Mengyi Xu, Michael Sherris and Adam W. Shao
The transition from defined benefit to defined contribution (DC) pension schemes has increased the interest in target annuitization funds that aim to fund a minimum level of retirement income. Prior literature has studied the optimal investment strategies for DC funds that provide minimum guarantees, but far less attention has been given to portfolio insurance strategies, especially for target annuitization funds. We evaluate the performance of option-based and constant proportion portfolio insurance strategies for a DC fund that targets a minimum level of inflation-protected annuity income at retirement. We show how the portfolio allocation to an equity fund varies depending on the member’s age upon joining the fund, displaying a downward trend through time for members joining the fund before ages in the mid-30s. We demonstrate how both portfolio insurance strategies provide strong protection against downside equity risk in financing a minimum level of retirement income. The option-based strategy often leads to higher accumulated savings at retirement and is also shown to provide a more robust level of protection when equity markets are more volatile and when contributions to the pension fund are lower.
Keywords: portfolio insurance strategies, defined contribution, pension risk management, target annuitization fund