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Retirement preparation the institutional-investor way

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Institutional investors have been among the most successful investors in recent years. They have adapted to changing market conditions and have been able to meet client needs, while reducing risk. Let’s take a close look at how they’ve done it, and how their strategies can be applied to retirement income planning.

Today’s retirement landscape

Clients are facing several challenges in planning for retirement. First is market volatility. We all remember the dramatic swings over the past 10 years. Many investors are concerned the wave of volatility will continue.

There is also the challenge of longevity. An individual age 65 has a 50 percent chance of living into his/her mid-to late 80s and a 25 percent chance of living into his/her 90s.1 The challenges become even greater for couples: one has a 50 percent change of living until age 92. This means that there is a high probability that clients could have a retirement that lasts 30 years or more.

Finally, there is the impact of rising costs–inflation, health-care expenses and taxes. This can have a dramatic impact on clients’ standard of living in retirement.

So where should a client invest? It’s a balancing act. Investing too conservatively or too aggressively can have negative results. This is where we can learn from institutions.

Institutional investing

In the mid-1990s, institutional investors began to seek alternatives to traditional asset allocation to achieve clients’ goals. Increased volatility, lower yields and market correlation forced them to adapt. Below are some common strategies. 

Liability-driven investing

This form of investing is most common among defined benefit pension plans. The risk for a pension plan is underperforming the liabilities, not just having negative asset returns. Most defined benefit plans have long liabilities, necessitating that they hedge the portfolio’s exposure to changes in interest rates and inflation. They use conventional fixed income, as well as inflation-linked and synthetic securities.

Alternative investments

Alternative assets are typically less correlated to the market. This can help dampen volatility. Alternative assets include derivatives, market neutral and global macro strategies. 


Options allow investors to buy or sell an underlying asset at a specific price on or before a certain date. They can improve a portfolio’s risk profile by hedging an investment in a related security. They include calls, puts, collars and spread options.

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Inflation hedges

Investors need to preserve capital during periods of inflation. This can be accomplished through investments in hard assets and securities with built-in inflation protection. These include Treasury Inflation-Protected Securities, commodities, and infrastructure (companies that provide the foundation of basic services, facilities and institutions upon which the growth and development of a community depends).

While all of the strategies mentioned above may sound appealing, they require significant time and expertise to implement successfully. In addition, they can have significant transaction costs.

Chance vs. certainty

In planning for retirement, clients are looking for as high a level of income as possible, and being able to maintain that income during retirement. Using a Monte Carlo analysis, let’s look at a portfolio comprised of 60 percent equities and 40 percent fixed income, and its ability to support a 5 percent withdrawal rate2 for 25 years. The chart below shows that the probability is 77.2% that there will be at least $1 in the account at the end of the 25 years. 

But what would happen if a client suffered negative returns early in retirement? Using the chart above, let’s look at a more aggressive asset allocation – 80 percent equities and 20 percent fixed income and a 30-year period. Assuming a 5 percent withdrawal rate, the probability of success starts off at only 64.3 percent. If, in the first year, market declines cause the account value to lose 30 percent, the probability of success drops to 17.9 percent. 

Variable annuities as a solution

A variable annuity can provide guaranteed retirement income, while helping to address the challenges of volatility, longevity and increasing costs. It is an optional benefit for an additional fee that can help protect income from market downturns, while still helping to capture market highs, providing a measure of certainty rather than just probability.

In addition, variable annuities can provide clients with access to professionally managed investment portfolios that can include traditional, tactical, quantitative and alternative strategies, including the institutional strategies mentioned earlier. Variable annuities are also tax-deferred, so clients can invest tax efficiently during their accumulation years. Variable annuities can also provide a guaranteed death benefit for beneficiaries.

Variable annuities can offer a comprehensive solution to a multitude of challenges. They’re can be an important part of a client’s retirement income plan. They’re not for everyone, though. Clients who have sufficient assets earmarked for retirement income may not have a need for a variable annuity. In addition, clients who will need access to those funds in the short term or prior to age 59-and-a-half should generally not consider a variable annuity.


1 Society of Actuaries U.S. Annuity 2000 Mortality table

2 indexed annually by 3% to keep pace with inflation

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