The EDHEC-Princeton Retirement Goal-Based Investing Index Series - December 2020 Highlights

Goal Price Index Series

• US interest rates began 2020 with a downward move that accelerated with the expansion of the coronavirus pandemic in Europe in late February and early March and the increasing concerns over the economic impact. The 10-year rate fell from 1.88% after the New Year’s Eve to 0.50% on March 9, and the 1-year rate fell from 1.58% to 0.29%. Falling Treasury yields are mechanically reflected in rising Goal Price Indices through the discounting mechanism, and the price of $1 per year of replacement income for 20 years grew from $18.99 to $21.69 for an individual retiring in 2028.
• During the Fall, long-term rates, represented for instance by the 10-year rate, showed a moderate increasing trend against the backdrop of promising news on vaccines, and this move led to a slight downturn in the price of replacement income. An individual expecting to retire in 2033 and targeting a 2% annual cost-of-living adjustment in benefits would pay $23.84 per dollar of replacement income in August 2020, and $21.82 in December. The change is less marked for someone who retires earlier, in 2023, because the impact of interest rate moves is smaller at these durations and rates of maturities shorter than 5 years moved less than long-term rates: for this individual, the decrease is only from $23.03 to $21.96.

Goal-Based Investing Index Series

• End of Winter featured historically large losses in equity indices around the world, and the S&P 500 index was no exception, with a drawdown by more than 40% from February 20 to March 20. With decreasing interest rates at the same time, these were hard times for portfolio insurance strategies with a fixed-income floor and a performance-seeking portfolio dominated by equities, and Goal-Based Investing indices, that have a similar rebalancing rule, were logically impacted in the same way. The procyclical nature of the investment strategy implies a higher allocation to the goal-hedging portfolio, which replicates the performance of a goal-price index. For someone retiring in 2028 and targeting inflation-adjusted replacement income, the GHP share went from 46% at the January rebalancing to 87.9% in April.
• For the longest horizon, which corresponds to a 2038 retirement date, and the longer retirement bond duration, which corresponds to 20 years of replacement income, the swing was even larger, from 26% in January to 100% in April. Once the portfolio is fully invested in the GHP, it remains “sterilized” in this state until the floor is reset back to a lower value, so as to replete the risk budget. The next reset is to take place shortly, in January 2021.
• The other indices, which have a non-zero risk budget, benefitted from the recovery in the equity market as of April. The index for an individual retiring in 2028 with 20 years of inflation-adjusted income had a return of 5.17% from April to December, while the corresponding Goal Price Index, which is its natural benchmark, displayed a 3.98% loss. This amounts to a 9.53% gain in the purchasing power in terms of replacement income, so the equity building block did boost the performance of these indices during that period.