Challenger is in the business of structuring, marketing and selling fixed annuities. These are financial instruments that offer investors a fixed and guaranteed return for a period of time.
Fixed annuities have a couple of features that are worth noting.
First, the cash flow is predetermined and guaranteed. Therefore, an investor doesn’t take any risk with market performance and this provides security and stability. It enables investors to plan their budgets, as they know how much income they will have and can then match it to their expenditure.
Second, the time period an annuity covers can be fixed or open-ended. This means that an annuity can provide longevity protection – in other words, protect against the risk of running out of money if you happen to live longer than anticipated.
Third, the annuity can be structured to either consume the whole capital or include a repayment of part or whole of the principal investment at the end, which can provide the option of ensuring enough capital remains to leave an inheritance.
All these traits make annuities attractive products for people in the retirement phase, and as Australia is seeing a rapid growth of the retired population this is the main reason we are attracted to Challenger as an investment.
On top of this, there are a couple of other reasons we like Challenger.
The first is that new age pension means-testing rules will be introduced on July 1, 2019, which will treat annuities more favourably than is currently the case. This should see more people who are close to qualifying for the age pension invest in annuities.
The second reason is that the federal government’s Comprehensive Income Products for Retirement review, which was released in May, says super fund trustees have to include an option that offers longevity protection to their members. The government-proposed model portfolio includes a 25% allocation to annuities as the default option to provide longevity protection.
Today only around 4% of post-retirement funds in Australia are invested in annuities and we believe this percentage will rise in the future.
Challenger is in a prime position to capitalise on these developments as it has a very strong first-mover advantage and currently has around 90% of the annuity market in Australia.
This should translate to strong future growth and we do not believe that the current share price fully reflects this.