A version of this article appeared in the January 2020 issue of Morningstar ETFInvestor. Download a complimentary copy of Morningstar ETFInvestor by visiting the website.
During the twilight of the 2000s, several fund companies launched retirement-income funds with the promise of a stable stream of income for retirees. The goal was to ease the transition between a retirement saver’s accumulation years and their spending years of early retirement: Asset managers designed the funds to be an instrument of compromise for retirees who sought predictable income, but didn’t want to give up control of their assets to an annuity. They also offered market appreciation in addition to income, diversifying across stocks and bonds.
Despite these merits, retirement income strategies didn’t take. In February 2020, Vanguard officially changed the name of Vanguard Managed Payout VPGDX to Vanguard Managed Allocation and eliminated its key feature--a monthly income stream in the form of a dividend. Vanguard chose to do so in part because many investors were choosing to reinvest the payouts they received from the fund. Now, investors seeking a monthly payment must elect to sell out of a portion of their investment, spending it down over time. This isn’t the first time Vanguard has tweaked its strategy--in 2014, Vanguard combined three managed payout funds, which varied based on risk levels, into a single offering: Vanguard Managed Payout.
As Vanguard has learned, retirees spending down their nest eggs have diverse needs. Cash outflows in retirement can be lumpy and unpredictable, especially early on, which could be why many investors in Vanguard Managed Payout chose to defer payments and reinvest income. And just as retirees’ spending needs vary greatly from other retirees, retirement-income funds are not all alike. In fact, other than their objective, very little unites this heterogenous group: Funds vary on many dimensions, including how much equity risk to take, how the payout is determined, and how retirees are supposed to take it.
Retirement-income funds also face competition for investors’ nest eggs. Investors can choose between many securities, like annuities, individual bonds, bond funds, and multi-asset funds. Annuities guarantee an income payment, but in most annuity contracts investors sign over control of their assets to their counterparty in order to receive these payments. Annuities also lack a transparent cost structure and can be pricey. Bonds and bond funds often have higher income streams, but typically less capital appreciation potential, than equities. Multi-asset funds combine the two, but carry more downside risk. That’s why some have explicit retirement income mandates, where the manager invests to increase income but dampen volatility to emphasize payment stability and predictable timing for retirees. Although payments may have been stable, retirees’ experiences with retirement-income funds have not been: during the last decade at least three funds were merged or closed. The 28 remaining individual funds, spread across nine distinct offerings, sum up to less than $6 billion in assets between them. Nearly $5 billion of that is split between Vanguard Managed Allocation and American Funds’ three risk-based funds. As of Dec. 31, 2019, the institutional category’s total assets under management is currently at its peak. Meanwhile, assets in annuities climbed to over $2.2 trillion dollars in 2019, according to the ICI.
It doesn’t help that over the past 10 years, multi-asset retirement-income funds failed to deliver either higher income or lower volatility than standard allocation funds in the allocation—30 to 50% equity Morningstar Category. The median multi-asset income fund’s trailing 12-month yield from December 2009 through November 2019 did not once beat the category. Plus, this lower yield came with 1.22 percentage points higher standard deviation, annualized.