The Investing for Drawdown Challenge Gavin Jobson-Wood Specialist Business Development Manager For Adviser Use Only

KEY LEARNING OBJECTIVES Understand the specific investment & advice considerations for clients approaching, and at, retirement. Understand what a dynamic volatility managed strategy is. Understand the benefits of using this type of investment strategy for you and your clients.

Drawdown The ‘New Norm’ “Drawdown has become much more popular: twice as many pots are moving into drawdown than annuities. Before pension freedoms, over 90% of these were used to buy annuities.” “We recognise that innovation may pick up as DC pots grow in size and the industry is given more time to develop propositions.” FCA Retirement Outcomes Review Interim Report – Published July 2017 Drawdown as the ‘new norm’ has become established twice as many pots are moving into drawdown than annuities The FCA and the financial media has regularly expressed its desire for innovation The challenge is many of the more recent drawdown cases were smaller values Financial advisers are now adapting their advice models - CRP 3

THE RETIREMENT INCOME REVOLUTION Over 3 years since pension freedoms were introduced and the shift from annuities to drawdown Drawdown is now accessed by clients with lower fund values who have less financial experience How do advisers deliver a clear, consistent and repeatable process? What can be done to reduce the risks around investing for retirement income? The FCA are increasing their focus on retirement income. Would your advice process pass scrutiny in a future thematic review?

CIP v CRP CIPs and CRPs represent the principles of good advice governance not just a fund range.

Flexible income – the risks

SEQUENCE OF RETURNS RISK A, B & C each has: £100,000 at the start of year 1 The same average return over 10 years In 9 of the 10 years – return is 5% In 1 of the 10 years there is a 20% loss Withdrawals of £10,000 per annum The same average volatility over 10 years Gross returns, no charges have been deducted

SEQUENCE OF RETURNS RISK

4% annual withdrawal of invested portfolio. Bengen’s ‘4% Rule’ 4% annual withdrawal of invested portfolio. Increasing annually by inflation. Portfolio of 50% U.S. equities & 50% U.S. bonds. Assumes no charges. Conducted in 1994 using historical data. Source: http://www.retailinvestor.org/pdf/Bengen1.pdf

Sustainable withdrawal rates

A natural income v total return? Absolute Return strategies INVESTMENT STRATEGY Reducing the retirement income risk: A natural income v total return? Absolute Return strategies ‘Smoothed’ Funds Building a cash reserve strategy

INVESTMENT STRATEGY Does one size fit all? Discretionary Fund Management Model portfolio Fund panels Single multi-asset fund

Multi Asset Funds The Price Consideration MULTI-MANAGER ACTIVE Traditional & Alternative Asset Classes Price ACTIVE Traditional Asset Classes The asset-class components used within multi-asset funds can vary significantly. Naturally there is often a trade off between the cost of the fund proposition and both the diversification (by way of asset classes) and degree of active management. The introduction of additional esoteric asset classes , that are non-correlated to other asset classes, has increased in popularity in recent years. It’s worth noting that whilst funds might utilise passive components there could be active management in respect of the asset allocation (Strategic and Tactical). PASSIVE

Significant volatility Equity investing exposes the client to investment risk and the potential for loss The sustainability of customers income drawdown can suffer in the long term Historically high volatility has been an indicator for loss There are many examples such as the dot.com bubble and the more recent global financial crisis Managing significant volatility can help a pension pot last longer 14

DYNAMIC VOLATILITY MANAGEMENT OVERVIEW When volatility is acceptable the fund performs like any other fund, exposed to equities, with the potential growth available As volatility rises, the risk of losses also increases. An automated algorithm monitors volatility Volatility may become significant, enough to exceed the threshold we have established If this happens we start to reduce equity exposure in proportion to the severity of the risk The algorithm continues to monitor volatility. It may eventually drop back below the threshold If that happens, equity exposure returns back to the SAA allocated amounts for the fund. NB – When DVM is dormant, it has little drag on the performance of the fund, so provides full access to market returns 15

Using derivatives The Retirement Portfolio Funds use derivatives as part of the investment and volatility management process. The investments for the Strategic Asset Allocation use a combination of: Physical investments in equities and bonds Long Equity Index Futures Equity Futures (held long) provide a return similar to the equities they mirror The futures we use are from large, highly liquid, daily traded indices When volatility becomes significant and exceeds the threshold, the DVM is triggered and we start to de-risk Instead of selling physical equities, we start to adjust our futures position instead We convert our long equity future position to a short equity future position Equity Futures (that are held short) provide a rising return when the equities they mirror fall in value This helps reduce investment losses As volatility becomes more acceptable, the process is reversed This is efficient, quick and low cost 16

Back-Testing We have back-tested the funds to see how they would have performed We looked at some common and familiar situations Our back-testing looked at funds in drawdown (£100k, 4% inflation adjusted withdrawal) We compared the same asset allocation with and without DVM The Dot.com tech bubble The Financial Crisis A steadily rising market, with acceptable levels of volatility (When the DVM is dormant it doesn’t drag on performance) The details are available in a separate pack 17

Future Simulations We have tested the funds to see how they would perform in different future situations We completed 5000 different scenario tests using a stochastic forecast Our testing looked at funds in drawdown (£100k, 4% inflation adjusted withdrawal) We compared the same asset allocation with and without DVM We looked at when they were most effective A loss in the early years of retirement – sequence of returns risk We also looked at when they were less effective A sudden sharp fall – An example would by like Black Monday in 1987 The reason is that there would be no signal from rising volatility – the fund would react like the rest of the market The details are available in a separate pack 18

KEY LEARNING OUTCOMES Understand the specific investment & advice considerations for clients approaching, and at, retirement. Understand what a dynamic volatility managed strategy is. Understand the benefits of using this type of investment strategy for you and your clients.

FLEXIBLE RETIREMENT SOLUTION WITH LOW INVESTMENT CHARGES DRIVING SUSTAINABILITY Retirement Account Single Plan Retirement Planning Retirement Income Property Purchase Share dealing DFM (inc MPS) Self-Select Fund Range Adviser Portfolios Solution Multi-Manager Funds (0.6 - 0.9%*) Premier Pension Portfolio Funds (0.4%*) Retirement Portfolio Funds (0.2%*) Pension Portfolio Funds (0.1%*) Scottish Widows Pensions Funds Fixed Term Cash Deposits** Governed Investment Strategies and Premier Governed Investment Strategies * Solution Funds Fund supermarket Share dealing Investment Advice Requirement SW Governed Multi-Asset Funds *Total Annual Fund Charge

August 2018 Scottish Widows Limited. Registered in England and Wales No. 3196171. Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number 181655.