Life-cycle Investment Strategy Research Articles

How sub-optimal are age-based life-cycle investment products?

We investigate the conditions under which life-cycle investment strategies based on age may be ‘near enough’ to optimal, focusing on the treatment of the pension account balance and assumptions about risk aversion. We show that dynamically adjusting the strategy in response to fluctuations in balance as well as age can lead to moderate improvements over product designs currently seen in the market; although most of the potential gains might be captured by specifying the glide path with reference to measures reflecting the projected balance over time. The risk aversion assumption emerges as a far more important consideration, with much greater reductions in expected utility arising from mismatches between the risk aversion of the investor and that underpinning the glide path design. Our analysis suggests possibilities for improving life-cycle or target date funds, and highlights the benefit of offering a suite of such funds that cater for members with differing risk aversion.

Effectiveness of investment activities of managers in the mandatory pension insurance system

This article examines reasons for the low efficiency of investment activity by pension asset managers, and pension investment rules are formulated. These rules are based on the Asset Allocation strategy, taking into account the long-term pension investments and the life-cycle investment strategy. All pension portfolios of Russiаn managers have weak diversification by asset classes, a high share of fixed income financial instruments, and a mismatch of the portfolio structure with the risk profile of the beneficiary. The pension industry has high costs. We evaluated the real efficiency of investment activity by pension asset managers according to the classical theory of investments, and compared it with the risk-return benchmarks of the Russian financial market. The real cumulative return by pension asset managers is negative for the period 2008–2018. At the same time, the Russian financial market provided opportunities for real growth of pension savings. Bank deposits allowed to defend capital from depreciation. Modeling of index pension portfolios (conservative, balanced, and aggressive) in the Russian financial market, according to pension investment rules, showed a positive impact on investment management efficiency of regular rebalancing of the portfolio containing stocks. The management of index pension portfolios by the proposed rules protect pension savings against inflation. Pension asset managers improve the investment policy efficiency following the pension investment rules.

확정기여형(DC) 퇴직연금의 라이프사이클 투자전략

확정기여형(DC) 퇴직연금의 라이프사이클 투자전략

From Theoretical Life-Cycle Strategies to Best Practices in Dutch Top-Up Plans

Top-up plans were introduced in the Netherlands in 2015. Within these individual and voluntary retirement saving plans, the accumulated wealth is invested according to the life-cycle principle. In this thesis, we quantify and analyze welfare losses in the net pension top-up plan due to a number of suboptimal life-cycle investment strategies. These alternative strategies are relevant with regard to practical considerations of pension funds and asset managers in the process of establishing and implementing life-cycle strategies. We construct a simulation-based welfare study, which includes an elaborate sensitivity analysis with respect to the benchmark parameter set. In order to quantify welfare losses, the optimal lifetime strategies resulting from a certain theoretical framework are introduced and operationalized first. This simulation study revealed amongst others that a dynamic life-cycle strategy could significantly improve the current welfare of participants in top-up plans.

How Sub-Optimal Are Age-Based Life-Cycle Investment Products?

We investigate the conditions under which life-cycle investment strategies based on age may be ‘near enough’ to optimal, focusing on the treatment of the pension account balance and assumptions about risk aversion. We show that dynamically adjusting the strategy in response to fluctuations in the balance as well as age can lead to moderate improvements over product designs currently seen in the market; although most of the potential gains might be captured by specifying the glide path with reference to a measure of expected value of the balance over time. The risk aversion assumption emerges as a far more important consideration, with much greater utility losses arising from mismatches between the risk aversion of the investor and that underpinning the glide path design. Our analysis points towards possibilities for improving life-cycle or target date funds, and highlights the benefit of offering a suite of such funds that cater for members with differing risk aversion.

Around the Life Cycle: Deterministic Consumption-Investment Strategies

We study a classical continuous-time consumption-investment problem of a power utility investor with deterministic labor income with the important feature that the consumption-investment process is constrained to be deterministic. This is motivated by the design of modern pension schemes of defined contribution type where, typically, the savings rate is constant and the proportional investment in growth stocks is a function of age or time-to-retirement, a so-called life-cycle investment strategy. We derive and study the optimal behavior corresponding to the optimal product design within this realistic family of products with deterministic decision profiles. We also propose a couple of suboptimal deterministic strategies inspired from the optimal stochastic strategy and compare the optimal stochastic control, the optimal deterministic control, and these suboptimal deterministic controls. The conclusion is that only little is lost by constraining to deterministic strategies and only little is lost by implementing the suboptimal simple explicit strategies rather than the optimal one we derive.

OPTIMAL LIFE-CYCLE INVESTMENT STRATEGY IN LITHUANIAN SECOND PENSION PILLAR

The proposition to introduce life-cycle investment strategy as a default option in second pension pillar in Lithuania is currently being intensely discussed as a measure to solve the problems of the irrational behaviour of pension fund participants. The latest analysis has shown that the majority of participants have selected an inappropriate pension fund (investment strategy and investment risk) while evaluating the accumulation period that they have left till the retirement. Moreover, most of them are not active and do not change the pension fund during accumulation period. The life-cycle investment strategy allows participants to switch automatically and gradually from one asset allocation to another as they get closer to retirement. Therefore, such dynamic asset allocation must have a strong analytical foundation. The goal of the study is to evaluate the optimal life-cycle investment strategy in the Lithuanian second pension pillar. In order to achieve this goal, the authors prepared a quantitatively calibrated model that closely follows such works as Cocco et al. (2005), Bagliano et al. (2009) and Blake et al. (2008). The model takes into account the specifics of the Lithuanian market such as contribution rates, the investment performance of pension funds, and participant?s labour income process. In this paper, the authors use the optimization problem, where participant?s utility is maximized only by the selected investment strategy (without consumption). The results show that from the beginning of accumulation period (the age of 20) till the age of approximately 42 years it is most rational to invest a high proportion of participant?s pension assets into equities. Then optimal asset allocation is gradually switching from equities to less risky assets (e.g. government bonds) as the retirement age (65) approaches, where only 19 per cent of assets are invested into equities. The paper consists of three main parts: literature review, the explanation of the model and calibrated parameters that were used to evaluate the optimal life-cycle investment strategy, and main simulation results, including benchmark and sensitivity analysis.

Approximations to Expected Utility Optimization in Continuous Time

In this paper, we explore approximate solutions to optimal control problems that cannot be solved analytically with existing techniques. Inspired by the mean-variance analysis of the single period environment, an advanced and a simple method are developed in order to approximate optimal investment strategies in continuous time. In the advanced method, the original problem is approximated by a Taylor series expansion in the conditional mean of terminal wealth. As the point of expansion is thereby continuously changing, the approximation results in a non-standard optimal control problem that can be characterised by an extended HJB equation. In the simple method, the problem is expanded in the initial mean, leading to a problem that can be solved using the classical HJB equation in an unconventional way. The advanced approximated problem inherits more features from the original problem than the simple approximated problem. In a numerical example, we illustrate how the advanced approximate strategy gives a better approximation than the simple approximated strategy. An approximate solution is determined to a prospect theory investment problem, utilising the advanced method of approximation. The solution reflects the same behaviour as the classical life-cycle investment strategy, where the proportion of wealth invested in the risky asset is decreasing over time and independent of the level of wealth.

Why Can't a Woman Invest More Like a Man? Gender Differences in Investment Behaviour

This research finds distinct life cycle patterns of equity participation by gender. The significant factors associated with equity participation also vary notably by gender and age. Women exhibit greater variability in both participation levels and significant factors. Family circumstances are more relevant factors for women. Family obligations appear to constitute a type of habit formation, which affects participation in risky assets in a manner consistent with recent research on life cycle investment models incorporating background risk in labour income and habit formation in consumption. An improved understanding of the life cycle patterns and significant factors in investment behaviour can improve life cycle investment strategies.

The Allocation of Financial Risks During the Life Cycle in Individual and Collective DC Pension Contracts

This paper measures how financial shocks - equity market, interest rate or inflation shocks - affect different generations of participants in pension schemes. We show that an individual scheme, by using a life cycle investment strategy, can largely replicate the allocation of traded risks across generations of a collective pension scheme that gradually adjusts pensions after financial shocks. Collective schemes can shift financial risk to generations that will participate in the future, whereas individual accounts cannot. In the current institutional setting this shift of traded risk in collective contracts to future generations is limited. Collective pension schemes are able to reallocate nontraded risks among the participants to obtain a more efficient distribution of risk across generations. In schemes with individual accounts, risk sharing is limited to risks traded on financial markets.

What is the Value of 'Collective' in Collective DC?

This paper measures how financial shocks - equity market, interest rate or inflation shocks - affect different generations of participants in Dutch collective pension schemes. We show that an individualized scheme, by using a life cycle investment strategy, can largely replicate the allocation of traded risks across generations of a collective pension scheme. Collective schemes can shift some financial risk to generations that will participate in the future, whereas individual accounts cannot. In the current institutional setting this shift of traded risk in collective contracts to future generations is limited. Collective pension schemes are able to reallocate non-traded risks among the participants to obtain a more efficient distribution of risk across generations. In schemes with individual accounts, risk sharing is limited to risks traded on financial markets.

Around the Life-Cycle: Deterministic Consumption-Investment Strategies

We study a classical continuous-time consumption-investment problem of a power utility investor with deterministic labor income with the important feature that the consumption-investment process is constrained to be deterministic. This is motivated by the design of modern pension schemes of defined contribution type where, typically, the savings rate is constant and the proportional investment in growth stocks is a function of age or time-to-retirement, a so-called life-cycle investment strategy. We derive and study the optimal behavior corresponding to the optimal product design within this realistic family of products with deterministic decision profiles. We also propose a couple of suboptimal deterministic strategies inspired from the optimal stochastic strategy and compare the optimal stochastic control, the optimal deterministic control and the suboptimal deterministic controls in terms of certainty equivalents. The conclusion is that only little is lost by constraining to deterministic strategies and only little is lost by implementing the suboptimal simple explicit strategies rather than the optimal one we derive.

Deterministic mean-variance-optimal consumption and investment

In dynamic optimal consumption–investment problems one typically aims to find an optimal control from the set of adapted processes. This is also the natural starting point in case of a mean-variance objective. In contrast, we solve the optimization problem with the special feature that the consumption rate and the investment proportion are constrained to be deterministic processes. As a result we get rid of a series of unwanted features of the stochastic solution including diffusive consumption, satisfaction points and consistency problems. Deterministic strategies typically appear in unit-linked life insurance contracts, where the life-cycle investment strategy is age dependent but wealth independent. We explain how optimal deterministic strategies can be found numerically and present an example from life insurance where we compare the optimal solution with suboptimal deterministic strategies derived from the stochastic solution.

Default investment strategies in a defined contribution pension system: a pension risk model application for the chilean case

AbstractIn a defined contribution pension system, one of the main risks faced by members refers to the investment of funds. In this context, we discuss which is the most suitable risk measurement for the affiliates to the pension system. Different life-cycle investment strategies are evaluated under this measure for different types of workers. We point out the importance of designing well-suited default investment options in light of the economic behavior of members, characterized by low financial knowledge, inertia and myopia in decision-making. We calibrate a pension risk model for the Chilean economy, including measures of life-cycle income, human capital risk, investment and annuitization risks. Our results suggest that affiliates can gain (loss) around 0.85 percentage points in terms of average replacement rates in return for an increase (decrease) of 1 percentage point in risk, measured as standard deviation of replacement rates. Using a stochastic dominance analysis, we find that there are no dominated strategies when subsidies from the Solidarity Pillar are excluded. When the Solidarity Pillar is considered, the most appropriate investment strategies for affiliates that receive these subsidies are concentrated on the riskier funds. However, this also means that there could be increased pressure on Government spending in order to grant additional benefits to affiliates. Our model has a wide range of practical applications that go from informing affiliates about the degree of uncertainty associated to their expected replacement rate to a guide to evaluate how different investment strategies affect the expected values of affiliates' pensions and their associated risk.

Average Price Portfolio Insurance as Optimal Implementation of Life-Cycle Investment Strategies

We design average price portfolio insurance (APPI) strategies with an investment floor and a buffer that is a power of a generalised geometric average of the underlying asset price. We prove that APPI strategies are optimal for investors with hyperbolic absolute risk aversion who become progressively more risk averse over time. During the averaging period, APPI strategies reduce the proportion of wealth allocated to the risky asset, which is the traditional life cycle investment recommendation. We compare the sensitivities of the fair price of equivalent payoffs generated by average and constant proportion portfolio insurance strategies and illustrate the performance of APPI strategies.

Assessing the Labour, Financial and Demographic Risks to Retirement Income from Defined-Contribution Pensions

This article examines the impact of labour, financial and demographic risks on retirement income from DC pension plans, with a special emphasis on labour-market risk. It uses a stochastic model that incorporates uncertainty about returns on investment, inflation, discount rates, life expectancy, employment prospects and real wages. The analysis herein highlights that labour-market risk, as well as uncertainty about returns on investment and inflation, have the largest impact on retirement income. The results suggest that default life-cycle investment strategies that reduce exposure to risky assets in the last decade before retirement are quite helpful in reducing the risk of sharp reductions in retirement income, in particular when a negative shock to equity markets occurs in the years before retiring. However, life-cycle strategies fail to address issues of retirement income adequacy or smooth out the volatility in retirement income from DC pension plans.

Assessing Default Investment Strategies in Defined Contribution Pension Plans

This paper assesses the relative performance of different investment strategies for different structures of the payout phase. In particular, it looks at whether the specific glide-path of life-cycle investment strategies and the introduction of dynamic features in the design of default investment strategies affect significantly retirement income outcomes. The analysis concludes that there is no “one-size-fits-all” default investment option. Life-cycle and dynamic investment strategies deliver comparable replacement rates adjusted by risk. However, life-cycle strategies that maintain a constant exposure to equities during most of the accumulation period, switching swiftly to bonds in the last decade before retirement, seem to produce better results and are easier to explain. Dynamic management strategies can provide somewhat higher replacement rates for a given level of risk than the more deterministic strategies, at least in the case of pay-outs in the form of variable withdrawals. The length of the contribution period also affects the ranking of the different investment strategies with life-cycle strategies having a stronger positive impact the shorter is the contribution period.

Lifecycle Funds and Wealth Accumulation for Retirement: Evidence for a More Conservative Asset Allocation as Retirement Approaches

A line of recent studies cast doubt on the efficacy of the lifecycle investment strategy, which calls for switching into a more conservative investment portfolio as retirement approaches, as a suitable way to provide for the retirement needs of workers with defined-contribution pensions. After comparing simulation outcomes for lifecycle and fixed asset allocation strategies, we determine that the lifecycle strategy can be justified even in a framework including only financial wealth. We find that investors with very reasonable amounts of risk aversion may prefer the lifecycle approach, despite the tendency for aggressive fixed allocation strategies to produce larger expected wealth.

Sustaining the Nation's Aging Infrastructure Systems: Lessons Learned Applying an Asset Management Framework

systems permeate society at both the personal and business levels. These systems are taken for granted, but the implications of system breakdowns are staggering and directly impact our national competitiveness, having both immediate consequences and long lasting effects on the local, regional and national economies. Many of the infrastructure systems found in the United States have been in place far beyond their design lives. How does an organization manage these aging assets given constrained resources? This paper presents an innovative research and problem formulation method created as part of an effort by the United States Army Corps of Engineers' to develop an Asset Management Framework (AMF) to manage its aging civil infrastructure assets. This paper outlines the development of the framework using an intent-driven command and control approach, grounded by the input from dozens of practitioners, gathered through a series of interviews, surveys, and field studies. The paper describes mechanisms used to bring together economists, biologists, civil engineers, and others to create a robust AMF. The AMF will be illustrated showing transparent integration of preservation and risk mitigation initiatives, as well as budget and resource allocation processes supporting a lifecycle investment strategy for sustainability across the entire agency. The Framework's scope includes oversight of much of America's watersheds covering 1,000 coastal structures, 800 dams, 250 navigation locks, 75 hydropower plants and other assorted facilities. Lessons learned in developing this system are provided, along with its current status. The implications of this work to other industries and pubic sector agencies will be examined.