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.     

Pension fund manager skills over the economic cycle: the (non-)specialization cost

We study whether pension fund managers, as professionals of important social and financial products, are able to add value for their clients and adapt to economic changes. To this end, we analyze the performance and skills (market timing and stock picking) over the economic cycle from both pension fund and manager perspectives. This double analysis allows examining whether skills reside in managers and/or funds and control for manager substitutions. Despite the long-term nature of pension funds, we find that both fund and manager skills vary with market conditions, showing better evidence of stock-picking in booms, and of market timing in recessions. Nonetheless, top (bottom) funds and managers exhibit both (incorrect) skills in booms and in recessions. Some of the top (bottom) funds and managers are the best (worst) in both abilities in the same periods, but not in different periods, showing that not all managers have the ability to adapt to market conditions. Additionally, managers with limited skills tend to specialize because diversification requires multi-task skills and the non-specialization of these managers usually results in incorrect skills.     

Dynamic portfolio strategy by loss-averse fund managers facing performance-induced fund flows

In a continuous-time framework, we establish an optimal dynamic portfolio strategy for a loss-averse fund manager facing performance-induced fund flows. Using the martingale approach, we derive closed-form solutions to both the optimal terminal value and optimal dynamic strategy of the fund under management. The model shows that the loss-averse manager strives to earn high returns in good market conditions at the risk of losing all investments at the terminal date in bad market conditions. The prospect of higher fund inflows induced by superior performance motivates fund managers to take more aggressive investment strategies, increasing the fund's risk exposure, whereas the prospect of fund outflows due to underperformance has no impact on the fund manager's investment decision. While the prospect of higher fund inflows increases dynamic optimal wealth as well as optimal terminal wealth in good market conditions, in bad market conditions, it reduces dynamic optimal wealth and results in a higher chance of a complete loss at the terminal date. Finally, a manager with a higher degree of loss aversion tends to take a conservative investment strategy with a lower risk exposure especially in bad market conditions, leading to a lower dynamic and terminal wealth in good market conditions and also a lower chance of a complete loss in bad market conditions.     

Would emerging market pension funds benefit from international diversification: investigating wealth accumulations for pension participants

In recent years, investment portfolio selection is growing in importance for many emerging market pension funds, as pension reforms replace traditional pay-as-you-go systems with advanced funding systems. Various investment regulations are applied to the funded pensions, particularly in the form of portfolio limits for equities and international assets. With a bootstrap simulation approach, this paper attempts to quantify the impacts on retirement benefits of restricting international assets from the investment portfolios of emerging market pension funds. We find that, on average, over half of the pension portfolios of emerging market countries should be in international assets in order to maximize the expected utility of moderate and conservative pension fund participants. More generally, international assets can play a significant role in the investment portfolios for workers with risk aversion varying from aggressive to conservative. With few exceptions, the entire probability distribution of wealth accumulations at retirement could be shifted higher with the inclusion of international assets.     

Iterated VaR or CTE measures: A false good idea?

The purpose of this paper is twofold. Firstly, we consider different risk measures in order to determine the solvency capital requirement of a pension fund. Secondly, we illustrate the impact of the time horizon of long-term guarantee products on these capital. We consider a financial market modelled by a common Black–Scholes–Merton model. We neglect the mortality and underwriting risks by assuming that the pension fund is fully hedged against these risks, which allows us to keep understandable and tractable formulæ (the longevity risk will be a part of future researches). A portfolio is built in this market according to different strategies and the pension fund offers a fixed guaranteed rate on a certain time horizon. We begin with well-known static risk measures (value at risk and conditional tail expectation measures) and then we consider their natural dynamic generalization. In order to be time consistent, we consider their iterated versions by a backward iterations scheme. Within the dynamic setting, we show that solvency capital can be expensive and that attention must be paid to the safety level considered.     

金融危机对拉美国家私营养老金的影响及经验启示

2008年爆发的金融危机对全球经济产生了重要影响,也对拉美国家私营养老金制度的发展产生了巨大冲击。文章介绍了拉美国家私营养老金制度的改革路径和养老基金概况,从养老金资产价值、投资收益率、投资组合、雇员、制度覆盖面和缴费密度方面切入,分析了金融危机对拉美私营养老金制度的影响。在现状分析的基础上,得出了要保障私营养老金制度可持续运行的一些经验启示:构建多元化的混合型养老金体系,增强退休和养老金支付的灵活性,积极运用生命周期投资策略,实施多元化和分散化投资,以养老金长期收益作为投资目标,建立社会风险应急储备基金和政府担保机制,以及加强员工退休教育。     

Institutional Traders' Behavior in an Emerging Stock Market: Empirical Evidence on Polish Pension Fund Investors

Abstract:   In this paper, we contribute to the literature on institutional herding and feedback trading by analysing the investment behavior of pension funds on the Polish stock market. Pension funds entered into the stock market due to the national pension system reform in 1999, providing a unique opportunity to receive deeper insight into the behavior of institutional investors in an emerging capital market. Our results show that Polish pension fund investors are to a greater extent involved in herd‐like behavior and pursue feedback trading strategies more often than their counterparts in mature markets. This finding is primarily attributed to a stringent investment regulation and high market concentration. We do not detect, however, that trading by the pension funds exerts significant influence on the future stock prices.     

Life-cycle funds: Much Ado about Nothing?

The core idea of life-cycle funds or target-date funds is to decrease the fund's equity exposure and conversely increase its bond exposure towards the fund's target date. Such funds have been gaining significant market share and were recently set as default choice of asset allocation in numerous defined contribution schemes or related old-age provision products in several countries. Hence, an assessment of life-cycle funds’ risk-return profiles – that is, the probability distribution of returns – is essential for sustainable financial planning of a large group of investors. This paper studies the risk-return profile of life-cycle funds in particular compared to simple balanced or lifestyle funds that apply a constant equity portion throughout the fund's term instead. In a Black–Scholes model, we derive balanced funds that reproduce the risk-return profile of an arbitrary life-cycle fund for single and regular contributions. We then analyze the accuracy of our results under more complex asset models with stochastic interest rates, stochastic equity volatility and jumps. We further show that frequently used ‘rule of thumb approximations’ that only take into account the life-cycle fund's average equity portion are not suitable to approximate a life-cycle fund's risk-return profile. Our results on the one hand facilitate sustainable financial planning and on the other hand challenge the very existence of life-cycle funds since appropriately calibrated balanced funds can offer a similar (often dominating) risk-return profile.     

Optimal Control of DC Pension Plan Management under Two Incentive Schemes

Since the late 1990s, a performance fee arrangement has been approved as a managerial incentive in direction contribution (DC) pension plan management to motivate managers. However, the fact that managers may take undue risk for the larger performance fees and thus reduce members’ utility has been a subject of debate. As such, this study investigates the optimal risk-taking policies of DC pension fund managers under both the single management fee scheme and a mixed scheme with a lower management fee, as well as an additional performance fee. The analytical solutions are derived by using the duality method and concavification techniques in a singular optimization problem. The results show the complex risk-taking structures of fund managers and recognize the win-win situation of implementing performance-based incentives in DC pension plan management. Under the setting of geometric Brownian motion asset price dynamics and constant relative risk aversion utility, the optimal risk investment proportion shows a peak-valley pattern under the mixed scheme. Further, the manager gambles for gain when fund wealth is low and time to maturity is short. As opposed to the existing literature, this study found that the risk-taking policy is more conservative when fund wealth is relatively large. Furthermore, the utilities of the manager and members could both be improved by appropriately choosing the performance fee rate.     

Pension Fund Manager Tournaments and Attitudes Towards Corporate Characteristics

Abstract:  This paper explores the relationship between the tournament incentives of pension fund managers and the characteristics of equities they choose to hold. Using a comprehensive data set on pension fund portfolio holdings, we determine the intensity of fund manager tournaments by sorting pension funds into portfolios based on the number of concurrent managers each pension fund employs. We then investigate which corporate characteristics are preferred by each of these portfolios by estimating share selection models that include a range of corporate characteristics that are expected to shape the returns to investment in stocks over the short and long run. We find that the intensity of the tournament faced by fund managers plays a significant role in shaping preferences over corporate characteristics. Managers facing more intense tournaments exhibit significantly weaker preferences for attributes associated with long run payoffs, such as social performance and growth potential, and significantly stronger preferences for short term attributes, such as operational efficiency, when compared to managers that face weak or no tournament incentives.     

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.     

The relationship between pension funds and the stock market: Does the aging population of Europe affect it?

In recent decades, pension fund investment has increased rapidly because of population aging and growing doubts about the viability of western public pension systems. As a result, pension funds have become dominant in stock markets. This paper examines the influence of the pension fund assets invested in equities on stock market development and the market efficiency of 13 European countries, from 1999 to 2014. Our results vary by country, by pension model and among the one-model countries. Nevertheless, revealing a concern about saving for retirement. Finally, our efficiency analysis reveals that the influence of pension funds varies over time and across markets, due to arbitrage opportunities that provoke adaptive managerial strategies.     

基金业绩如何影响风格漂移和经理离职?——理论与经验分析

本文通过一个两期模型,刻画了基金业绩如何通过影响市场信念,进而影响基金风格漂移和基金公司的解雇行为。若上期基金业绩很好,基金经理就会在乐观的自我能力预期下,完全按照自己的判断选择基金投资风格;若上期业绩一般,基金经理会因为调整成本而不太愿意切换投资风格;而若上期业绩很差导致自我能力预期悲观,基金经理就宁愿模仿上期绩优基金的投资风格。综合起来,基金风格漂移将随上期基金业绩呈现出显著的U型关系。进一步,因为业绩很差的基金经理会采取模仿策略,因此在市场风格发生切换时更有可能发生基金经理解雇事件。此外,本文基于中国开放式基金的季度数据,检验了风格漂移与滞后一期基金业绩之间的关系,经验证据稳健地支持了理论分析的各种结论。     

Pension Fund Design under Long-term Fairness Constraints

We consider optimal portfolio insurance for a mutually owned with-profits pension fund. First, intergenerational fairness is imposed by requiring that the pension fund is driven towards a steady state. Subject to this condition the optimal asset allocation is identified among the class of constant proportion portfolio insurance strategies by maximising expected power utility of the benefit. For a simple contract approximate analytical results are available and accurate, whereas for a more involved contract Monte Carlo methods must be applied to pick out the best design. The main insights are (i) aggressive investment strategies are disastrous for the clients; (ii) in most cases it is optimal to gear the bonus reserve; and (iii) the results are far less sensitive to the agent's risk aversion than in the classical case of Merton (1969), and as opposed to Merton horizon matters even with constant investment opportunities (because of the serial dependence between bonuses).     

Behavioral currency hedging for international portfolios

The purpose of this paper is to incorporate behavioral issues as it relates to the active currency hedging of international portfolios in the context of traditional expected utility maximization approach. The uniqueness of the approach is that separate risk aversion parameters are introduced for asset and currency markets. The paper is similar in spirit to Black (Black, F. 1989, Universal hedging, Financial Analysts Journal (July-August), 16-22.), who argued that a portion of foreign equity investments should be permanently unhedged, which is basically postulating that one should take a buy-and-hold position in currency with a fraction of the capital. The behavioral twist included in the traditional expected utility maximization approach results in lower hedge ratios, ceteris paribus, partly due to the asymmetric nature of the compensation structure of currency managers.Since the asymmetric nature of incentive schemes of asset and currency managers dictates how one optimizes the investment portfolio of a pension or endowment fund, the unusual behavior of a given institutional fund manager should not be called “irrational,” only because the optimal currency hedging level deviates from the one derived under rational expectations. This only justifies the use of different hedging strategies by various institutional investors. We describe in detail how the level of hedging should be revised downwards because of behavioral factors. Conclusions are in the context of what people would predict to see in the market, if certain investors behave in an “irrational” way.     

A global approach to mutual funds market timing ability

In this paper, we globally investigate market timing abilities of mutual fund managers from the three perspectives: market return, market-wide volatility and aggregate liquidity. We propose a new specification to study market timing. Instead of considering an average market exposure for mutual funds, we allow mutual fund market betas to follow a random walk in the absence of market timing ability. As a consequence, we capture market exposure dynamics which is really due to manager market timing skills while allowing dynamics to come from other sources than market timing. We find that on average 6% of mutual funds display return market timing abilities while this percentage amounts to respectively 13% and 14% for volatility and liquidity market timing. We also analyze market timing by investment strategies and for surviving and dead funds. Dead funds exhibit lower volatility and liquidity timing skills than live funds.     

On the Interaction between Transfer Restrictions and Crediting Strategies in Guaranteed Funds

Guaranteed funds with crediting rates for fixed periods determined by a pension provider or insurance company are common features of accumulation annuity contracts. Policyholders can transfer money back and forth between these accounts and money market accounts that give them features similar to demand deposits, and yet they frequently credit a higher rate than the money market. Transfer restrictions are commonly employed to prevent arbitrage. In this article, we model the interaction between company and policyholder as a multiperiod game in which the company maximizes risk-neutral expected present value of profits and the policyholder maximizes his expected discounted utility. We find that the optimal strategy on the part of the company is to credit a rate higher than the money market rate in the first period to entice the policyholder to invest in the guaranteed fund. The company then credits the floor in the remaining periods as the policyholder transfers out the maximum amount. This does better for the policyholder in low interest rate environments and worse in high interest rate environments and acts as a type of “interest rate insurance” for the policyholder.     

基金业绩如何影响风格漂移和经理离职?——理论与经验分析

本文通过一个两期模型,刻画了基金业绩如何通过影响市场信念,进而影响基金风格漂移和基金公司的解雇行为。若上期基金业绩很好,基金经理就会在乐观的自我能力预期下,完全按照自己的判断选择基金投资风格;若上期业绩一般,基金经理会因为调整成本而不太愿意切换投资风格;而若上期业绩很差导致自我能力预期悲观,基金经理就宁愿模仿上期绩优基金的投资风格。综合起来,基金风格漂移将随上期基金业绩呈现出显著的U型关系。进一步,因为业绩很差的基金经理会采取模仿策略,因此在市场风格发生切换时更有可能发生基金经理解雇事件。此外,本文基于中国开放式基金的季度数据,检验了风格漂移与滞后一期基金业绩之间的关系,经验证据稳健地支持了理论分析的各种结论。     

Investor sophistication and risk taking

Using investment policy data of 857 Dutch pension funds during 1999–2006, we develop three indicators of investor sophistication. The indicators show that pension funds’ strategic portfolio choices are often based on coarse and less sophisticated approaches. First, most pension funds round strategic asset allocations to the nearest multiple of 5%, similar to age heaping in demographic and historical studies. Second, many pension funds invest little or nothing in alternative, more complex asset classes, resulting in limited asset diversification. Third, many pension funds favor regional investments and as such do not fully employ the opportunities of international risk diversification. Our indicators are correlated with pension fund size, in line with the expectation that smaller pension funds are generally less sophisticated than large pension funds. Using the indicators for investor sophistication, we show that less sophisticated pension funds tend to opt for investment strategies with less risk.     

Pension funds with a minimum guarantee: a stochastic control approach

In this paper we propose and study a continuous-time stochastic model of optimal allocation for a defined contribution pension fund with a minimum guarantee. We adopt the point of view of a fund manager maximizing the expected utility from the fund wealth over an infinite horizon. In our model the dynamics of wealth takes directly into account the flows of contributions and benefits, and the level of wealth is constrained to stay above a “solvency level.” The fund manager can invest in a riskless asset and in a risky asset, but borrowing and short selling are prohibited. We concentrate the analysis on the effect of the solvency constraint, analyzing in particular what happens when the fund wealth reaches the allowed minimum value represented by the solvency level.