Long-term Investment and Asset Allocation Strategies in Defined Contribution Pension Plans
Date: 18 December 2012
Thesis or dissertation
University of Exeter
PhD in Finance
As the most influential factor driving investment performance, asset allocation has received a considerable amount of attention from researchers since the introduction of the mean variance framework by Markowitz; however, as far as is known, there has been little agreement on asset allocation for multi-period long-term investors. ...
As the most influential factor driving investment performance, asset allocation has received a considerable amount of attention from researchers since the introduction of the mean variance framework by Markowitz; however, as far as is known, there has been little agreement on asset allocation for multi-period long-term investors. Therefore, this doctoral research investigates the performance of long-term investment over major asset classes and explores some issues in terms of asset allocation for individual retirement plan participants from an international prospective. The first essay investigates the relative performance of stocks, long-term government bonds and treasury bills for various investment horizons across seventeen nations and considers whether or not investment risk decreases over time, i.e. whether or not the notion of time diversification is valid. It was observed that investment outcomes at short horizons were quite different from outcomes at longer horizons and investment outcomes are different with the different asset classes. The results indicate that the benefits of time diversification are apparent for stocks as evidenced by the reduction of investment risk over longer holding periods. The diminishing relative riskiness of stocks over bills/bonds with investment horizon implies that equity weights in optimal asset allocation should depend on investment horizon. Therefore, the conventional wisdom of increasing equity exposure with an increasing investment horizon is strongly supported. Drawing on the results of the previous study, the second essay examines the asset allocation strategies of individual retirement participants and investigates the lifecycle investment strategy that is most widely used in DC pension plans. The conventional lifecycle strategies are shown to underperform the alternative buy and hold strategies. Furthermore, two dynamic lifecycle asset allocation strategies, which incorporate performance feedback, are introduced, and these are found to be responsive to past performances of stock returns or portfolios, with more superior wealth outcomes than the conventional lifecycle strategy, which is currently most commonly used. The final study extends the previous study by using various savings rates and varying investment horizons rather than fixed numbers. In addition, since most previous research on pension investment completely ignores tax, this study examines the tax effect on retirement outcomes over various tax regimes. The results indicate that a relatively shorter savings period and a lower savings rate significantly reduce the probability of achieving the target retirement income. Additionally, investment strategies for a relatively shorter investment period are crucial for the success of retirement planning because of the huge differences in the success rates of various strategies. Moreover, countries that apply an EET tax regime have less significant reduction in success rates than those that operate an ETT or TTT tax regime. Thus, retirement participants in countries with an EET regime have more incentive to invest their savings in pension funds and countries under other tax regimes need to contribute more to achieve their target retirement wealth outcomes.
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