Abstract:
The aim of this study is to investigate whether smoothed bonus portfolios (SBPs) are effective at
managing the investment risk that members of a defined contribution pension fund are exposed
to. Investment risk arises from the uncertainty of the performance of the assets invested in by
the fund during the accumulation phase. This creates uncertainty for a member as to what the
outcome at retirement will be. It is measured as the value at risk as well as conditional tail
expectation, calculated on a member's simulated savings at retirement. The effectiveness of
an SBP is investigated through applying three methodologies, namely 1) a return/risk analysis
where the contribution of each of the features of an SBP to its return and return/risk ratio is
analysed; 2) comparing the simulated outcome at retirement of an SBP with the outcome of
two types of notional benchmark portfolios that apply simpler investment strategies, but are set
up to have the same level of risk as the SBP; and 3) applying first-order stochastic dominance
(FSD) rules.
On a risk adjusted basis, the guarantee and smoothing mechanism of an SBP make positive
contributions to its performance. However, when comparing the outcome of the notional
benchmark portfolios with that of the SBPs, the former consistently outperform the SBPs
modelled. Applying FSD rules, the notional benchmark portfolios are found to be preferred to
a greater extent than the SBPs.
