From Defined-Contribution Towards Target-Income Retirement Systems

58 Pages Posted: 22 May 2020

See all articles by Daniel Mantilla-Garcia

Daniel Mantilla-Garcia

Universidad de Los Andes - School of Management; EDHEC Risk Institute

Miguel Martinez-Carrasco

Universidad de los Andes, Colombia - School of Management

Manuel Enrique Garcia Huitron

Inter-American Development Bank (IDB)

Arun Muralidhar

AlphaEngine Global Investment Solutions; George Washington University

Date Written: April 17, 2020

Abstract

The current trend towards Defined Contribution (DC) retirement systems around the world has rendered the risk management of pension funds crucial for the financial health of millions of people. Severe market downturns have put in evidence the need for more effective practices to control losses of retirement income for pension funds' investors. Although the move from the static allocation of policy portfolios toward target-date funds (TDFs) encouraged by regulators features significant improvements, the latter strategies completely ignore the variations in the cost of financing future consumption, which lessens the strategies' ability to control losses in retirement income. While optimal long-term portfolio selection literature emphasizes the importance of hedging against changes in the discount rates that determine the cost of financing future consumption, TDFs strategies, regulatory incentives, and reporting to pension funds' investors disregard the variations in long-term discount rates by focusing in absolute returns. We address these shortcomings by (i) developing performance metrics, such as DC funding-ratios, that foster appropriate incentives for pension fund managers and more sensible and simple reporting to their investors, (ii) introducing a series of asset allocation rules designed to secure a minimum level of target-income in retirement regardless of the returns of the risky assets in the portfolio. The strategies are consistent with insights from long-term portfolio theory and have the critical advantage of being free of any model or parameter estimation risks. We illustrate its advantages relative to a standard TDF strategy in terms of retirement security.

Keywords: Asset Allocation, Pension Fund Regulation, Portfolio Insurance, Risk Management

JEL Classification: G11, G18, J26

Suggested Citation

Mantilla-Garcia, Daniel and Martinez-Carrasco, Miguel and Garcia Huitron, Manuel Enrique and Muralidhar, Arun, From Defined-Contribution Towards Target-Income Retirement Systems (April 17, 2020). Available at SSRN: https://ssrn.com/abstract=3585154 or http://dx.doi.org/10.2139/ssrn.3585154

Daniel Mantilla-Garcia (Contact Author)

Universidad de Los Andes - School of Management ( email )

Bogota, Bogota D.C.
Colombia

EDHEC Risk Institute ( email )

Lille
France

Miguel Martinez-Carrasco

Universidad de los Andes, Colombia - School of Management ( email )

Carrera Primera # 18A-12
Bogotá
Colombia

Manuel Enrique Garcia Huitron

Inter-American Development Bank (IDB) ( email )

1300 New York Avenue NW
Washington, DC 20577
United States

Arun Muralidhar

AlphaEngine Global Investment Solutions ( email )

Great Falls, VA
United States

HOME PAGE: http://www.mcubeit.com

George Washington University ( email )

2121 I Street NW
Washington, DC 20052
United States

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