4 Income in the Face of Dividend Cuts

Better Together: Defensive Equity Income

As we’ve pointed out above, equity income strategies often have higher exposure in a particular style or sector, but defensive equity income strategies are different. Yield is important, but not the only consideration.

Equity income managers generally point out that high-yielding stocks tend to have low beta, making their strategies less volatile. However, a stock can have a low beta and still be very risky by being uncorrelated to market returns. An extreme example: gold stocks can have low or negative betas yet are still very volatile.

Defensive equity strategies, especially those focused on portfolio-level volatility, can help moderate these risks. Portfolio-centric defensive equity strategies also tend to not only have low beta stocks, but also account for correlations between stocks, seeking to improve diversification and reduce systematic risk exposures.

The combination of defense and equity income is powerful. In Figure 5, we return to the yield-volatility chart, but now we’ve added a hypothetical defensive equity income strategy.

You can see that a defensive equity income strategy reduces volatility beyond a naïve equity strategy focused on income. Indeed, the yield-volatility tradeoff for defensive equity income resembles fixed-income assets as much as equity strategies. Yet, they offer the potential equity upside retirees are seeking to reduce longevity risk – a one-two punch.

Figure 5 Defensive Equity Income is More Than Low Beta

Learn More

Retirement income investors will need new solutions like defensive equity income to address the balance between longevity and market risk, while tapping a source of income. We highlight why these considerations are moving to the forefront for DC plan participants in our paper, “What Happens When Income is the New Outcome?” Download it today.

What Happens When Income is the New Outcome?  The SECURE Act portends shifts in risk preferences. Are you ready? Download Paper


The information expressed herein is subject to change based on market and other conditions. The views presented are for general informational purposes only and are not intended as investment advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation, or sponsorship of any company, security, advisory service, or fund nor do they purport to address the financial objectives or specific investment needs of any individual reader, investor, or organization. This information should not be used as the sole basis for investment decisions. All content is presented by the date(s) published or indicated only, and may be superseded by subsequent market events or other reasons. Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal and fluctuation of value. Hypothetical examples are for illustrative purposes only. Hypothetical examples are not real and have many inherent limitations. They do not reflect the results or risks associated with actual trading or the actual performance of any portfolio, and have been prepared with the benefit of hindsight. Therefore, there is no guarantee that an actual portfolio would have achieved the results shown. In fact, there will be differences between hypothetical and actual results. No investor should assume that future performance will be profitable, or equal to the results shown. Hypothetical results do not reflect the deduction of advisory fees and other expenses incurred in the management of a portfolio.