Volume 18, No. 4, Fourth Quarter 2020
Retirement Investing
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Article
A Six-Component Integrated Approach to Addressing the Retirement Funding Challenge
This paper offers an integrated approach to addressing the global retirement funding challenge, especially in light of the coronavirus shock that has created an unanticipated and unprecedented impact on lifetime income/consumption. It frames the problem in a six-component approach to the funding challenge with an integrated package presented in a transparent, detailed modular fashion, so that any one module can be replaced with a different version and the rest of the system works. This also means that all six components need not be employed simultaneously, but can be done in a secular fashion. Finally, it develops and proposes in detail a new financial instrument, SeLFIES (Standard-of-Living indexed, Forward-starting, Income-only Securities)—a single financial innovation that provides greatly improved efficiency of implementation to four of the six components. SeLFIES can help complete financial markets and could be a timely innovation given the coronavirus crisis because they are beneficial to governments that seek long-term, local currency debt financing.
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Insight
Towards Replacing the Defined Benefit Plan: Assured Retirement Income Provided by a Liquid Investment Fund
Traditional corporate defined benefit (DB) plans provided retirees with constant retirement income, butDB plans have now all but disappeared. While defined contribution (DC) plans now permit low-fee wealth accumulation, the conversion of wealth to predictable nominal or real income during retirement remains opaque and expensive. Complicated, illiquid, and high-fee products dominate the landscape. The goal of acquiring low-fee, predictable future income in retirement, has remained elusive.We describe a relatively simple, liquid, and low-cost series of funds that can address this challenge. The key features are: (1) A minimum assured annual income (real or nominal) for a significant period of time. (2) Maximal exposure at all times to a higher-expected-return risky asset, while meeting the income assurance per share. (3) Liquidity that allows investors’ flexibility to withdraw funds or change assured levels of income at any time, with minimal cost. (4) A simple but significant “behavior nudge” that gives clarity on the future income levels: each share will provide a minimum income of $1 per year for 20 years with the possibility to be extended for lifetime. An investor will know future assured income simply by knowing the number of shares she/he owns. (5) Scalability through reliance on underlying securities backed by the deepest markets in the world. While a strategy to provide the features above is relatively straightforward for a single investor, a deeper challenge is to create a fund that provides these features to all investors, regardless of when shares are purchased. We consider the nature of asset management that achieves all the previous features in a single fund, and believe that it can be done while qualifying for QDIA status.
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Article
How Much Can Collective Defined Contribution Plans Improve Risk-Sharing?
Collective Defined Contribution (CDC) plans have been suggested as an attractive and sustainable alternative to public sector DB plans. A CDC plan is a hybrid structure, designed to provide more predictable retirement benefits than a traditional DC plan while operating at the lower cost of a DB plan. It does this by sharing investment risk across worker cohorts and centralizing asset management. We develop a model of an unsubsidized CDC plan, and use it to characterize the risk-sharing rules and investment policies that maximize a “scheduled benefit” for retirees that is almost always achieved or exceeded. We compare the outcomes under the CDC system with those from an otherwise similar options-augmented DC model, where participants have access to self-financing strategies that involve trading in one-year put and call options. The ability to effectively trade long-dated options in the CDC framework delivers a somewhat higher scheduled benefit than can be achieved by self-insuring in an options-augmented DC plan. However under current contribution policies, the scheduled benefit in the CDC plan falls short of what most would consider an adequate retirement income.
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Article
A Personal Tribute to Professor Harry Markowitz on the Occasion of the JOIM Special Achievement Award
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Article
Multi-Period Portfolio Selection: A Practical Simulation-Based Framework
The topic of optimal portfolio selection over time has garnered significant attention from investment researchers since the introduction of portfolio theory in 1952. While computational, theoretical, and numerical methods have advanced, solutions introduced to date have yet to effectively address many practical aspects of the multi-period portfolio selection problem.
In this paper, we propose three key requisites for practical multi-period portfolio selection solutions that highlight the central challenges of managing portfolios across a multi- period investment horizon: effective duration management, incorporating real-world asset dynamics, and considering investment frictions and illiquidities. Based on these criteria, we detail an analytical framework for multi-period portfolio selection that provides intuition and yields guiding principles that describe how allocations and duration should evolve across a multi-period investment horizon, given specific investor objectives. We then introduce a practical simulation-based portfolio selection (SBPS) framework and present solutions for common investor objectives that are not only aligned with intuitive principles but also demonstrate the flexibility afforded by SBPS in allowing us to address the three stated requisites for practical multi-period solutions. -
Practitioner's Digest
Practitioner’s Digest • Vol. 18, No. 4
The “Practitioners Digest” emphasizes the practical significance of manuscripts featured in the “Insights” and “Articles” sections of the journal. Readers who are interested in extracting the practical value of an article, or who are simply looking for a summary, may look to this section.
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Book Review
The Ascent of Market Efficiency: Finance That Cannot Be Proven
“Book Reviews” identifies important, and often popular, new books from a wide range of investment topics. Beyond providing a summary and review of the content and style of the books, “Book Reviews” seeks to contribute to a conscious, critical, and informed approach to investment literature.