The arrival, and focus on income solutions, highlight an acknowledgment that the financial landscape we’ve known for decades is on the brink of a colossal shift, driven largely by the wave of retiring Baby Boomers. At the same time, Australia’s financial landscape is undergoing a subtle yet crucial transformation, with more lending occurring outside traditional banks.
The number of people over the age of 65 is expected to more than double, while the number over 85 is tipped to more than treble.
As this demographic milestone – outlined in great detail with this week’s Intergenerational report from the government – suggests where we are heading, the financial landscape is transforming.
Treasurer Jim Chalmers spelled out the big picture midweek when he released the IGR report.
“As we age, there will be a smaller share of working-age people, putting pressure on our tax base at the same time as we face growing spending pressures from the NDIS, aged care, health, defence and debt interest costs,” he said.
“Our economy will expand substantially … but our productivity challenge which we have reflected in the adoption of a more realistic productivity assumption, means that overall, real GDP projections are down from the report released a couple of years ago.”
It is crucial for investors to recognise and respond to these issues – especially the ageing of Australia and the broader shift across the superannuation industry towards focusing on the retirement period – rather than the accumulation period of the wider population.
Steering your focus toward more stable, income-producing investments will be a necessity as a tidal wave of investor switching reprices all asset classes.
The post-World War II period saw the birth of the Baby Boomer generation, a cohort who has left an indelible mark on Western society, culturally and financially.
They underpinned the burgeoning global pension pool, which estimates now put at a staggering $US55 trillion. And these funds have long fuelled economic growth by funding governments with debt and corporations with equity. But that might all be changing as the Boomers begin to draw down on that accumulated pool.
The shift towards income
As Boomers now begin liquidating their investments and pension assets, financial markets and their investors face a paradigm shift. Instead of investing in building wealth, their focus will, by necessity, transition towards safeguarding or preserving existing wealth and ensuring steady income.
Australia’s hefty pension assets in relation to our economic size puts us at the epicentre of this change because those nearing, and in, retirement own a significant portion of these assets.
Yet, despite the advent of regulations like the retirement income covenant in 2022, which was added to the Superannuation Industry (Supervision) Act 1993 and required advisers to have a strategy to assist members in or approaching retirement, super fund trustees are reported to be woefully unprepared for the massive shift in required investment outcomes.
It’s estimated that by 2030, assets belonging to Australian retirees in super funds will soar to $1 trillion. This monumental pool of funds is likely to prioritise capital preservation and steady income over high-risk, high-reward investments.
That’s a trillion dollars potentially looking for a new home in income-producing products, including private credit or private debt.
Particularly as interest rates rise, and the financial landscape shifts, the investment strategies that once thrived may now be ignored.
I recently wrote to investors about the implications for the equity market, suggesting the “dips” may not elicit the same buying response from retail investors that we are accustomed to from past episodes of stock market declines. On the other hand, the enthusiasm for corporate debt and fixed-income investments is witnessing a renaissance – especially private debt, which is emerging as something of a favourite.
While the past may have seen an emphasis on equities, high-yield bonds, and other even riskier products, shifting demographics necessitate a pivot towards more reliable income-producing alternatives. And the shift is just beginning.
You will have to widen your asset allocation
Importantly, retirees mustn’t forget they’ll be living longer than their parents, so “growth” assets (think equities) will remain a vital portfolio component to ensure lifestyle and health requirements can be funded in 10, 15 and 20 years’ time. Nevertheless, an increasing portion of a portfolio will be dedicated to capital preservation and income.
Private credit’s benefits are broad. One of the primary appeals is the consistent cashflow they can provide. Most private loans, especially in the middle market, come with regular interest payments. This contrasts with equities, for example, which may or may not provide dividends and can be more exposed to volatile price swings.
Meanwhile, many private credit investments are secured by tangible assets. If a borrower defaults, the lender may have a claim to certain assets as collateral. In contrast, equity investors are at the bottom of the capital structure, meaning they are last in line to receive any remaining assets in the event of bankruptcy.
The private credit market is less correlated with public market swings, and private credit offers predictable returns based on interest rates set out in loan agreements. This contrasts with equities, where returns are highly dependent on company performance, market perception, and broader economic factors.
Meanwhile, sharemarket returns depend on company performance for returns (in the form of dividends or stock appreciation), and private credit returns are typically contractually obligated. Borrowers are legally required to make interest and principal payments.
By adding private credit to a portfolio, investors can achieve greater diversification. It’s another asset class, with a different risk and return profile compared to equities, that can work to balance out portfolio returns over time, while offering higher yields than traditional bonds or other fixed-income assets, thanks to the direct relationship between investor, manager, originator and borrower.
The private credit market has matured significantly over the past decade. With this maturation comes better infrastructure, more data for making informed decisions, and a larger number of experienced participants, making it a more viable investment option for many.
If it hasn’t happened already, traditional portfolio asset allocation is about to be disrupted by a bunch of new kids on the block.
The only thing is, these new kids aren’t new at all.
Private Credit, for example, is well established in the US and Europe and has long been the preserve of Ultra High Net Worth (UHNW) investors and their family offices. A more risk-averse, income-oriented demographic will now see the market for these funds expand significantly.
The Baby Boomer retirement wave will see a tidal shift away from aggressive growth to
stable, income-producing investments. And to ensure long-term prosperity, advisers will have to reassess portfolio allocations and introduce more diversified, stable income options that must also withstand sudden economic shifts.
Roger Montgomery is founder and chief investment officer at Montgomery Investment Management
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