Page 11 - Investment Advisor - December 2023

downside risk and upside potential. “Well, we are asking, what if you structured, buffered approach as an
Though the mechanics are somewhat change that approach in a more funda- asset class in an asset allocation model,”
complicated, when added to a diversified mental way, for example by bringing a Pfau emphasizes. “That’s the punchline
portfolio, these solutions may provide registered index-linked annuity into the of the research, seeing what these types
an opportunity for household investors picture, one that features a buffer on the of solutions can do to move the efficient
to improve their financial outcomes by downside performance,” Pfau explains. frontier for the whole portfolio.”
offering a beneficial trade-off between He gives the example of a structured solu- Put another way, when one adds
upside and downside risk, he adds. tion with a 10% downside buffer, which these types of structured annuity seg-
Ultimately, Pfau argues, the growing can be achieved by purchasing a RILA. ments that change the distribution of
category of structured annuity prod- “So, if you are holding this solution returns, an investor can dramatically
ucts provides an alternative for house- and you see a market drop of 8% in that improve portfolio performance while
holds to manage market risks as they year, you’ll get a 0% return, and if you also achieving higher risk-adjusted
approach retirement. He says these see the market fall 12%, you’ll only suf- returns. “We found strong evidence that
annuities allow an investor to design fer a 2% drop,” Pfau said. “That’s the you can build portfolios with a higher
their own distribution of investment original idea of what a RILA is. It has return expectation and less volatility
outcomes to better manage downside the indexing component, which means relative to what you can achieve with
risks, while still providing participation there is a downside component to grap- stocks and bonds alone,” Pfau says.
in the market upside. ple with, but this in turn means you can
get more of the upside over time.” Bond (or stoCk) rePlACeMent?
GAInInG AttentIon According to Pfau, if explained clearly to
“The ability to better manage downside dUAl steP UP APProACH clients, this approach to investing can be
risks can lay a foundation for either According to Pfau, another emerging very appealing, especially to those pre-
needing less savings to successfully investing approach that was “really retirees who feel they have saved suc-
retire, or to enjoy a higher standard of intriguing” and that contributed sig- cessfully and want to protect what they
living from a given asset base,” Pfau nificantly to the positive performance have set aside, but who are also worried
posits. This research is focused on asset seen in the analysis is called the “dual about their longevity risk. Using these
accumulation during the run-up to step up,” which is a feature of some solutions provides meaningful down-
retirement, and often when people hear structured products already available in side protection without sacrificing too
the word “annuity,” he explains, they the marketplace. much upside.
tend to think more or less exclusively “The basic idea here is that you are “In addition, there is another really
about retirement income. going to get credited with a fixed return interesting dynamic in our findings,”
“It’s exciting because this research whenever the index achieves a certain Pfau says. “I often talk about annuities
project with Equitable is actually broken degree of performance,” Pfau explains. as a bond replacement, and certainly you
into two phases, and this first phase is “So, for example, consider a 15% segment see that, compared to bonds, these types
not specifically talking about retirement buffer. As long as the market was not of structured financial products can per-
income,” Pfau notes. “That will be the down more than negative 15% — even if form significantly better, especially when
second part of the project. This initial it was down 14% or up 50% — that inves- you layer in the tax-deferral factor.”
phase is about exploring the question of tor will be credited with an 8.5% return But, Pfau says, it was also interesting
what having a structured return on a por- for that year, and you’re only exposed to to see that, if one looks to more conser-
tion of your investments can allow you to the loss beyond that negative 15%.” vative investors, this approach can also
do with the overall asset allocation and In Pfau’s extensive Monte Carlo be really appealing: “I don’t want to say
your risk and performance goals.” performance simulations, a theoretical these annuities are good stock replace-
According to Pfau, advisors and near-retiree could expect to get that ments for the typical investor, but they
their clients are used to talking about 8.5% return in something like 92% of the can play an interesting role if someone
bell curve distributions of stocks years projected, and the other 8% of the was only going to have a really low stock
and bonds, and about setting limits time they see only a small loss. Naturally, allocation anyway,” Pfau explained. “By
on both the upside and the downside. this is an attractive performance distri- allocating to bonds in the structured
Generally, advisors seek to limit the bution for a near-retiree worried about product, they can still dramatically
downside while the client is approach- market shocks. improve the frontier of potential returns
ing retirement, at the expense of poten- “The big conclusion we can draw compared with, in this case, a small
tial upside performance. here is that you can basically treat this stock allocation.”

December 2023 Investment AdvIsor 9