globally, as well as risk increasingly being turned over to individuals who are least capable of bearing it using the current range of
investment instruments and approaches, the introduction of BFFS
may be timely. If such an investment instrument can be created,
it could allow for the creation of individual defined benefit plans,
thereby lowering the risk to governments of citizens retiring poor.
This paper examined some of the technical details around the creation of such an instrument and also discussed some of the practical challenges. It appears that BFFS could help lower the risk, cost,
complexity of, and the number of entities involved in achieving a
target retirement income, as well as improve the liquidity of retirement income options and eliminate error-prone processes, especially if a high-quality issuer such as the U.S. Department of the
Treasury created the instrument. The Treasury may be the perfect
candidate to create the basic instrument because of its low default
risk, the BFFS-issuing government benefits from less retirement
poverty, and budget-strapped governments would benefit from for-ward-interest payments. Governments could use these bonds to
finance infrastructure investments, which have a complementary
cash-flow profile; this characteristic opens the door to issuance by
multi-lateral agencies with the dual goals of improving retirement
security and investing in infrastructure. Insurance companies also
may be interested in issuing these bonds as a proxy for more-customized annuities.
From a theoretical perspective, a BFFS is a useful addition to the
available instruments for retirement planning, especially because it
fills such a clear role in the complex retirement process. Additional
research is needed to evaluate the feasibility of the creation and
issuance of this instrument.
Arun Muralidhar, PhD, is an adjunct professor of finance at
George Washington University and founder of Mcube Investment
Technologies, LLC. Contact him at email@example.com.
Kazuhiko Ohashi, PhD, is a professor of finance at the Graduate
School of International Corporate Strategy at Hitotsubashi
University in Tokyo, Japan. Contact him at firstname.lastname@example.org.
Sunghwan Shin, PhD, is a professor of finance at Hongik University
and a president of Korea Institute of Finance in Seoul, Korea.
Contact him at email@example.com.
Thank you to many individuals who helped and supported us in
the development of this idea. Robert Merton, Monte Tarbox, James
Russell, Roland van den Brink, and John Adler read early drafts
and offered comments that improved the idea and its presentation.
Hank Kim was instrumental in getting many folks to at least con-
sider this idea. Kathleen Kennedy was very helpful and constantly
pushed to clarify key aspects. We thank Adam Kobor, Joe Ramos,
Robert DeConcini, George Grimbilas, and Michael Zaremsky for
their detailed analytical assistance. Thanks especially to members
of the CT Retirement Security Board and thanks also to Mark Iwry,
Joshua Gottbaum, Timothy Barrett, Judy Mares, Raghuram Rajan,
Jesko Hentschel, Bill Belchere, George Jabbour, Robert Savickas,
Jonathan Grabel, Ken Miranda, Christopher Li, Jon Forman, Srini
Pulavarti, Mohammad Baki, and the Overture Financial Team
working with California’s Secure Choice Board, Frances Denmark,
Barney Buscemi, Karin Brodbeck, Audrey Kent, Carol Sung,
Michael Bennett, Akinchan Jain, Mahendra Pratap Singh, Tenzing
Sharchok, Brad Jones, Theo Kocken, Angela Antonelli, Ronald van
der Wouden, Joe McLean, Michael Ashton, Charles van Vleet,
Thomas Fiske, Karen Smith, Gerald Chen-Young, and others who
provided useful feedback.
1. The challenge for institutional investors, which pool the risks of many individuals
(i.e., inter- and intra-generational pooling) is simpler than that of a single individual,
who must manage the risk over just one lifetime; see Muralidhar (2011).
2. Savings glut describes a situation where desired saving exceeds desired investment.
Savings glut results in low real long-term interest rates.
3. Leibowitz et al. (1989) would dismiss the use of duration for equities.
4. Japan offers a forty-year security.
5. Bodie et al. (1992) have argued for standard-of-living indexed bonds as a way to
manage cost-of-living risk because typical inflation-linked instruments do not provide
an adequate hedge against, say, medical inflation risk. Theo Kocken in personal
correspondence notes that in countries such as the Netherlands there is no incentive
to issue inflation-linked bonds because these bonds do not help with compliance with
European measures of deficits, etc.
6. The authors thank Charles van Vleet for this insight.
7. More recently, some have argued for the creation of tontines, a unique financial
product based on payouts to survivors. See for example Forman and Sabin (2015).
Because tontines are not part of either institutional or retail portfolios we do not address them here, but they seek to achieve a similar goal of hedging retirement income
and longevity risk.
8. The authors thank Roland van den Brink for this comment.
9. See Lintner (1965), Markowitz (1952), Mossin (1966), Sharpe (1964), and Tobin (1958).
10. In the interest of brevity, we did not include a more extensive list of research that
highlights the asset allocation implications of a liability-driven investing approach.
11. Waring and Whitney (2009) use a version of the Black (1972) model to make a similar
case; they replace the volatile risk-free asset in the Black model with the liability
variable. This imposes severe constraints on the correlation between the liability
portfolio and other risky assets. In addition, they assume that the investor’s objective
is to maximize surplus, whereas RAPM is focused on maximizing funded status.
This seemingly minor twist has interesting implications for asset allocation and asset
12. Some would argue that Solnik (1974), which allows for a different currency numeraire
to the standard CAPM, is a precursor to RAPM and provides the theoretical basis for
RAPM. This is a fair point: The true contribution of Muralidhar et al. (2014) is not in
the model (because they use a modified version of Reisman and Lauterbach 2002),
but rather in the recognition of the variable and its characteristics in actual investment
decisions. The more interesting contribution of Muralidhar et al. (2014) is probably the
demonstration that the behavioral finance critique—that MPT lacks a reference point
—is validated and reconciled with an MPT approach. They go further to try to show
how MPT might be reconciled to the factor approaches and this will be addressed in
13. Target-date funds are portfolios of stocks and bonds where the allocation to bonds
increases as the investor ages. They normally are referred to by a retirement date
(e.g., 2050), and have a starting allocation to stocks and bonds and then a glide path,
which adjusts this allocation based on the calendar year.
14. Recent lawsuits against university DC plans have focused on how this approach has
led to multiple recordkeepers, in turn raising costs to participants.
15. Consumer Action, a consumer advocacy group, notes that people age 60 and older
make up 15 percent of the U. S. population, but they account for about 30 percent of
fraud victims (see http://www.nasaa.org/1950/senior-investor-alert-free-meal-seminars/).
16. See for example the Public Act for Connecticut ( http://www.osc.ct.gov/crsb/statutory-
language.html). In addition to requiring no liability for the state, it requires low costs, op-
tions for participants with low sophistication, a guaranteed return, and the provision of
an annuity (with survivor benefits). BFFS would be ideally suited for these requirements.
17. See http://www.ssa.gov/history/lifeexpect.html.
18. When an investor has a liability benchmark to meet, the investment decision can be
decomposed into two steps; first, borrow and invest in a liability portfolio to hedge the
liability risks; second, optimize the asset-only type investment decision.
19. See https://www.merkley.senate.gov/news/press-releases/merkley-introduces-major-new-retirement-security-legislation-to-give-every-worker-access-to-a-retire-ment-savings-plan/?utm_source=link&utm_medium=splash&utm_campaign=ASA.