Abstract:
The evolution of modern pension systems saw the introduction of individual defined-contribution (DC) schemes alongside existing intergenerational solidarity i.e. pay-as-you-go (PAYGO) models in the former transitioning economies in Europe. Although systemic privatization was widely advocated to relieve fiscal pressures in the former transitioning economies, cumulative empirical evidence highlights significant structural shortcomings, leading several nations to partially or fully reverse these reforms due to stagnant coverage, inadequate replacement rates, and the transfer of financial market risks onto individuals. Furthermore, a shift from defined-benefit (DB) pension fund schemes to defined-contribution (DC) schemes occurred in the developed countries. Consequently, individuals in the developed countries and former transitioning economies now bear higher responsibility for financing their retirement, facing complex decisions amidst market volatility, longevity risks, and inflation. Standard retirement products, such as traditional target-date funds (TDFs) or retail annuities, fail to provide optimal solutions for individual wealth accumulation. While annuities are hampered by irreversibility, high costs, and lack of upside potential, conventional TDFs focus primarily on terminal wealth at a fixed date rather than securing replacement income in retirement. Moreover, traditional TDFs rely on deterministic glide paths that ignore dynamic market conditions and utilize safe assets (e.g., cash or standard sovereign bonds) that carry substantial interest rate and duration risks when evaluated against a stream of replacement income. To bridge this gap, Goal-Based Investing (GBI) principles offer a novel paradigm by shifting the focus from absolute wealth to generating guaranteed purchasing power of replacement income. Within this framework, an investor’s portfolio is dynamically allocated between a Performance-Seeking Portfolio (PSP) to harvest market risk premium and a dedicated Goal-Hedging Portfolio (GHP) designed to replicate the present value of future replacement income cash flows. By managing the risk budget dynamically, GBI strategies protect essential minimum income levels while maximizing the probability of achieving aspirational retirement targets. The practical viability of dedicated retirement goal-hedging assets has recently been validated in government bond markets. In 2023, the Brazilian Treasury introduced the RendA+ bond (a retail-targeted implementation of the retirement bond concept), enabling individual DC plan participants to easily acquire inflation-linked forward-starting income streams tailored to their specific retirement horizons. Building upon these theoretical GBI principles and empirical developments, this paper evaluates the performance and hedging efficacy of introducing retirement bonds within a fully funded pension framework.
