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Outcome orientated investing for retirementFrom the DC scheme member’s perspective
For European professional investors only
2
Contents Page
Executive summary 4
1 Introduction 6
2 Literature review 10
3 A brief history of lifestyling 13
4 The future of lifestyling 19
4.1 Static lifestyle with full annuitisation at age 65 21
4.2 Static lifestyle with gradual annuitisation between ages 65 and 75 25
4.3 Dynamic asset allocation strategies 27
4.4 Liability driven asset allocation and ‘loss aversion’ 29
References 34
3
We believe there is a need for more innovative alternatives to the lifestyling approaches
that are typically employed in defined contribution (DC) pension schemes.
As we explored everything that has worked well, and not so well, with the traditional
lifestyling approaches, and considered the evolving role of target-date funds, we
questioned the application and ‘fitness for purpose’ of various existing solutions.
With this in mind, we sought the involvement and academic input of Cass Business School
to evaluate alternative approaches which might also consider the desired outcomes for
DC scheme members.
The past and present solutions treat people of a like age and/or number of years before
they retire as if they have the same income objectives in retirement. Moreover, and
most importantly, this approach fails to consider how close individuals are to achieving
their target retirement incomes. What this means in practice is that, in most existing
DC arrangements, two people of the same age, with entirely different retirement income
objectives, with one ‘on target’ and the other significantly ‘under target’, will have
identical asset allocation profiles. This is clearly wrong.
Much is made of the fact that DC is different from defined benefit (DB), and rightly so. DB
schemes treat members’ assets as a single pool with corresponding liabilities, whereas
DC schemes have historically focused solely on scheme members’ assets, with little
consideration to their needs in retirement. In view of this, we wanted to investigate the
extent to which aspects of the way in which DB schemes view and treat assets in the
context of liabilities could be applied to DC schemes.
Pension managers, trustees and their advisors will, we hope, find this paper to be both
interesting and challenging. We propose some highly original theories and approaches,
to which the asset management industry should now respond with workable products,
solutions and technology. We believe that these approaches would require the industry
to rethink how it engages with scheme members, and challenge assumptions on the key
inputs for future product developments.
David CalfoGroup head of DC strategy
BNY Mellon
Outcome orientated investing for retirementFrom the DC scheme member’s perspective
4
Few now dispute that the future of
pension provision, not just in the UK
but in other developed countries too,
seems to be the DC model1. In moving,
albeit gradually, from a DB to a DC world,
the burden of risk is also shifting from
employers and their shareholders, to
individuals.
However, unlike under DB arrangements,
under DC provision employers will not
be obliged to make up any pension
shortfalls, meaning that this risk is borne
by the member. Given this significant
shift to a scenario in which scheme
members must bear the risk that their
retirement income will not be at the
desired level, it is right to ask whether
the investment approach taken to DC
pension provision is appropriate.
The key findings from this paper include:
• ‘Traditional’ DC lifestyling approaches
are producing ever-lower eventual
pensions.
• This paper proposes a ‘dynamic’
investment strategy that is outcome-
driven (targeting the generation of an
income in retirement that will offer
a minimum acceptable replacement
ratio relative to the income earned
during employment), recognises
investors’ attitudes to risk and takes a
flexible approach to the decumulation
phase.
• We show that a more dynamic
investment and annuitisation strategy
produces a less uncertain outcome
with regard to the final DC-related
retirement income replacement ratio,
thereby helping greatly to reduce the
risk of future DC pension shortfalls.
Executive summary
1 Indeed, the National Employment Savings Trust (NEST), which is due to launch next year and which has been designed to provide pensions for potentially millions of low paid UK workers, has a DC structure, and within a few years is likely to become one of the largest DC pension schemes in the world.
5
The vast majority of DC members invest
their precious pension pots in the default
fund provided by the scheme. Given
that saving for a pension is a long-term
investment commitment for most people,
most (if not all) DC funds are heavily
weighted to equities, on the assumption
that, in the long-run, equities will out-
perform all other asset classes.
A second feature of a traditional default
DC investment strategy, is the lifestyling
that takes place, usually over the 10
years leading up to retirement and full
annuitisation, when investors’ pots
are automatically and mechanistically
switched out of equities and into
government bonds, with little reference
to the risk preferences of the member,
to the size of the investment fund
accumulated over this period, or, indeed,
to financial market developments.
In this paper we address some of
the shortcomings of the current DC
framework. In keeping with other studies
our empirical work shows the typical
approach to de-risking, or to lifestyling,
and how this mechanical strategy
has produced ever-lower eventual
pensions for a typical DC member over
the past 20 years. With annuity rates
at such depressed levels currently, it is
imperative that investment strategy is
more enlightened.
To examine these substantial investment
challenges we develop a model that
incorporates three important elements.
First, the asset allocation strategy is
dynamic and, crucially, it is driven
by the target replacement rate of the
representative DC member. The strategy
is not to generate the largest DC pot
possible, but, instead, to minimise the
likelihood of not achieving the target
replacement ratio.
The second feature of the model is that
we do not impose a constraint that forces
DC members to annuitise at the normal
retirement age – although we do impose
the constraint that they should be fully
annuitised by age 75. A crucial feature
of any dynamic DC investment strategy
should be the ability to bring forward or
delay the annuitisation process, or to
annuitise partially over time.
Finally, we adopt the framework
first proposed by Blake, Wright and
Zhang (2011) and suggest that the risk
preferences of each DC member should
be recognised and in particular the
notion that most individuals are actually
‘loss averse’, meaning that they are
generally more distressed about a loss
of a given amount, than they are happy
about a gain of the same amount.
Using this framework, it can be seen
that when compared with the traditional
approach to DC investment strategy,
the dynamic, outcome-oriented strategy
increases the probability of achieving
the desired pension significantly, while
greatly reducing the probability of
the replacement ratio falling below a
minimum ‘acceptable’ level.
In keeping with other studies our empirical work shows the typical approach to de-risking, or to lifestyling, and how this mechanical strategy has produced ever-lower eventual pensions for a typical DC member over the past 20 years.
6
IntroductionSection 1
The UK’s private sector pension
landscape has been dominated for many
years by the DB model. Until the early
part of this century, the amount of risk
that DB plan sponsors were assuming
was not widely appreciated. However, a
prolonged bear market in equities has
had a significant impact upon DB asset
portfolios over the past decade or so.
But DB balance sheets have also come
under pressure from continuing (and
recognised) improvements in longevity
and the move to marked-to-market
accounting practices at a time when the
discount rate used to market DB liabilities
to market, have fallen substantially.
Upwardly revised estimates of longevity
and low discount rates have together
pushed up the present value of DB
scheme liabilities. The net result of these
pressures is widespread DB deficits.
This widening of deficits put a sharp
focus on the scheme sponsor – arguably
the most valuable asset that a DB scheme
has2. Since the early part of this century,
DB plan sponsors have been trying to
plug the gap left behind by the weak
performance of high-risk asset classes
and the growth in the present value of
scheme liabilities. The burden has been,
and remains, quite considerable.
According to the Office for National
Statistics (ONS)3, the average contribution
made by employers on behalf of their DB
members was 16.6% of salary at the end
of 2008. It is, therefore, not uncommon
for some scheme sponsors to contribute
the equivalent of over 20% of a member’s
annual salary bill to his or her DB pension
fund. Some pay considerably more.
2 See for example Brigden et al (2008 and 2009)3 Pension Trends 2009, ONS
7
As DB trustees looked to their scheme
sponsors, finance directors, backed
by their boards, sought to reduce their
exposure to this risk. Consequently,
today, 79% of DB sponsors do not allow
new employees to join their DB scheme.
Many of these schemes have also
reduced the benefits that can be earned
by the remaining scheme members.
However, some scheme sponsors have
gone further still. 17% of DB schemes are
not only closed to new members, but are
also closed to ‘future accrual’. This means
that even active members cannot earn
any further pension benefits.4 Although
DB pension provision is no longer the
future, the liabilities are so long dated
that the ‘DB pension problem’ will be
with us for a very long time yet. To coin a
phrase, over the past few years we have
almost certainly witnessed the beginning
of the end of DB pension schemes.
So what about the future?Increasingly, new employees are not
permitted to enter existing DB plans;
instead they are offered an alternative
DC arrangement. For those schemes
that have closed to future accrual, their
existing members retain their pension
benefits accrued in the past under the DB
arrangements, but their future pension
accrual is offered on a DC basis. The
eventual pensions of these members will
therefore comprise a mixture of DB and
DC pension rights.
As the world’s third largest pensions
market by assets – accounting for
8.6% of global pension assets,5 the
UK occupational pension industry is
huge. Indeed, total UK pension assets
(excluding those in personal and
stakeholder pensions) are estimated
to be US$2,279 billion (£1,381 billion),
equivalent to 101% of UK GDP, or national
output. According to the ONS, at the end
of 2008, 9 million people were active
members of either an occupational DB
or DC scheme, comprising 3.6 million in
the private sector and 5.4 million in the
public sector.6 Furthermore, the ONS
estimated that 8.8 million people in
the UK were receiving a DB and/or DC
occupational pension.
According to the ONS, at the end of 2008, 9 million people were active members of either an occupational DB or DC scheme, comprising 3.6 million in the private sector and 5.4 million in the public sector. Furthermore, the ONS estimated that 8.8 million people in the UK were receiving a DB and/or DC occupational pension.
4 Source of statistics: NAPF, March 20115 Only the US and Japan are bigger, accounting for 57.8% and 13.1% of global pension assets respectively. Towers Watson Global Pension Asset Study 20116 Remember that many public sector pension plans are run in the same way as private sector DB plans
8
The membership split between DB and
DC plans is difficult to estimate, and
indeed, as we explained earlier, many
employees may be members of both a
DB and a DC scheme. However, in a more
recent report by the Pensions Regulator 7,
it was estimated that:
• 2.3millionpeoplecurrentlycontribute
to a private sector DB pension scheme
(compared to 5.5 million in the early
1980s);
• 1 million active members currently
contribute to DC schemes;
• 2.5millionpeopleintotalhavesavings
in DC schemes;
• annual contributions to schemes
with 12 or more members amount to
approximately £2.2 billion, or £4,200
per active member, where 75% of these
contributions come from the employer;
and
• around half of all DC membership is
concentrated in 130 large schemes,
while most DC schemes (around
44,000) are very small, with less than
12 members, accounting for just 5% of
total DC membership.
In this paper we focus on DC pension
provision. In Section 2, we briefly
review the relevant academic literature
on this topic and identify some of the
key parameters and issues. The basic
conclusion of the recent literature is
that a more dynamic approach to DC
asset allocation is required. However,
the majority of DC members invest in
default funds that have historically been
heavily weighted towards equities, and
are then usually shifted mechanically
from equities into government bonds
over the 10-year period leading up to
their chosen retirement date, such that
they are fully invested in government
bonds when they annuitise their pension
pot. The approach typically taken to DC
asset allocation then is very static – and
is therefore unlikely to be optimal for all,
or for even any single individual.
In Section 3, we take a look at the
history of lifestyling, that is, the all-
important few years prior to retirement
and full annuitisation, which gradually
moves DC members from high- to low-
risk asset classes in a mechanical and
deterministic fashion. We believe that
our results in this section are the first full
examination of the performance of this
de-risking process.
7 The Pensions Regulator, DC Trust 2010
9
One of the key parameters of our model with regard to the asset allocation decision is the target replacement ratio, that is, the representative DC member in the scheme adopts a strategy towards achieving a certain level of pension relative to his or her final salary. That investment decision is driven largely by the extent to which the individual is likely to meet this target or not.
In Section 4, we develop and describe
a theoretical, whole-of-life model of DC
accumulation and decumulation for a
representative DC member. One of the
key parameters of our model with regard
to the asset allocation decision is the
target replacement ratio, that is, the
representative DC member in the scheme
adopts a strategy towards achieving
a certain level of pension relative to
his or her final salary. That investment
decision is driven largely by the extent
to which the individual is likely to meet
this target or not. It is in this sense
then that the DC member in our model
adopts a Liability Driven Investment (LDI)
strategy, a strategy that has become
very common for DB schemes in recent
years. Our LDI-based model allows us to
explore a number of important issues.
First, it allows us to consider whether it
is optimal to annuitise at a single point in
time. Would it instead be more beneficial
for DC members to annuitise partially
as they approach, and then pass, the
normal retirement age?
Secondly, we explore the possible
benefits of adopting a more dynamic
approach to asset allocation in both the
pre- and post-retirement periods. We
look at both momentum and contrarian-
based investment strategy, where the
DC member chooses between a risky
and risk-free asset class. Finally, we
consider DC member attitudes to risk
and, in so doing, introduce some of the
latest academic research in this area
that emanates from behavioural finance
literature.
10
Literature reviewSection 2
A number of authors have investigated
the performance of DC pension provision
in the past from a historical perspective.
The focus has generally been on the
‘replacement rate’, which is defined
as the annual pension divided by the
individual’s final salary. Using US
data from 1872 and assuming that an
individual’s fund was invested 100% in
US equities, Burtless (2009a and 2009b)
found that the highest replacement rate
was 89% in 1999, while the lowest was
12% in 1920. In a related study using
UK data from 1948 to 2007, Cannon and
Tonks (2009) found that the size of the
average DC fund relative to final salary
was 17.9 times, although the average for
the lowest decile of outcomes was 7.3
times – again indicating a wide range of
possible outcomes. This result and others
have shown how variable the resulting
DC pension can be when the fund is left
essentially unmanaged (with 100% of
the assets being invested, for example,
in equities, with no discretionary
management techniques being applied).
Other studies have investigated the
importance of the asset allocation
decisions taken by DC members. Blake
et al (2001) showed that the major
determinant of final DC pensions was
asset allocation, rather than stock
selection. However, all the evidence
shows that members typically show very
little interest in the asset allocation of
their fund – perhaps not surprisingly
given that most are not investment
experts. This is why the asset allocation
of the default fund is so important.
11
Levy (2009) reported that, in 2008,
96% of UK DC members used their
default fund, and yet these funds are
typically heavily tilted towards equities.
This is generally corrected in the last
10 years before the member’s chosen
retirement, with a default, mechanical
lifestyling asset allocation process. This
process involves the gradual reduction
of members’ equity allocation and
gradual proportionate increase in their
investment in government bonds. This
mechanical process is designed so that,
by the end of a typical 10-year lifestyling
period, they are entirely invested in
government bonds and ready to purchase
their annuity. But few would now argue
that heavy reliance on equity returns,
followed by a mechanical de-risking
strategy, would be ‘optimal’ for any DC
member.
Given the evidence of how important
asset allocation is to the eventual DC
pension, and the widespread use of
default funds and their associated
mechanical approach to de-risking, a
consensus has been building for some
time, in the academic literature and
within the pensions industry, that a more
dynamic approach to investment, and, in
particular, to asset allocation, is needed.
In a recent paper Basu et al (2010)
argue for a more dynamic investment
strategy. However, not one based upon
the number of years until retirement, or
even on the fund value at each point in
time, but instead upon a target, or hurdle
rate of return on the DC fund. Through
simulations they show that a dynamic
strategy with an investment hurdle rate
of 10% out-performed what they refer
to as the ‘Rip Van Winkle’, traditional
approach to asset allocation, particularly
over the 10 years prior to retirement.
The rule that they propose for the final
accumulation years involves investing
60% of assets in equities and 40% in
bonds each year whenever the target
return has been met or achieved. In
years where it has not been met, the
fund is allocated 100% to equities. This
rule therefore relies heavily on the idea
that equity prices tend to trend up over
time. It also requires a sensible hurdle
rate of return. Setting a hurdle rate that
is too high could result in an investment
portfolio that is always invested in
equities; setting it too low could result
in a fixed 60/40 equity bond allocation.
But there is another issue with this
rule, which the authors acknowledge,
which is that it does not pay sufficient
attention to individual attitudes to risk.
For example, suppose with three years to
retirement, that the investment fund had
under-performed its hurdle rate, the rule
would switch or keep the entire DC pot
invested in equities. It seems unlikely
that any individual so close to retirement
would be comfortable with 100% of his
or her funds invested in equities at any
time, let alone at a time when they had
been performing poorly and had possibly
generated substantial losses. Equally, no
responsible adviser would recommend
such a strategy either.
Given the evidence of how important asset allocation is to the eventual DC pension, and the widespread use of default funds and their associated mechanical approach to de-risking, a consensus has been building for some time in that a more dynamic approach to investment, and, in particular, to asset allocation, is needed.
12
Blake, Wright and Zhang (2011) address
this issue of risk aversion in their model
of DC investment accumulation and
integrate it with a dynamic investment
strategy. In particular, they integrate
one of the main findings from the
behavioural finance literature, which is
that individuals (investors) tend to be
loss averse. This means that they are
more upset about a loss of £20, than
they are happy about a gain of £20. In
other words, they do not view gains and
losses in a symmetric manner; it is in this
sense that we say individuals are ‘loss
averse’. By integrating loss aversion into
a dynamic DC asset allocation strategy
the authors arrive at some very intuitive
results.
First, in agreement with Basu et al,
they confirm that a dynamic strategy
is preferable to a static, Rip Van Winkle
strategy. They also show that it is optimal
to increase weightings in equities when
the fund is either significantly below the
target (with the aim of making good the
deficit) or significantly above the target
(as the resulting cushion allows for more
risk to be accepted). However, when the
fund is close to the target, it is optimal to
reduce significantly the equity weighting
to minimise the risk of falling below
the target in future years. The degree of
adjustment is shown to be dependent
upon the degree to which individuals
are loss averse. Overall, they conclude
that when compared to the Rip Van
Winkle approach – which is the common
approach taken to asset allocation by
many DC members today – a dynamic,
target-driven approach to investment,
with the assumption of loss aversion,
produces a much greater degree of
certainty in retirement planning.
Blake, Wright and Zhang (2011) address this issue of risk aversion in their model of DC investment accumulation and integrate it with a dynamic investment strategy. In particular, they integrate one of the main findings from the behavioural finance literature, which is that individuals (investors) tend to be loss averse.
13
A brief history of lifestylingSection 3
In a DC scheme, regular contributions
by the member, and usually also their
employer, gradually build up over time.
Each DC member effectively builds
up his or her own fund over time. The
contributions attributable to each DC
member are invested, so that the size
of the eventual fund will be determined
by the size of regular contributions over
time, and the rate of return achieved
on the invested funds. At retirement,
the entire value of a member’s fund is
usually used to purchase an annuity,
that is, a regular income that is paid until
death. Clearly, other things being equal,
the larger the fund at this time, the larger
the pension will be.
When a DC member is relatively young,
his or her fund will usually be invested
predominantly in high-risk, growth
asset classes, normally equities. This
is because these asset classes are
normally expected to produce a higher
return on average over time. However,
equity markets can be very volatile. For
example, in October 1987 the UK equity
market fell by 27% and by a further 10%
during November 1987. Imagine having
one’s entire DC fund invested in equities
in October 1987 immediately prior to
one’s intended retirement. The resulting
collapse in the value of the fund would
have led to a commensurate decline
in the value of the pension. It’s for this
reason that DC plans (and many personal
pension plans) have a lifestyling option,
that is, a mechanistic asset allocation
process that starts to move the member’s
funds out of equities and progressively
into gilts, until the plan is 100% invested
in gilts just prior to the member’s chosen
retirement date.
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Max
imum
ann
ual d
raw
dow
n
Year lifestyling begins
£0
£5,000
£10,000
£15,000
£20,000
£25,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Gro
ss a
nnua
l sal
ary
Year lifestyling begins
Starting salary
Final salary
£0
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
£35,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Sta
rtin
g va
lue
of D
C fu
nd
Year lifestyling begins
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Annu
ity
rate
s
Year lifestyling begins
RPI-linked payment Level payment
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Pens
ion
as a
pro
port
ion
of fi
nal s
alar
y
Year lifestyling begins
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot
Year lifestyling begins
0.0
2.0
4.0
6.0
8.0
10.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot a
s pr
opor
tion
of s
alar
y
Year lifestyling begins
0%
5%
10%
15%
20%
25%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Aver
age
annu
al re
turn
Year lifestyling begins
Pension/Final salary (Level)
Pension/Final salary (RPI)
Necessary DC pot at 55
Necessary DC pot at 55 as % of salary at 55
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Max
imum
ann
ual d
raw
dow
n
Year lifestyling begins
£0
£5,000
£10,000
£15,000
£20,000
£25,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Gro
ss a
nnua
l sal
ary
Year lifestyling begins
Starting salary
Final salary
£0
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
£35,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Sta
rtin
g va
lue
of D
C fu
nd
Year lifestyling begins
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Annu
ity
rate
s
Year lifestyling begins
RPI-linked payment Level payment
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Pens
ion
as a
pro
port
ion
of fi
nal s
alar
y
Year lifestyling begins
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot
Year lifestyling begins
0.0
2.0
4.0
6.0
8.0
10.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot a
s pr
opor
tion
of s
alar
y
Year lifestyling begins
0%
5%
10%
15%
20%
25%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Aver
age
annu
al re
turn
Year lifestyling begins
Pension/Final salary (Level)
Pension/Final salary (RPI)
Necessary DC pot at 55
Necessary DC pot at 55 as % of salary at 55
Panel A: Average annual returns
Source: Centre for Asset Management Research, Cass Business School
Panel B: Maximum annual draw-downs
Figure 1: 10-yearly lifestyling return performance
15
This lifestyling often begins 10 years
before a member’s chosen retirement
date, and assumes that the member
wishes to have his or her DC fund fully
annuitised at this point in time. In this
section of the paper we look at how
this mechanical approach to asset
allocation and eventual annuitisation
has performed historically. What sort of
pension has this static approach to asset
allocation produced for lifestylers?
In Panel A of Figure 1 we present the
average 10-yearly returns that any
investor would have achieved from being
100% invested in UK equities at the
start of each 10-year period, and 100%
invested in gilts at the end of this period.
We assume a ‘straight line’ reallocation
of funds at the end of each year so, for
example, half way through this 10-year
period the investor has a 50% allocation
to equities and a 50% allocation to gilts.
The equity investment is represented
by the total return on the FTSE All-
Share Index, while the return on the gilt
portfolio is based upon the total return
on the IBOXX £ Gilts All Maturities Index.
The figure shows how the nominal returns
achievable from this asset allocation
strategy have declined over time. This, of
course, is largely a function of the equity
bear market that began in the early part
of the noughties. In Panel B we present
the maximum annual drawdown in each
10-year period, that is, the worst annual
return in each 10-year period.
As you can see from Panel A Figure 1,
early on, the worst year still produced a
positive return. Clearly, greater equity
market volatility has been a significant
problem for all DC members that have
adopted this lifestyling approach in
more recent years, as evidenced by the
negative draw-downs for most of this
sample period.
Any DC member, or indeed any investor,
adopting this approach to asset
allocation over each 10-year period
would have achieved these investment
returns. However, the question we wish
to address here is: what pension might
have been bought with the accumulated
DC pot at the end of each 10-year period?
To answer this question we hypothesise
a representative UK DC member, who
adopts the mechanistic lifestyling
approach at the beginning of each 10-
year period from 1980.
At the start of each 10-year period the representative worker:
• is a male aged 55 and has ten years
to go until retirement;
• earnsanaverageannualsalary;
• makes an annual contribution
equivalent to 6% of his annual
salary to the DC default fund, and
has an employer that matches this
contribution; and
• has a DC fund comprising 100%
equities and 0% in UK government
bonds, but by the time he retires his
investment pot comprises 100% UK
government bonds. This is achieved
over the 10 years by selling equal
amounts of his equity holding at the
end of every year, using the proceeds
to increase his holdings of UK
government bonds.
When a DC member is relatively young, his or her fund will usually be invested predominantly in high-risk, growth asset classes, normally equities. This is because these asset classes are normally expected to produce a higher return on average over time. However, equity markets can be very volatile.
16
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Max
imum
ann
ual d
raw
dow
n
Year lifestyling begins
£0
£5,000
£10,000
£15,000
£20,000
£25,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Gro
ss a
nnua
l sal
ary
Year lifestyling begins
Starting salary
Final salary
£0
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
£35,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Sta
rtin
g va
lue
of D
C fu
nd
Year lifestyling begins
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Annu
ity
rate
s
Year lifestyling begins
RPI-linked payment Level payment
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Pens
ion
as a
pro
port
ion
of fi
nal s
alar
y
Year lifestyling begins
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot
Year lifestyling begins
0.0
2.0
4.0
6.0
8.0
10.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot a
s pr
opor
tion
of s
alar
y
Year lifestyling begins
0%
5%
10%
15%
20%
25%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Aver
age
annu
al re
turn
Year lifestyling begins
Pension/Final salary (Level)
Pension/Final salary (RPI)
Necessary DC pot at 55
Necessary DC pot at 55 as % of salary at 55
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Max
imum
ann
ual d
raw
dow
n
Year lifestyling begins
£0
£5,000
£10,000
£15,000
£20,000
£25,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Gro
ss a
nnua
l sal
ary
Year lifestyling begins
Starting salary
Final salary
£0
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
£35,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Sta
rtin
g va
lue
of D
C fu
nd
Year lifestyling begins
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Annu
ity
rate
s
Year lifestyling begins
RPI-linked payment Level payment
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Pens
ion
as a
pro
port
ion
of fi
nal s
alar
y
Year lifestyling begins
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot
Year lifestyling begins
0.0
2.0
4.0
6.0
8.0
10.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot a
s pr
opor
tion
of s
alar
y
Year lifestyling begins
0%
5%
10%
15%
20%
25%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Aver
age
annu
al re
turn
Year lifestyling begins
Pension/Final salary (Level)
Pension/Final salary (RPI)
Necessary DC pot at 55
Necessary DC pot at 55 as % of salary at 55
Panel A: SalaryFigure 2: Representative DC member’s salary and DC pot at age 55
Panel B: DC fund at start of lifestyling
Source: Centre for Asset Management Research, Cass Business School
Panel A of Figure 2 uses historic wage
and salary data collected by the ONS to
show how the representative worker’s
salary has progressed over time. The
two bars in this chart show the value of
the annual (pre-tax) salary at the start
of each 10-year period and at the end,
that is, at the point of retirement and
annuitisation. Panel B of Figure 2 shows
the value of the pension pot accumulated
by the representative DC member at
the start of each 10-year period, which
we set at twice his annual salary at that
point in time. If our representative worker
started making contributions along with
his employer at the age of 40 equivalent
to 12% of his gross salary, and achieved
an average real return of around 5% on
his investment fund up until age 55, the
DC pot would be around twice his annual
salary at age 55. It is for this reason that
we choose this value for the starting
value of the DC pot. We will return to
this issue later, but, for the moment, it’s
important for the calculations to have a
starting value for the DC fund.
Had DC members begun their lifestyling in 1980, and assuming that they did not take any tax-free lump sum from their fund, they would have been able to purchase a level payment annuity equivalent to 73% of their final salary, or an RPI-linked annuity equivalent to 40% of their final salary.
17
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Max
imum
ann
ual d
raw
dow
n
Year lifestyling begins
£0
£5,000
£10,000
£15,000
£20,000
£25,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Gro
ss a
nnua
l sal
ary
Year lifestyling begins
Starting salary
Final salary
£0
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
£35,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Sta
rtin
g va
lue
of D
C fu
nd
Year lifestyling begins
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Annu
ity
rate
s
Year lifestyling begins
RPI-linked payment Level payment
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Pens
ion
as a
pro
port
ion
of fi
nal s
alar
y
Year lifestyling begins
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot
Year lifestyling begins
0.0
2.0
4.0
6.0
8.0
10.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot a
s pr
opor
tion
of s
alar
y
Year lifestyling begins
0%
5%
10%
15%
20%
25%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Aver
age
annu
al re
turn
Year lifestyling begins
Pension/Final salary (Level)
Pension/Final salary (RPI)
Necessary DC pot at 55
Necessary DC pot at 55 as % of salary at 55
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Max
imum
ann
ual d
raw
dow
n
Year lifestyling begins
£0
£5,000
£10,000
£15,000
£20,000
£25,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Gro
ss a
nnua
l sal
ary
Year lifestyling begins
Starting salary
Final salary
£0
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
£35,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Sta
rtin
g va
lue
of D
C fu
nd
Year lifestyling begins
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Annu
ity
rate
s
Year lifestyling begins
RPI-linked payment Level payment
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Pens
ion
as a
pro
port
ion
of fi
nal s
alar
y
Year lifestyling begins
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot
Year lifestyling begins
0.0
2.0
4.0
6.0
8.0
10.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot a
s pr
opor
tion
of s
alar
y
Year lifestyling begins
0%
5%
10%
15%
20%
25%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Aver
age
annu
al re
turn
Year lifestyling begins
Pension/Final salary (Level)
Pension/Final salary (RPI)
Necessary DC pot at 55
Necessary DC pot at 55 as % of salary at 55
Panel A: Historic annuity rates
Panel B: Annual pension for typical DC member
Source: Centre for Asset Management Research, Cass Business School
The last part of the jigsaw puzzle needed
to calculate the annual pension of our
representative DC member is the annuity
rate that prevailed at the end of each 10-
year lifestyling period. Panel A of Figure 3
shows both level and RPI-linked annuity
rates over time for a 65 year-old, non-
smoking man. Annuity rates are closely
related to government bond yields. This
is because annuity providers (mainly
insurance companies) back these
annuities with government bonds, so,
as bond yields have fallen over the past
30 years, so have annuity rates. Panel B
of Figure 3 shows the value of both the
level and inflation-linked pension that
could be bought given all the elements
discussed above, that would be the end-
result of each 10-year lifestyling period.
The results in Panel B are quite
astounding. Had DC members begun
their lifestyling in 1980, and assuming
that they did not take any tax-free lump
sum from their fund, they would have
been able to purchase a level payment
annuity equivalent to 73% of their
final salary, or an RPI-linked annuity
equivalent to 40% of their final salary.
Contrast this with the fortunes of the
equivalent individuals beginning their
lifestyling journey in 2001.
These unfortunate individuals can only
afford a level payment annuity equivalent
to 21% of their final salary, or a RPI-linked
payment equivalent to a measly 12% of
their final salary.
Figure 3: Annuity rates and pensions
18
In Figure 4 we present the results of a
further experiment. The figure shows the
necessary size of the DC pot at the start of
the lifestyling process, that is, at age 55,
that would have been required to produce
a level annual pension equivalent to two-
thirds of the representative DC member’s
salary at 65. Remember that the pension
achieved and shown in Panel B of Figure
3 is based upon an assumption that the
DC pension pot was only twice the size of
the value of the individual’s salary at the
start of the 10-year de-risking process.
The results should not come as too much
of a surprise given the earlier analysis.
In cash terms Panel A of Figure 4 the size
of the required DC pot at 55 has increased
massively. A DC member beginning the
lifestyling, or de-risking process in 1980,
required a DC pot of £5,766 to achieve
a replacement ratio of two-thirds of his
or her final salary; by 2001 this figure
had risen to a staggering £152,986. To
put this into a real context, as shown in
Panel B, in 1980 our representative DC
member would have needed a DC pot
equivalent to just under twice his annual
salary at 55; by 2001 the necessary pot
size would have needed to be just over
nine times his annual salary at 55.
In the next section of this paper we
will explore how the sort of standard
lifestyling strategy described here might
be expected to perform in the future
and to see whether we can design
an alternative approach that may be
more successful in providing a desired
income in retirement. We will do this by
developing a forward-looking model of
DC pension provision and applying this
model to the situation of a representative
individual.
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Max
imum
ann
ual d
raw
dow
n
Year lifestyling begins
£0
£5,000
£10,000
£15,000
£20,000
£25,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Gro
ss a
nnua
l sal
ary
Year lifestyling begins
Starting salary
Final salary
£0
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
£35,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Sta
rtin
g va
lue
of D
C fu
nd
Year lifestyling begins
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Annu
ity
rate
s
Year lifestyling begins
RPI-linked payment Level payment
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Pens
ion
as a
pro
port
ion
of fi
nal s
alar
y
Year lifestyling begins
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot
Year lifestyling begins
0.0
2.0
4.0
6.0
8.0
10.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot a
s pr
opor
tion
of s
alar
y
Year lifestyling begins
0%
5%
10%
15%
20%
25%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Aver
age
annu
al re
turn
Year lifestyling begins
Pension/Final salary (Level)
Pension/Final salary (RPI)
Necessary DC pot at 55
Necessary DC pot at 55 as % of salary at 55
Figure 4: DC pot at age 55 necessary to produce a level annual pension of two-thirds of salary on retirement at age 65
Panel A: DC pot in cash terms
Panel B: DC pot as proportion of salary at age 55
Source: Centre for Asset Management Research, Cass Business School
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Max
imum
ann
ual d
raw
dow
n
Year lifestyling begins
£0
£5,000
£10,000
£15,000
£20,000
£25,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Gro
ss a
nnua
l sal
ary
Year lifestyling begins
Starting salary
Final salary
£0
£5,000
£10,000
£15,000
£20,000
£25,000
£30,000
£35,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Sta
rtin
g va
lue
of D
C fu
nd
Year lifestyling begins
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Annu
ity
rate
s
Year lifestyling begins
RPI-linked payment Level payment
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Pens
ion
as a
pro
port
ion
of fi
nal s
alar
y
Year lifestyling begins
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot
Year lifestyling begins
0.0
2.0
4.0
6.0
8.0
10.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Siz
e of
DC
pot a
s pr
opor
tion
of s
alar
y
Year lifestyling begins
0%
5%
10%
15%
20%
25%
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Aver
age
annu
al re
turn
Year lifestyling begins
Pension/Final salary (Level)
Pension/Final salary (RPI)
Necessary DC pot at 55
Necessary DC pot at 55 as % of salary at 55
19
The future of lifestylingSection 4
We will begin by considering an
individual who is currently aged 25, who
has an annual salary of £20,000 and
who has no previous pension savings. In
order to project this individual’s pension
entitlement in the future we first need a
model for future salary growth.
We will assume that future salary growth
for this individual will consist of two
components:
• general salary inflation of 2% per
annum, representing the real growth in
the economy over time; and
• promotional salary increases, based
on the Office for National Statistics
2005 Annual Survey of Hours and
Earnings.
The assumed future salary pattern is
shown in Figure 5. We can see that
income can be expected to fall slightly in
the years immediately before retirement.
This is a typical age-earnings profile
for an average UK worker. The decline
in age-related pay towards the end of
individuals’ working lives is typically
brought about because they undertake
less overtime, and perhaps do less
demanding work as they approach
retirement.8
Our representative DC member
contributes to his or her DC pension
pot over time. These contributions will
be invested in return-generating asset
classes. For simplicity, we will assume
that the individual invests in just two
asset classes:
• a risk-free asset (for example, an
index-linked government bond), which
provides a guaranteed real return of
2% per annum; and
• ariskyasset(forexample,adiversified
portfolio of equities), which produces
a real average return of 6% per annum
(that is, an equity risk premium of
4% per annum) and with standard
deviation of 20% per annum
Finally, we assume that, on retirement,
annuity prices are calculated using the
risk-free real return of 2% per annum and
a suitable standard mortality table used
by the actuarial profession.9
8 For ‘white-collar’ occupations, it may be appropriate to assume a slightly different pattern of promotional salary growth, although this will not make much difference to the results shown below.9 The mortality table used is PMA92C20, which is based on the experience of male pension annuitants over the period 1991-94 projected to the calendar year 2020. Thus, the annuity price at
retirement is fixed and the model does not explicitly include annuity risk. In practice, the price of annuity will depend on the prevailing interest rate environment at retirement and then current mortality projections (which are likely to be lower than those in use today, leading to higher annuity prices).
Figure 5: Assumed future salary progression of a representative individual with current salary of £20k
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
21
Using these parameters we will begin
by investigating the suitability of a
standard ‘static’ lifestyle investment
strategy for this individual. That is, the
traditional approach to lifestyling and
annuitisation described in Section 3.
As with the experiments in Section 3
with historic data, we assume that the
representative DC member’s investment
fund is 100% invested in equities from
age 25 to age 55 and then the equity
allocation is reduced by 10% each year
(by switching to risk-free government
bonds) to give an equity allocation of
0% on retirement at age 65. We refer
to this strategy as ‘static’ because the
asset allocation at each age is set in
advance and does not vary according to
either current economic conditions or to
the individual’s personal circumstances.
Initially, we assume a contribution
rate of 8% of salary per annum prior to
retirement. This is consistent with the
minimum National Employment Savings
Trust (NEST) contribution.10 We assume
that the accumulated fund is used to
purchase an annuity at age 65 and
we define the ‘replacement ratio’ on
retirement as in the equation below.
When we apply these parameters to the
case of our representative DC member,
simulating the outcome 10,000 times
based on different realisations of the
random return on the risky asset each
year prior to retirement, we find that the
mean replacement ratio is 43%, that is,
on average the accumulated fund at
retirement is sufficient to purchase an
RPI-linked pension income of 43% of
salary immediately prior to retirement.
This is significantly lower than the
‘desired’ replacement ratio of two-thirds
(or 66.7%) that has been traditionally
targeted by members of both DC and
DB pension plans.11 However, when
analysing the effectiveness of a particular
investment strategy, it is more useful to
consider the range of possible outcomes.
The distribution for the replacement ratio
on retirement is shown in Figure 6.
Replacement ratio =Annual income immediately before retirement
10 From 2017 onwards, NEST will be introduced in October 2012 and lower minimum contribution rates will apply initially.11 Some of the most generous DB pension schemes provide a pension of 1/60th of final salary on retirement for each
year of service. With a ‘typical’ working lifetime of 40 years, this led to a pension of 40/60th of final salary being considered by many as standard. While it is true to say that, with the demise of DB schemes as discussed previously, very few individuals currently in employment can expect to achieve a pension on this scale, it can be considered as a desirable goal.
4.1 Static lifestyle with full annuitisation at age 65
Annual income immediately after retirement
12 We include this for comparison purposes as it is increasingly common for individuals to postpone retirement savings until age 40 (or, indeed, even later).
Figure 6: Distribution of replacement ratio on retirement assuming standard lifestyle investment strategy and annual contributions of 8% of salary
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
In the event of very high investment
returns, particularly prior to age 55 (when
the fund is invested entirely in equities),
then a replacement ratio of 120% of
final salary (or more) can be achieved.
However, because equity returns are
very volatile in our experiment, it can
also be seen from Figure 6 that a very
low replacement ratio (perhaps of 20%
or less) is also a distinct possibility.
The default lifestyle strategy then is
not very effective at ensuring that the
income after retirement will be consistent
with the income before retirement.
The probability of achieving or exceeding
the desired replacement ratio of two-
thirds of salary at retirement is only
12%. And, equally as important, there
is a probability of 72% of failing even to
achieve what we might consider to be an
acceptable replacement ratio of 50% of
salary at retirement.
For comparison purposes, we will also consider what happens if:
a the annual contribution rate is reduced
to 6% per annum,
b the annual contribution rate is
increased to 10% per annum, and
c the individual does not begin
contributing until age 40 (rather than
at age 25) and then contributes at 15%
of salary per annum until retirement.12
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
Figure 7: Distribution of replacement ratio on retirement assuming a standard lifestyle investment strategy and annual contributions of 6%, 8%, 10% and 15% of salary
Table 1: Replacement ratio on retirement assuming standard lifestyle investment strategy and annual contributions of 6%, 8%, 10% and 15% of salary
Annual contribution rate
6% of salary 8% of salary 10% of salary 15% of salary from age 25 from age 25 from age 25 from age 40Mean replacement ratio 32% 43% 54% 43%
Probability of replacement ratio > 66.7% 4% 12% 24% 7%
Probability of replacement ratio < 50.0% 88% 72% 55% 73%
Figure 7 shows the distribution of the
replacement ratio on retirement for the
parameters defined in (a), (b) and (c)
above (again, obtained empirically using
10,000 simulations), as well as for the
baseline version of the model shown in
Figure 6.
These results are summarised in
Table 1. Unsurprisingly, contributing a
higher percentage of salary each year
increases the probability of achieving the
desired replacement ratio of two-thirds
of salary at retirement (from 12% with
a contribution rate of 8% per annum,
to 24% with a contribution rate of 10%
per annum) and reduces the probability
of failing to achieve an acceptable
minimum replacement ratio of 50% of
salary at retirement (from 72% with a
contribution rate of 8% per annum, to
55% for a contribution rate of 10% per
annum). It can also be seen from Table
1 that, for a ‘typical’ individual with a
salary of £20,000 per annum at age 25,
an additional contribution of 2% of salary
a year (that is, £400 or just over £30 a
month) can be expected to result in an
average replacement ratio of around 11
percentage points higher, corresponding
to an additional annual pension income
of around £2,200 in current prices. While
it may be difficult for a 25 year-old earning
£20,000 a year to find an additional £30
a month to save (particularly those with
a young family), doing so will make a
significant difference to the standard of
living in retirement.
While it may be difficult for a 25 year-old earning £20,000 a year to find an additional £30 a month to save (particularly those with a young family), doing so will make a significant difference to the standard of living in retirement.
Finally, given that many individuals
appear to be unwilling (or unable) to
begin pension savings at age 25, we
have also considered the effect of
delaying contributions until age 40 (and
contributing at a higher rate of 15% per
annum thereafter). In this case, the
mean replacement ratio is similar to that
achieved by contributing 8% of salary per
annum from age 25. The probability of
failing to achieve a ‘minimum’ acceptable
replacement ratio is also similar.
However, while it may seem desirable for a
25 year-old to delay saving for retirement,
it should be noted that if saving does not
begin until age 40, individuals will be
required to pay almost twice as much as
they would have to pay had they started
contributing at 25, at a time when other
commitments – mortgage, school and
university fees etc – may be high too.
Also, given that the funds are invested
fully in higher-risk equities for only 15
years (as compared to 30 years if saving
begins at age 25), the upside potential
is lower, meaning that the probability of
achieving the desired replacement ratio
is commensurately lower too.
From this analysis we can conclude that
the standard, static lifestyle approach
to retirement planning can produce a
highly variable outcome for a typical DC
member.
So, can we do better?
25
Suppose that, rather than purchasing
an annuity on retirement at age 65, the
DC member gradually annuitises the
accumulated pension fund between
age 65 and age 7513, with the remainder
of the fund invested in equities. How
would this affect the distribution of the
replacement ratio? Figure 8 shows the
asset allocation to equities for each age
under this strategy (and for the standard
static lifestyling with full annuitisation on
retirement at age 65 considered above).
To shed some light on this issue, we
again assume that the asset allocation
is 100% in equities from age 25 to age
55 which then reduces linearly to 0%
at age 75.14 Then, prior to age 65, funds
not invested in equities are assumed
to be invested in the risk-free asset
(that is, index-linked government bonds)
and, after age 65, funds not invested
in equities are assumed to be used to
purchase an annuity (to benefit from the
‘mortality drag’ effect).15
13 From 6 April 2011, the government removed the requirement to annuitise fully accumulated pension wealth by age 75. However, as a result of the ‘mortality drag’ inherent in annuity products, it remains optimal for most individuals to annuitise fully from about age 75.
14 For consistency, we assume that, after age 65, the accumulated fund provides the same level of income as before. However, in this case, the income consists of both an annuity instalment and a “draw-down” of funds from the remaining equity investments.
15 Even though we assume that annuities are priced using the risk-free interest rate (of 2% per annum), the annual return achieved on an annuity investment exceeds the risk-free interest rate, assuming that the individual survives to receive the next instalment. The additional return arises from the redistribution of annuity wealth from annuitants who died during the year to those who survived, and is known as the “mortality drag”. A consequence of this is that it is sub-optimal to invest directly in the risk-free asset after retirement (and, indeed, the effect of this mortality drag is so strong that, by age 75 or so, the return achieved on annuity investment even exceeds that available on the risky equity investment, so that it is usually optimal to invest the entire amount of the pension wealth in annuities from this age).
Figure 8: Asset allocation strategy assuming lifestyle investment strategy with full annuitisation by age 75
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
4.2 Static lifestyle with gradual annuitisation between ages 65 and 75
26
Figure 9: Distribution of replacement ratio on retirement assuming lifestyle investment strategy with full annuitisation by age 75
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
Figure 9 shows the distribution of the
replacement ratio (that is, the pension
income received as a percentage of
the final salary immediately before
retirement) compared with the standard
static lifestyle approach shown in
Figure 6. In both cases, we have used
a contribution rate of 8% of salary
per annum (consistent with the NEST
requirements).
From Figure 9 we can conclude that a
more gradual approach to de-risking
and the maintenance of some equity
allocation (as a proxy for allocation
to risky asset classes generally) after
age 65 (with full annuitisation at age
75 only) is more effective than the
standard lifestyle approach above.
The mean replacement ratio of 49% is
significantly higher than that assuming
full annuitisation immediately on
retirement at age 65 (as would be
expected given that some equity
investment is now held between age 65
and age 75).
However, crucially, the strategy is also
less risky – the probability of achieving
the desired replacement ratio of two-
thirds is also significantly higher (that
is, 20% compared with 12%) and the
probability of failing to achieve an
acceptable replacement ratio of 50%
is also significantly lower (that is, 63%
compared with 72%).
Thus, as a first step to improve DC pension
outcomes, we propose extending the
standard static lifestyle investment
strategy offered to most DC members to
allow for a more gradual annuitisation
after retirement, rather than using the
full accumulated fund on retirement to
purchase an annuity immediately.
However, can we improve further on this?
27
So far, we have considered only static
asset allocation strategies, with 100%
invested in equities prior to age 55 and
full annuitisation either immediately
on retirement at age 65 or gradually
between age 65 and 75. We now consider
the effect of two simple dynamic asset
allocation strategies – a ‘momentum’
approach and a ‘contrarian’ approach. As
full annuitisation at age 75 is significantly
better than immediately on retirement at
age 65, we will use this as the ‘underlying’
driver for asset allocation and the basis
for comparison. However, in addition we
implement the following two dynamic
investment strategies:
A momentum strategy• if equities performed well in the
previous year, then we increase the
allocation for the coming year;16
• iftheequityreturninthepreviousyear
is greater than 16% (that is, risk-free
real return + equity risk premium + 0.5
* volatility of equity return), then we
increase the equity allocation by 5%
(subject to a maximum of 100%);
• iftheequityreturninthepreviousyear
is less than -4% (that is, risk-free real
return + equity risk premium – 0.5 *
volatility of equity return), then we
decrease the equity allocation by 5%
(subject to a minimum of 0%); and
• if the equity return in the previous
year is between -4% and 16%, then
we follow the standard static lifestyle
allocation above.
A contrarian strategy• if equities performed well in the
previous year, then we decrease the
allocation for the coming year;17
• iftheequityreturninthepreviousyear
is greater than 16% per annum, then
we decrease the equity allocation by
5% (subject to a minimum of 0%);
• iftheequityreturninthepreviousyear
is less than -4%, then we increase the
equity allocation by 5% (subject to a
maximum of 100%); and
• if the equity return in the previous
year is between -4% and 16%, then
we follow the standard static lifestyle
allocation above.
16 The rationale for this being that, as we now have a higher fund (as a result of the previous year’s high returns), we can afford to take on some extra risk. While this runs counter to the efficient markets hypothesis, Jegadeesh and Titman (1993) report that, over the period from 1965 to 1989, such a strategy would have produced significant positive returns over 3 to 12-month holding periods.
17 The rationale for this being that we choose to protect some of the previous year’s gains by de-risking.
4.3 Dynamic asset allocation strategies
28
Figure 10 shows the distribution of the
replacement ratio on retirement for both
the momentum and contrarian strategies,
as well as for the static lifestyle approach
from Section 4.2 (that is, with full
annuitisation by age 75). These results
are summarised in Table 2.
We can conclude from this experiment
that a contrarian asset allocation
strategy is an improvement on the static
lifestyle strategy, in that the probability
of meeting the desired two-thirds
replacement ratio is increased slightly
from 20% to 21% and the probability of
failing to achieve even the acceptable
50% replacement ratio is reduced from
63% to 61%. This is because a contrarian
strategy protects previous gains by
switching out of equities when returns in
the previous year have been significantly
above average, and increases the
opportunity to recover previous losses
by increasing the equity allocation when
returns in the previous year have been
significantly below average. However,
on the downside, this approach gives
a slightly lower mean replacement
ratio due to de-risking following high
investment returns. The momentum
strategy is the more risky giving the
highest mean replacement ratio, but
at the cost of both a lower probability
of meeting the desired two-thirds
replacement ratio (that is, 19% compared
with 21% for the contrarian approach)
and a higher probability of failing to
achieve the acceptable 50% replacement
ratio (of 65% compared with 61% for the
contrarian approach). However, it does
improve the mean replacement ratio in
retirement, as a result of taking on more
risk following high investment returns in
the previous year.
Figure 10: Distribution of replacement ratio on retirement assuming momentum and contrarian investment strategies
Table 2: Replacement ratio on retirement assuming momentum and contrarian investment strategies
Investment strategy
Static lifestyle (to age 75) Momentum ContrarianMean replacement
ratio 49% 50% 48%
Probability of replacement
ratio > 66.7% 20% 19% 21%
Probability of replacement
ratio < 50.0% 63% 65% 61%
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
29
The results presented in Table 2 (page
28) and in Figure 9 (page 26) lead Blake,
Wright and Zhang (2011)18 to suggest
that a ‘loss aversion’ framework may
be suitable for DC pension plan asset
allocation. The concept of ‘loss aversion’
was first proposed by Kahneman and
Tversky (1979) within the framework
of prospect theory, one of the building
blocks of behavioural finance.19 Loss
aversion is defined in terms of the
satisfaction (utility)20 of gains and
losses in wealth relative to a pre-defined
reference or endowment point, rather
than in terms of the satisfaction derived
from the absolute level of total wealth, as
it is in traditional finance theory.
In particular, it states that, relative to
the chosen reference point, individuals
prefer avoiding losses to acquiring
equivalently sized gains (that is, they are
loss averse). The degree of loss aversion
varies from person to person, although
studies suggest that individuals can
be somewhere between two and five
times more sensitive to a particular
loss (relative to the chosen reference
point) than to a corresponding gain.21
The standard loss aversion framework
suggests that individuals exhibit ‘typical’
risk aversion with respect to gains
(relative to the pre-defined reference
point) – thus, the satisfaction of a gain
of $200 is less than twice that of a gain of
$100. However, because individuals are
loss averse, they prefer risks that might
reduce a loss, leading to risk-seeking
behaviour with regard to losses. Thus,
the investment behaviour that results
from loss aversion is similar to the sort
of investment decision making that a
contrarian investor might follow.
So, when it comes to a DC pension, how
do we determine a suitable reference
point? The Blake, Wright and Zhang
(2011) framework assumes that the
representative DC member wishes to
retire on a pension equivalent to two-
thirds of his final salary. The authors
then use this ‘desire’ to determine the
required fund at retirement based on the
current salary and expected salary growth
up to retirement. Then, at each age
prior to retirement, they can determine
a fund target by discounting this final
amount to allow for future investment
18 The intellectual property for the loss aversion framework discussed in this section belongs to the authors of the original Blake, Wright and Zhang (2011) paper and we are grateful to them for allowing its inclusion here.
19 Kahneman & Tversky (1979) developed this theory to remedy the descriptive failures of subjective expected utility theories of decision-making in the face of uncertainty, thereby leading the way for the development of the field of behavioural finance.
20 In economics, utility is a measure of relative satisfaction or happiness. Given this measure, economists then try to explain an individual’s economic behaviour, including decisions regarding investment, in terms of attempting to maximise satisfaction or utility.
21 Tversky & Kahneman (1992) suggest that individuals are 2.25 times more sensitive to a loss than to a corresponding gain (that is, a loss aversion parameter of λ=2.25). However, this was based on a study of decisions made under uncertainty by a group of only 25 graduate student in the US, so may not representative of the typical DC plan member. Hwang and Satchell (2005) propose a long-term loss aversion parameter of λ=3, but suggest that a value as high as 4.5 may be appropriate in some circumstances.
4.4 Liability-driven asset allocation and ‘loss aversion’
30
returns (and for future contributions to
be paid into the fund). In this framework,
the current ‘target’ fund serves as the
reference point and is used to determine
the current ‘optimal’ asset allocation
needed to achieve it. This approach to DC
retirement planning works like this if the
actual fund is:
• closetothecurrentdiscountedtarget,
the asset allocation in the risky
asset (that is, equities) is reduced to
minimise the risk of a loss (relative to
the current target) in future.
• significantly higher than the current
target, then the asset allocation in the
risky asset can be increased again,
because the likelihood of a loss,
relative to the current target, falls
because of the bigger cushion held;
and crucially,
• iftheactualfundissignificantlylower
than the target, the asset allocation in
the risky asset will rise in order that the
shortfall can be made up.
The key parameter controlling the asset
allocation over time is the loss aversion
parameter. A typical loss aversion
parameter might be around 4, with a
lower value appropriate for a member
who is more risk (or, strictly speaking,
loss) tolerant and a higher value
appropriate for a member who is risk (or
loss) averse.
In this model the DC member’s focus on
the target replacement ratio is analogous
to the liability-driven approach to
investment strategy which many DB
plans have adopted over the past few
years. That is, all investment decisions
are made with a view to maximising
the likelihood of meeting the targeted
replacement ratio.
Integrating this loss aversion behaviour
and the liability-driven approach to
asset allocation allows us, once again, to
generate a distribution of the replacement
ratio. But before we do this it’s worth
considering the impact of this framework
on the optimal asset allocation of our DC
member at each age. The optimal asset
allocation at each age will depend only
upon the ratio of the current fund level to
the current target fund, which is simply
a function of the current salary. For
example, consider the way in which the
optimal asset allocation can vary when
our DC member reaches age 64. Under
the assumptions used by Blake, Wright
and Zhang (2011), the target fund at this
time is about 10 times the current salary,
that is, he needs to have accumulated
a fund 10 times his salary at age 64 to
be confident of achieving the desired
target replacement ratio of two-thirds on
retirement at age 65.
It is clear from these results that a loss aversion strategy is much more successful in meeting the desired replacement ratio of two-thirds of salary at retirement.
31
Figure 11 shows how the optimal asset
allocation varies according to the ratio of
the current fund to the target fund. In this
case, the individual is assumed to have
a ‘typical’ loss aversion parameter of 4,
although in practice this will vary from
individual to individual. We can see that
a higher allocation to equities is optimal
if the current fund is significantly lower
than the target (with 100% in equities for
ratios of about 80% or less). This higher
allocation to equities is made in the hope
of increasing the fund accumulated at
retirement to that required to achieve the
target replacement ratio of two-thirds at
retirement. Also, a higher allocation to
equities is also made if the actual fund
is significantly higher than the target,
with 100% in equities for ratios of about
120% or above. This is because the risk
of the fund accumulated at retirement
falling below that required to achieve
the target replacement ratio at retirement
is sufficiently low. However, if the ratio
is between 80% and 120%, then the
optimal allocation to equities is lower
to reduce the risk of a significant loss at
retirement, relative to the target.
Figure 11 could be reproduced for a DC
member at each age from 25 to 75, and
Blake, Wright and Zhang (2011) shows
that the younger the DC member, the
more optimal it will be to be invested in
equities, or at least high-risk, high-return
asset classes. That is, the younger the
DC member, the shallower will be the ‘V’
shape shown in Figure 11. The optimal
asset allocation varies then, with age,
with the ratio of the actual to the targeted
DC fund, and the individual’s aversion to
losses.
Figure 11: Determining optimal asset allocation within loss aversion framework for a 64 year-old
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
32
Figure 12: Distribution of replacement ratio on retirement assuming loss aversion
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
Figure 12 shows the distribution of the
replacement ratio at retirement for the
loss aversion framework, as well as for
the static lifestyle approach, with full
annuitisation by age 75. These results
are also summarised in Table 3. It is clear
from these results that a loss aversion
strategy is much more successful in
meeting the desired replacement ratio
of two-thirds of salary at retirement.
This is unsurprising because, unlike the
other dynamic asset allocation strategies
above, the asset allocation at each
age is set with reference to the current
discounted value of this target – that is,
it is outcome driven. Compared with the
static lifestyle asset allocation with full
annuitisation by age 75, the probability
of meeting the desired replacement ratio
of two-thirds increases significantly from
20% to 34% and, equally as important,
the probability of failing to achieve
an acceptable minimum replacement
ratio of 50% of salary at retirement
is substantially lower, that is, 48%
compared to 63%.
The asset allocation strategy at each
age is dynamic and will depend on the
individual circumstances prevalent at the
time (and, in particular, the level of the
current accumulated fund relative to the
current target fund).
Table 3: Replacement ratio on retirement assuming loss aversion framework
Investment strategy
Static lifestyle (to age 75) Loss aversionMean replacement ratio 49% 49%
Probability of replacement ratio > 66.7% 20% 34%
Probability of replacement ratio < 50.0% 63% 48%
33
Figure 13: Mean optimal allocation in equities assuming a loss aversion framework
Probability of replacement ratio
of greater than 66.7% = 20% (cf. 12%)
Probability of
replacement ratio
of less than
50% = 63%
(cf. 72%)
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
Figure 13
0.6
0.5
0.4
0.3
0.2
0.1
0
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
0% 140%20% 40% 60% 80% 100% 120%
Replacement ratio
Replacement ratio
Replacement ratio = 50%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio = 66.7%
Replacement ratio = 50%
Replacement ratio = 66.7%
Replacement ratio
Replacement ratio
Replacement ratio
Age
Ratio of current fund to current ‘target’ fund
Probability of replacement ratio
of greater than 66.7% = 12%
Probability of
replacement ratio
of less than
50% = 72%
30,000
40,000
50,000
60,000
70,000
General salary inflation
Promotional increases
Total salary
Sal
ary
20,00025 30 35 40 45 50 55 60 65
Age
0.6
0.5
0.4
0.3
0.2
0.1
0
100%
80%
60%
40%
Equi
ty a
lloca
tion
20%
Static lifestyle asset allocation (to age 65) Static lifestule asset allocation (to age 75)
0%756555453525
Age
0.6
0.5
0.4
0.3
0.2
0
0.1
0.6
0.5
0.4
0.3
0.2
0
0.1
100%
80%
60%
40%
20%
0%0% 25% 50% 75% 100% 125% 150% 175% 200%
0.5
0.4
0.3
0.2
0.1
0
Replacement ratio = 50%
Replacement ratio = 66.7%
6% contributionfrom age 25
8% contributionfrom age 25
10% contribution from age 25
15% contribution from age 40
Static lifestyle asset allocation (to age 65)Static lifestyle asset allocation (to age 75)
Static lifestyle asset allocation (to age 75)Dynamic asset allocation (to age momentum)Dynamic asset allocation (contrarian)
Opt
imal
allo
cati
on to
equ
itie
s
Replacement ratio = 50%
Replacement ratio = 66.7%
Probability of
replacement
ratio of less
than 50%
= 48%
(cf. 63%)
Probability of replacement ratio
of greater than 66.7% = 34%
(cf. 20%)
100%
80%
60%
40%
Opt
imal
allo
cati
on in
equ
itie
s
20%
0%706050403020
Static lifestyle asset allocation (to age 75)Loss aversion
Static lifestyle asset allocation (to age 75)Loss aversion
In particular, from Figure 11 (page 31), the
actual allocation in the risky asset will be
much lower if the current fund is close
to the current target. As such, it is useful
to compare the mean asset allocation
strategy under the loss aversion
framework with that for the static lifestyle
strategy. From Figure 13, we can see
that, based on the 10,000 outcomes
generated, loss aversion can be expected
to lead to an earlier switch out of equities
(from around age 40, although in any
particular realisation, this will depend
on the level of the current fund relative
to the current target), but can also lead
to a significantly higher equity weighting
at older ages (particularly if the current
fund is significantly above or significantly
below the current target).
The challenge in terms of applying this
asset allocation strategy is that no
individual will follow this ‘average’ path
of equity allocation. The average is high
at older ages because there will be some
scenarios when the equity weighting is
very high (for example, 100%, if the fund
is well above or well below the target),
but there will be many scenarios where
the allocation is very low (as the fund is
close to the target). Thus, the distribution
is very polarised (that is, either very high
or very low), so the ‘average’ is not really
very meaningful.
The asset allocation strategy at each age is dynamic and will depend on the individual circumstances prevalent at the time (and, in particular, the level of the current accumulated fund relative to the current target fund).
34
References
Basu, A., Byrne A. and Drew M. (2009),
‘Dynamic lifecycle strategies for target
date retirement funds’, University of
Edinburgh working paper.
Benartzi, S., and Thaler, R. (1995),
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Premium Puzzle’, Quarterly Journal of
Economics, 110, pp. 73-92.
Blake, D., Cairns, A.J.G. and Dowd, K.
(2001), ‘Pensionmetrics: Stochastic
Pension Plan Design and Value at
Risk During the Accumulation Phase’,
Insurance: Mathematics and Economics,
29, 2, October, pp. 187-215.
Blake, D., Wright D. and Zhang Y. (2011),
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aversion’, Working Paper, Cass Business
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Brigden, A., A. Clare, R. Driver and M.
Selvaggi (2008), Coping with uncertainty
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Brigden, A., A. Clare, R. Driver and M.
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Cannon, E. and Tonks, I. (2009), ‘The
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Hwang, S., and Satchell, S. (2005), ‘The
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Jegadeesh, N., and Titman, S. (1993),
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91.
Levy, S. (2009), Occupational Pension
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Mehra, R. and Prescott, E. (1985). ‘The
Equity Premium: A Puzzle’, Journal of
Monetary Economics, 15, pp. 145–161.
Tversky A., and Kahneman, D. (1992),
‘Advances in Prospect Theory: Cumulative
Representation of Uncertainty’, Journal of
Risk and Uncertainty, 5, pp. 297-323.
Contributors
David Calfo
David Calfo joined BNY Mellon in
September 2010 as the group’s head of
defined contribution (DC) strategy.
His role is to define the firm’s DC strategy
and business approach in the UK and in
other markets.
Prior to joining BNY Mellon, David was
at Ignis Asset Management (part of Pearl
Group Limited) where he had worked
since 2006 as chief operations officer
and, subsequently, as head of corporate
development and strategy.
In these roles, David was instrumental
in establishing the group’s asset
management business.
Before Pearl Group, David was founder
and director of his own strategic advisory
firm, specialising in investment and DC
pensions businesses across Europe.
He also spent a significant portion of his
career at Fidelity Investments, working in
both the US and UK, and is recognised for
establishing and running Fidelity’s UK DC
business.
Professor Andrew Clare
Andrew Clare is the Professor of Asset
Management at Cass Business School
and the Associate Dean responsible for
Cass’s MSc programme, which is the
largest in Europe.
He was a Senior Research Manager in the
Monetary Analysis wing of the Bank of
England which supported the work of the
Monetary Policy Committee. While at the
Bank, Andrew was responsible for equity
market and derivatives research.
Andrew also spent three years working
as the Financial Economist for Legal and
General Investment Management (LGIM),
where he was responsible for the group’s
investment process and where he began
the development of LGIM’s initial Liability
Driven Investment offering.
He has published extensively in both
academic and practitioner journals on
a wide range of economic and financial
market issues. In a recent survey Andrew
was ranked as the world’s ninth most
prolific finance author of the past fifty
years.
Andrew serves on the investment
committee of the GEC Marconi pension
plan, which oversees the investments
and investment strategy of this £3.2bn
scheme, and has recently been appointed
as a trustee to the Magnox Electric Group
Pension scheme.
Dr Douglas Wright
Dr Douglas Wright is a Senior Lecturer
in the Faculty of Actuarial Science and
Insurance at Cass Business School in
London.
Douglas joined Scottish Provident Life
Assurance in Edinburgh in October 1991,
after completing a BSc (Hons) in Actuarial
Science and Statistics at Heriot-Watt
University. He returned to Heriot-Watt
in October 1993 to begin a PhD entitled
“A Stochastic Approach to Pension
Scheme Funding and Asset Allocation”
under the supervision of Dr Mary Hardy.
After completion of the PhD, he joined
the Faculty of Actuarial Science and
Insurance at Cass Business School in
January 1997, specialising in financial
mathematics and investment, stochastic
modelling and life insurance.
Douglas is author (or co-author) of papers
published in, amongst others, the Journal
of Economic Dynamics and Control, the
Journal of Management Mathematics,
Insurance: Mathematics and Economics
and the British Actuarial Journal.
His current research interests include
the optimal asset allocation for defined
contribution pension schemes, the future
of defined benefit pension schemes and
applications of agent-based models in
non-life insurance.
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