Funding retirement is one of the most important issues for retirees. Where is the money going to come from? Will the retiree outlive their money?
A lot of people leave it up to their financial advisor to manage the money and pay a small fortune in the process.
Others make being an investor the last job in their life, they manage a portfolio themselves and hopefully do quite well.
However, there's another option that's becoming increasingly popular with retirees and financial planners called annuities.
You give the annuity provider an amount of capital, then they return income and capital over a number of years or over your life depending on the annuity.
Challenger Ltd (ASX: CGF) is the dominant annuity provider in Australia and it has a market capitalisation of $6.2 billion. Here are three reasons why I think it's a great investment:
Tapping into the aging population
Annuities are mainly aimed at people entering retirement, which is why people in their 60's are the biggest consumer of annuities.
The potential target market for Challenger is rapidly increasing as baby boomers start entering retirement. Not only is there a very large number of baby boomers, the cohort will take approximately 20 years from now to be fully retired thanks to the youngest boomers. That is a very long tailwind to boost growth.
Growing popularity
Not only is the target market getting bigger each year, but annuities are steadily becoming more popular too.
In Australia the amount of retirees with fixed income was only 9%, yet in other western countries the average is around 52%. Even if Australia were just to reach parity with other countries, this would vastly increase the size of the annuity market.
I think it's definitely possible as both retirees and financial planners are becoming more aware of Challenger and what it's offering. In the second half of FY16 Challenger grew annuity sales by 45% and there could be more strong updates to come.
Defensive financials
Most financial companies are quite cyclical and would be heavily damaged in a recession. Challenger would also be affected, however there are a couple of reasons why it would be hurt less.
At least 50% of its annuity balance sheet is made up of fixed interest products and cash, therefore these would not lose value and Challenger's value would hold up.
In a recession retirees would see how dangerous the stock market and property market is, so Challenger would have more reason to attract retirees to the safety of annuities with their advertising.
Risks
There are risks with every company, Challenger is no different. Although it may fare better than most financial companies, a recession wouldn't be a positive for the business as the equities on its balance sheet would take a hit.
There is a chance that one of the major finance companies such as a big four bank, Macquarie Group Ltd (ASX: MQG) or AMP Limited (ASX: AMP) may launch competitive annuities. So far that hasn't happened.
The long term risk is potentially that Challenger may not have allocated resources correctly, or people live longer than the initial calculation of the annuity, therefore future profits could take a hit, but we can't know this for a long time.
Foolish takeaway
I think Challenger is one of the best growth companies on the ASX and can continue posting strong results for at least the next 10 to 15 years, which is why it's one of my biggest holdings.
Challenger is trading at 16.3x FY17's estimated earnings with a grossed up dividend yield of 4.29%, quite a reasonable price to pay for this great business. Another business trading at reasonable levels with exciting growth planned and a bigger dividend yield is our number one dividend pick for 2017.
