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Challenges in Designing Mechanisms to Handle Intergenerational Transfers. Leo de Bever, Ph.D. Chief Executive Officer and Chief Investment Officer. November 16 th , 2011. Rising Cost of Retirement (50% real income replacement). Pension costs rise approximately as (yrs retired)/(yrs worked)
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Challenges in Designing Mechanisms to Handle Intergenerational Transfers Leo de Bever, Ph.D. Chief Executive Officer and Chief Investment Officer November 16th, 2011
Rising Cost of Retirement (50% real income replacement) Pension costs rise approximately as (yrs retired)/(yrs worked) The % of retirement income paid for from post-retirement investment income rises with real asset return assumption Higher rates of return have more downside risk Pension funds have dealt with longevity costsby assuming higher return from taking more risk
Discounting by LT 60-40 Returns is Dangerous Market returns show strong year-to-year serial correlation Had Methuselah taken on a 60-40 fund in 1899 at the top of a bull market and 140% funding ratio, he would have ended up with the same funding ratio in 2010 (by construction: because I discounted by the historical portfolio return) with some stomach-turning volatility along the way
Short Term Return Volatility Underappreciated Range of 30 Years of Cumulative Asset Growth [65% Equities - 35% Fixed Income] 1st Percentile 1600 CPI + 7.2%Top 1% 10th Percentile 25th Percentile 800 50th Percentile CPI + 4.25% 75th Percentile 400 90th Percentile CPI + 1.3%Bottom 1% Cumulative Returns Index 100 in Year 0 99th Percentile 200 Y-Axis 100 100 50 25 25 25 25 25 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Years
1982-2000 Real Returns Exceptional 2000-2009 Barely Positive CPI + 7.2%Top 1% Tech Boom CPI + 4.25%Trend return CPI + 1.3%Bottom 1% The top 1% 30 year scenarios yield 6%/year more than the bottom 1% The 1982-1999, 65-35 boom was in large part due to very high bond returns
OECD Public and Private Pension Costas % of 2005 GDP Private Public
Long Term Real Return on Equities and BondsReal Value in 2009 of $1 invested in 1900 $519Stocks $63Stocks -2%costs $9Bonds • Government bonds are not risk free • Equities are volatile, but they pay well over time