WO2004081748A2 - Methods of issuing, distributing, managing and redeeming investment instruments providing securitized annuity options - Google Patents
Methods of issuing, distributing, managing and redeeming investment instruments providing securitized annuity options Download PDFInfo
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- WO2004081748A2 WO2004081748A2 PCT/US2004/007363 US2004007363W WO2004081748A2 WO 2004081748 A2 WO2004081748 A2 WO 2004081748A2 US 2004007363 W US2004007363 W US 2004007363W WO 2004081748 A2 WO2004081748 A2 WO 2004081748A2
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- G—PHYSICS
- G06—COMPUTING; CALCULATING OR COUNTING
- G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
- G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
- G06Q40/04—Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange
Definitions
- pension plans have several drawbacks for employees and employers alike: the benefits are not portable, and may be lost when an employee leaves the company; employees have no control over or access to their benefits before retirement; the pension fund could fail if the employer becomes insolvent; and the employer's profits include not only the results from business operations but must reflect the employer's pension fund's investment losses as well.
- “defined contribution” plans have largely displaced pensions. These plans are sponsored by employers but are funded voluntarily by employees. Their strengths include: ease of participation; tax-deferred contributions by employees; full employee ownership (vesting) of their own contributions; portability when changing employment, either to other plans or to Individual Retirement Accounts (IRAs); flexibility in the amount and timing of contributions; borrowing privileges; and choice of investments.
- Deferred annuity contracts are typically sold in exchange for a lump sum premium, possibly with a contract to make additional payments until retirement, and grow at variable rate (sometimes with partial guarantee of rate) until retirement.
- Annuity contracts typically make payments for single life, joint life, or for period certain, with other options for minimum payout and recovery of some amount of cash value.
- annuity contracts exhibit most if not all of the following significant disadvantages: the rates of return is either not guaranteed, or guaranteed only for a short term; annuity contracts are typically complex and hard to understand, making it difficult for most investors to make the sound choices needed to properly fund their retirement; annuity contracts are not liquid and may only be exchanged for a sum which is aptly named the contract's "surrender value;" annuity contracts cannot be altered or exchanged to provide a different maturity in case the investor's seeks earlier or later retirement or otherwise changes plans; and annuity contracts are subject to insurance regulations that vary from state to state, adding overhead and complexity.
- a defined benefit plan there is a party that implicitly guarantees the performance of the investments set aside to fund the liability represented by the future benefits, and that guarantees the payouts that derive from those investments.
- the employer or sponsor of the plan expects the value of labor to meet or exceed the total costs of compensation, including the pension plan.
- a defined contribution plan there is no party that will make such guarantees, unless it has a fair chance of making a profit in return for the guarantee.
- To provide a pension replacement vehicle in a defined contribution plan you must have a guarantee of a minimum rate of return and a minimum conversion of accumulations to payouts (or in the absence of absolute guarantees, a rate of return and conversion in which you can have high practical or statistically measurable confidence). If you know the minimum return and the minimum conversion, then you can express a target or minimum income that will be provided for any given amount today.
- the present invention takes the form of a method for issuing a "Pension Share", which may take the form of a security or a contract, and for managing the investment which funds the obligation represented by the Pension Share.
- the management process consists of an accumulation process and a payout process.
- the accumulation process seeks to meet or exceed a particular net asset value at a specified future maturity date.
- the payout provides the holder of the Pension Share with the option to obtain either a lump sum cash payment or a lifetime annuity, the terms of which are specified by the Pension Share instrument (e. g. paying the holder $1 per month per share for the life of holder).
- Pension Shares can be purchased or redeemed daily at a published net asset value (NAV). Since individual Pension Shares mature at a specified date, they may be exchanged for other Pension Shares having a different maturity.
- NAV published net asset value
- a Pension Share as contemplated by the invention incorporates a "Normalized Annuity Option” (NAO) which is a security or contract that gives the NAO holder the right to purchase a life annuity of specified terms at a defined date in the future for a predefined price, adjusted by age, etc., but not adjusted by population mortality assumptions or interest rates.
- NAO Normalized Annuity Option
- the NAO can be thought of as a call option on a defined annuity product, or, financially, as an interest rate put option and a call option on a population longevity index.
- the seeuritized annuity option clearly reveals the present value of the future choice.
- the NAO becomes an asset, not 5 simply a cost, and the purchase price is set by market conditions and thus 'discovered' and made available to both buyers and sellers to inform their decision making and planning.
- prior deferred annuity products hide the value and do not make that value available to policy holders. Should the embedded annuity option have a market value, the holder cannot realize it except through obscure or complicated arbitrage.
- the securitization of the annuity option provides significant advantages, such as standardization, fungibility, transferability, and preserves the 'anonymity' of the holder until exercise.
- the seeuritized annuity may be advantageously offered in the form of a mutual fund although, as described in more detail below, specific preferred methods of issuing and managing such mutual fund Pension Shares may be employed to comply with applicable
- LCBO internalized longitudinal collateralized bond obligation
- Fig. 1 is a flow chart showing the method or accumulating and paying out a Pension Share which provides a Normalized Annuity Option in accordance with the invention
- Fig. 2 is a flow chart which illustrates the accumulation process employed to securitize the annuity option
- Fig. 3 is a chart graphically depicting factors that influence the pricing of a Normalized Annuity Option (NAO);.
- NAO Normalized Annuity Option
- Fig. 4 shows the distribution of payouts estimated by applying historical interest rates
- Fig. 5 shows a simulation of results for investing $1,000 for 20 years in a portfolio with a mean return of 8% and annual standard deviation of 12%;
- Fig. 6 shows the effect of combining the distributions of accumulations with payouts
- Fig. 7 shows current Benchmark results superimposed on the results of the balanced portfolio
- Fig. 8 shows a simulation of a number of possible outcomes from investing $1,000 for 20 years in a balanced, moderate risk portfolio
- Fig. 9 shows the same results, but with the GRInS Benchmark superimposed;
- Fig, 10 illustrates the probability that the risky portfolio will fall below the Benchmark return, the expected value of returns that fall below the Benchmark, and the average amount of shortfall when it occurs;
- Fig. 11 compares the probable yield from PensionShares with the yield from fixed- income funds (coupon bonds);
- Fig. 12 shows a Web page form displayed by a "Spend It Or Save It" calculator which enables a consumer to compare current dollar savings with the future pension income those savings will provide;
- Figs. 13 and 14 show Web page fo ⁇ ns for a more detailed retirement income calculator.
- the funds which secure the obligation represented by each pension share are managed by a process consisting of an accumulation process and a payout process.
- the accumulation process shown at 13 seeks to produce a particular net asset value at a specified future maturity date 15.
- the payout provides the holder of the Pension Share with the option at 17 to obtain either a lump sum cash payment 19 or a lifetime annuity 21, the terms of which are specified by the Pension Share instrument (e. g. paying the holder $1 per month per share for the life of holder) when issued at 11.
- Pension Shares can be purchased or redeemed daily at a published net asset value (NAV) as indicated at 23. Since individual Pension Shares mature at a specified date, they may also be exchanged for other Pension Shares having a different maturity as shown at 25.
- NAV net asset value
- a Pension Share is an investment product that is packaged as shares or units. More specifically, a Pension Share may take the form of a contract, but is preferably a "security" as 5 that term is used in Article 8, Investment Securities, of the Uniform Commercial Code. More specifically, the term "security” as used herein means a share which is:
- issuer of a Pension Share promises to pay to the holder of the security at a stated maturity date either a predetermined lump sum payment or, in the alternative and at the option of the holder, to pay a sequence of predetermined annuity payments at defined times.
- Pension Shares are issued to holder in advance of the maturity date in return for a purchase price payment.
- pension Shares are fungible, their ownership is not confined to >0 natural persons, and they may be bought, sold, exchanged, and redeemed by the current holder.
- Insurance products are contracts that can simulate many features of securities.
- a variable annuity can work like a mutual fund, with investments held in a separate account, insurance products can even include direct investments in securities, and net asset value pricing (NAV) can be simulated with market value adjustment (MVA) procedures defined 5 in the product.
- NAV net asset value pricing
- securities can simulate features of insurance. For example, put and call options are explicitly treated as insurance instruments; structured securities and mutual funds can have external guarantees, such as 'capital preservation funds' that guarantee your initial investment back; the NAO provides conversion to annuities.
- each type of product can be subject to dual insurance and securities 0 regulation, but the external packaging of the product remains either insurance or security. While the security packaging is preferred for Pension Shares, an insurance product can be constructed that provides most of the same benefits as the security. In the U.S., deferred annuity products have a tax deferral characteristic that the security version would not have outside of a tax-qualified retirement account.
- a deferred annuity could be configured to provide the Pension Shares features of: sold in units of benefits (such as the $1 /month/unit option at maturity) with a target unit lump sum value, flexible purchase at net asset value or a published buy and sell price, flexible redemption before maturity at net asset value or the buy and sell price, maturity easily changed or units exchanged from one maturity to another.
- Such a deferred annuity product would be further enhanced by holder anonymity during accumulation (e.g., removing features such as a death benefit that tie the contract to a particular holder, invade privacy, or otherwise increase the cost of the contract).
- the product could also be enhanced by using an NAO to represent the guaranteed annuity conversion rate of the product.
- the NAO has the advantage that its price can be included in the net asset value unit price or the buy/sell price, thus revealing the value of the option as an asset.
- the traditional practice is that the cost of providing the option is revealed as an expense of (fees charged to) the product, which can leave the underwriter in flexible purchase contracts vulnerable to the annuity option being 'in the money' at maturity.
- the holder cannot easily extract the economic value of an in the money option if he does not want the annuity.
- the entity issuing the Pension Shares is preferably a "transparent issuer" but may be an "opaque issuer.”
- the shares or units represent proportional claims on the assets held by the issuer, such as a mutual fund or collective trust.
- Pension Shares are issued by a transparent issuer such as a mutual fund, they may be readily distributed through conventional channels, such as IRA accounts.
- mutual funds have higher fixed costs and are more closely regulated than are obligations from an opaque issuer.
- a transparent issuer must hold contracts or obligations from an external entity, such as an insurance company, in order to make accumulation guarantees.
- Opaque issuers that represent obligations of an opaque issuer are backed by the issuer's own capital, and accumulation guarantees can be relied upon only to the extent of the issuer's capital and resources.
- Opaque issuers that market Pension Shares have the opportunity for higher profit, since they can keep the residuals if they manage well, but they bring single-firm risk to investors, since failing to manage well will create losses for the firm and it may default on its obligation to the investors.
- the accumulation process which the issuer follows in order to meet the obligations of an issued Pension Share security is selected based on the whether the Pension Share, as issued, specifies that the lump sum amount to be paid is a fixed target, an indexed target, a variable target, or a variable target with a minimum.
- the lump sum is "fixed target”
- the lump sum amount a Pension Share obligates the issuer to pay at maturity is intended to be met exactly and represents a fixed rate of return from the initial purchase of a Pension Share to maturity.
- a transparent issuer of a fixed target Pension Share will accordingly invest in a portfolio with a duration that matches the time to maturity. This can be done with an "immunized portfolio,” with instruments of fixed duration such as zero-coupon bonds, or with investment products with sequential maturities that create the effect of zero-coupon instruments by internal stripping.
- a Pension Share with an "indexed target” is like a fixed target, but the target amount is adjusted in a defined way in accordance with changes to an index value, such as an inflation index, to preserve the purchasing power of the target amount to be paid at maturity.
- an index value such as an inflation index
- an accumulation process is chosen which incorporates investments whose value is more likely to track the selected index, such as U.S. Treasury Inflation-Indexed Notes and Bonds.
- a Pension Share which defines the lump sum payout as a "variable target” does not set a return that can be predicted or managed with any certainty, but rather defines an investment process. Examples of the accumulation process for a variable target payout include investing in stocks or stock indexes.
- a Pension Share may define a "variable target with a minimum" by defining a guaranteed minimum payout that is intended to be met or exceeded if the defined investment process performs well.
- the accumulation process may take the form of a combination of investing in stocks or stock indexes and stock put contracts, index puts, or portfolio insurance wraps.
- variable target When an indexed target, variable target, or variable target with a minimum is used, it is beneficial to the holders to either: a) adjust the number of NAOs per share or unit (buy buying additional NAO units proportionately as performance in excess of the minimum is realized, or b) issuing new shares to holders as a distribution in proportion to the performance in excess of the minimum, or c) using NAOs where the payout and strike are adjusted proportionally with the excess performance.
- a Pension Share may mature at a fixed maturity date, or at a variable maturity date.
- processing at the time of liquidation is significantly simplified and the Pension Shares need not define the manner in which the payout is adjusted to provide a variable maturity.
- Different Pension Shares may have different fixed maturity dates and, a holder can exchange shares having one maturity for shares having a different maturity if the holder's planned time of retirement changes. Alternatively, the holder may redeem shares early to "cash out" and possibly purchase a different investment product if the holder's plans change.
- the simplification provided by a fixed maturity date need not significantly restrict the flexibility that the holder enjoys.
- the lump sum amount may take the form of target amount, a variable amount, or a guarantee amount.
- a range of dates before and/or after the maturity date may be allowed for converting the lump sum into payments.
- the range is desirable to allow individual holders to adapt the payout to their personal situation.
- additional constraints may be imposed to specify any changes or adjustments to the conversion process. For example, before maturity the accumulation process may not have built up a value equal to the lump sum, so the payout would be adjusted pro rata. In practice, if the share value is higher than the lump sum, adjustment higher than the guaranteed payout would not be permitted, to protect the NAO underwriters from the risk of accumulation overruns.
- the target amount is the value resulting from the accumulation process used to manage the fund as described above with the intent that the lump sum will have the target value at maturity, but the target may not be met since the issuer is a transparent issuer and has no resources other than its defined assets to make up any deficiency.
- the target amount paid at maturity may be a fixed target value, an indexed target value, a variable target value, or a variable target value having a "guaranteed" minimum.
- variable amount lump sum payment is simply the accumulated return from the initial investment and has no relation to a target amount, guarantee or "defined amount” (described below).
- a guarantee amount may be either a defined money amount or a defined minimum amount (which a transparent issuer must secure with insurance from a financial guarantor, or which is backed by the full faith and credit of an opaque issuer).
- a defined minimum amount may be exceeded, but only the stated minimum value is guaranteed.
- the holder may elect to convert the lump sum amount into one of three possible alternative forms: a payout security (that is not contingent on the life of the holder); an annuity contract; or an option to obtain an annuity contract.
- the Payout Process The amount of money needed to fund the payout of a Pension Share at its maturity (here called the "defined amount”) is calculated or estimated as a function of: a. the payment amount, b. the initial payment adjustments, c. the periodicity of the payments, d. the conditions under which payments continue, and e. estimates of likely future interest rates and mortality curves available at the time of conversion.
- the "payment amount” may be simply a fixed payment (a defined money amount that is constant for all payments).
- An incrementing payment in which successive payments increase a defined rate (e.g. 3% annually) provides some protection against inflation which is desirable as life expectancies continue to increase. Otherwise, even with moderate 3% inflation, the purchasing power of a fixed payment would drop in half between age 65 and 90; 90 is only about 1 standard deviation above median life expectancy for 65 year olds.
- An incrementing payment is easy to price and build, and is readily understood by Pension Share purchasers.
- the payment amount may be an indexed payment where successive payments are adjusted based on an index, such as an inflation index.
- an index such as an inflation index.
- COLA Cost of Living Allowances
- the Pension Shares may further define initial payment adjustments which, for life-based payments, are adjustments made using a defined table or mathematical function that makes actuarial adjustments to the initial payment amount. These adjustments are typically a function of data such whether the annuity is joint and survivor or single life, and the sex and age(s) of annuitant(s).
- the Pension Shares payout process further defines the times at which payments are transmitted to the holders or beneficiaries (e.g. monthly, quarterly, annually, etc.) and the conditions under which payments continue, including a period certain (i.e. a defined number of payments) or preferably as a life annuity, which may be for a single life, or as "joint-and- survivor" payments that when only one annuitant is alive (e.g. 50%,75%, or 100% of the payment made when both are alive).
- a life annuity may be accompanied by a minimum cumulative payment or minimum number of payments.
- the holder At the time of conversion to an annuity, the holder is allowed to choose between single and joint-and-survivor plans, and whether or not there will be a minimum payment. This choice is one of the factors that affects the amount of payment which is to be made based on the defined value of the Pension Share at the time of conversion to an annuity. Note that, in the United States, retirement plans are required to default to spousal inclusion in benefits; consequently, a joint-and-survivor plan will be used unless the holder affirmatively chooses a different payout process. For simplicity, the preferred "benchmark" terms for payout by a single Pension Share would provide a payment of $1 (one dollar) per month for the joint-and- survivor' s lifetime.
- the present invention takes the form of a method for issuing a new kind of security called "Pension Shares.”
- Pension Shares can be thought of as bundling two components:
- a fixed terminal value component guaranteeing a predefined lump sum value per share at maturity (analogs are zero-coupon bonds or long-term bullet GICs);
- a Normalized Annuity Option (NAO) contract guaranteeing that the lump sum value of the share at maturity can be converted to a joint and survivor life annuity paying $1 per month per share, with the actual payout adjusted based on the ages of the annuitants at conversion. In other words, this is a security that represents a unit of guaranteed annuity purchase rates.
- NAO Normalized Annuity Option
- Normalized refers to the fact that the terms of the NAO are based on circumstances that are hypothetical when the Pension Share is purchased, and defined so that a particular common case results in the $1 per month payout.
- the NAO contract component of a Pension Share is an "option" because the holder is not required to convert the lump sum into the annuity, and may choose instead to take the lump sum as cash.
- NAO Normalized Annuity Option
- the specifications for the Normalized Annuity Option need to be both financially conservative and contractually conservative.
- the NAO should be 'financially conservative' in that it should be easy to value and not be subject to speculative extremes in pricing.
- the implied interest rate of the annuity can be high or low, but low is preferred so that the value of the NAO is a small part of the value of a Pension Share. While the outcomes will be essentially the same, the low rate assumption focuses the holder's attention on the rate of return to maturity without introducing a large element of speculation on interest rates at the time of maturity.
- 'contractually conservative' it is meant that the NAO contract delivered as a result of exercise of the option should be widely available, easy to understand, and writable in all regulatory jurisdictions where the Pension Shares will be sold.
- NAO is included in Pension Shares because it: a) Creates a floor or guarantee the holder can depend on; b) Allows Pension Shares to be priced in a way that is more meaningful than other products (in other words, the share defines the benefit). This meets our goal of providing a defined benefit within a defined contribution plan; c) Has the side effect of creating interest in guaranteed payout products among holders.
- Pension Shares are designed to be attractive at all links in the defined contribution value chain, including the following benefits for NAO underwriters: a) The price of a Pension Share includes a premium for the NAO underwriter; b) The NAO underwriter has a new, very low cost institutional source of demand for annuities. The underwriter's other products will usually be attractive compared to the NAO annuity.
- One feature of Pension Shares is that prior to maturity, an "assignment" process links holders to a single annuity underwriter for all of that holder's shares. This one-to-one retail relationship is an opportunity for the underwriter to market other investment or retirement payout products to the holder. There may be an exception to this, where the shares are pre- assigned when issued, in cases where the plan provider is, or is related, to an NAO underwriter. In that case, the pre-assigned underwriter would be subject to other constraints, such as a requirement to fulfill all demand from its provider.
- a single NAO issuer can be used to advantage. Instead of assignment, all annuities are written by one underwriter, and the annuities are pooled by means of reinsurance. This spreads the risk of annuity default across many insurers, pooling that risk, and makes it true that all holders who take annuities face identical risk. Regulators will see that non-discrimination among holders is important.
- Pension Share portfolios are managed to meet a target net asset value at the defined maturity date which involves a number of challenges, particularly within the mutual fund structure as defined by the Investment Company Act of 1940.
- the procedure begins, as seen at 111 in Fig. 2, by specifying the terms of the Normalized Annuity Option (NAO), an instrument (either a security or a contract) equivalent to the guaranteed annuitization feature of a deferred annuity.
- NAO Normalized Annuity Option
- the NAO grants the owner of a Pension Share the right but not the obligation to buy a life annuity or other payout product on predefined terms at a date in the future regardless of market prices for such annuities at that time.
- the annuity terms which are to be established at step 111 include: a) the maturity date (i.e., date of option exercise); b) a payout table (payout as a function of the number of annuitant(s), their sex, age, etc.); c) the annuity premium; d) the legal features of the annuity contract to be delivered; and e) the underwriting fees, per annuity contract.
- the important item for the portfolio manager is setting the annuity premium, since that establishes the target Net Asset Value (NAV) which is determined at step 113.
- NAV Net Asset Value
- the fund may be administered by active management or alternatively by passive or indexed approaches. Passive management can reduce costs, and the ultimate performance of these products will be very sensitive to costs. Credit spreads historically range from too-low (risk underpriced) to too-high, so there should be opportunities for an active manager to stick with government securities when spreads are low and enhance returns with corporate bonds when spreads are historically high.
- Pension Shares may be funded by (1) "risk-free" assets, (2) insured assets/portfolios, or (3) reserves, or a combination of these.
- peak yields are about 5.40% for 2024 Treasury STRIPS, 5.95% for FNMA 0s of ' 19, and about 7% for 20 year coupon A A financials.
- the horizon for credit or default swaps is currently limited to about 5 years, and there has been no market for insuring corporates for very long terms.
- insurance for municipal bonds exposes 'inefficiencies' in the ratings and pricing of that market, it may be that the price of insurance for baskets of corporates would equal or exceed the spread. Internal reserving would be very efficient, but adds some uncertainty to performance and can make the yield to target NAV look low even if the yield to probable maturity NAV is competitive.
- the cost of managing the fund including shareholder servicing costs and the cost of fund administration, investment management, and transaction costs must also be estimated.
- the foregoing information may be used to calculate the initial share price, Po, using the following relation:
- N m NAO price for maturity pv() present value(future value, periods, rate per period) V m target net asset Value at maturity
- the fund manager must estimate liquidity requirements to meet normal redemptions to a given certainty (e.g., two standard deviations).
- the liquidity requirements estimated at 120 indicate the target allocation to cash and highly liquid securities which is to be maintained in the portfolios
- Method 1 Immunization This method shown at 121 uses traditional techniques for matching the assets held by the fund to the 'liability' implied by the target NAV and maturity date.
- the duration of the portfolio will be managed to equal the time to maturity, so the ultimate value of the portfolio will not be affected by changes in interest rates along the way.
- a prototype allocation within the portfolio includes the following components, listed in order of decreasing liquidity:
- the traditional immunization strategy illustrated at 121 requires that the portfolio be constantly monitored and that its composition be adjusted with changes in the term structure (yield curve). With a static fund that has no cash flows, the manager would need to periodically buy and sell securities to bring the portfolio back to the proper duration. Fortunately, with normal net inflows, the manager can be more efficient by buying additional securities that correct the portfolio's duration without also having to sell other securities, thus reducing turnover and trading costs.
- the portfolio manager also needs to monitor credit quality. Unfortunately, simply selling any asset when it is downgraded cumulatively has the same effect as defaults since the price of the asset drops in the event of, and even before in anticipation of, a downgrade. The manager will need to make judgments informed by quantitative models of the relative value of holding a possibly defaulting asset versus immediately realizing a loss. This strategy will be controlled by requirements of any insurance or credit derivatives used to mitigate default risk, and by the rating agencies if the funds are rated.
- the portfolio is monitored daily (policy enforcements can be performed in real time) in order to: a) maintain liquidity b) keep allocations within predetermined policy limits and regulatory limits c) maintain duration match within limits d) keep portfolio diversified e) monitor and maintain credit quality.
- the second strategy is to use a Collateralized Bond/Debt Obligation structure, where a pool of bonds is shared among the funds in the series (and perhaps external participants). But instead of tranches based on repayment priority, the tranches are based on time: coupons and principal repayments are assigned to the tranche matching the year (or other period) in which they occur. Owners of the tranches therefore get a diversified instrument with a fixed duration (zero convexity). This process is much like 'stripping' of treasuries, with shares of each tranche becoming zero-coupon instruments. Further, this approach scales well, since you can have one very large portfolio instead of 15 to 20 small portfolios. There can be more or fewer portfolios, for longer or shorter terms, based on market acceptance and costs, The scale makes management more efficient and makes diversification easier. Insurance wraps and default swaps can be used to further enhance the effective quality.
- Collateralized bond obligations may have "latitudinal" tranches (conventional repayment priority tranches) as well as time-based (“longitudinal”) tranches as described above.
- latitudinal tranches By employing latitudinal tranches, the CBO does not require insurance or other schemes to be able to issue high quality securities (i.e., a high probability that the securities will be paid off in full).
- FTVs are contracts like bullet GICs, except they are standardized, reinsured for uniform high credit quality, and easily tradable and liquid. FTVs may be traded on an exchange formed to be the issuer and clearing facility for FTVs. In this case, the work of portfolio management would be almost entirely distributed to the underwriting members of the exchange. Bullet GICs with redemption or put features may serve as FTVs.
- Pension Shares would ordinarily consist of "zero coupon” instruments that pay no interest before maturity (or a portfolio otherwise managed to have the effect of meeting the target value as if were invested in zero coupon instruments), and a Normalized Annuity Option (a security or a contract than assures the delivery of annuity contracts to shareholders).
- the accumulation process may take the form of a combination of investing in stocks or stock indexes and stock put contracts, index puts, or portfolio insurance wraps.
- a method for building such a product includes:
- the fund purchases FTVs (Fixed Terminal Value instruments) for the expected term of the investment period such that the FTVs mature with a value equal to the initial fund investment (e.g, if FTV yield to maturity is 5% and the period is 5 years, the fund purchases $0.78 of FTV for each $1 invested in the fund).
- FTVs Fixed Terminal Value instruments
- the remainder of the investment is used to purchase equity index call options (or a call-option-like derivative that participates in the positive returns of some security or asset class with no possibility of a negative value). If the equity index has a negative return by the end of the period, the fund is still worth at least its original value because of the FTVs.
- the call option will have a positive value that is added to the value of the FTV. a.
- Other strategies can be used instead of call options plus FTVs, including "dynamic hedging” b. So far this is the same as structured products, such as MITTS (Market Index Target-Term Securities SM ), index-linked CDs, "principal protection” funds or “principal preservation” funds.
- IPPS Index-Participating Pension Shares
- Variations can include: a. A variable investment period, where the fund manager is allowed to 'reset' the fund according to his judgment and start a new 5-year period (or whatever) before the prior period has ended. This allows him to 'lock in' a portion of the gains that may have occurred. At a reset event, whether early or not, any gains realized can be distributed in the form of additional shares (necessitating the purchase of additional NAOs), which increases the eventual per-share benefit in terms of annuity income. (Actually, this distribution and adjustment can take place any time, such as every year). b. Guarantees or targets of some minimum rate of return. It isn't necessary to have a minimum return of 0%, but higher minimum returns necessarily reduce the amount of participation in the index. c. The index can be based on many things, including baskets of commodities, foreign currencies or investments, or cost-indexes such as an index of college expenses.
- the FTVs can be inflation-adjusting, although there is a component of inflation protection in equities.
- These new methods for Index-Participating Pension Shares allow more retirement saver problems to be addressed, including the desire for 'upside' and intrinsic flexibility regarding changing his expected date of retirement (and annuity conversion).
- NAOs can be more efficiently priced over short periods than over very long periods like 20 years (to the mutual benefit of the underwriter who incurs less risk and the shareholder who pays less for the guarantee).
- GIC Guaranteed Investment Contract
- NAO Guaranteed Investment Contract
- the GRInS Effect is achieved by unitizing and/or future income denomination. While these fixed-income products do not have participation in the upside of equities or other indexes, they do have an upside in that the periodically set crediting rate can be higher than the guaranteed minimum used to calculate the minimum future income.
- IPPS funds when the crediting rate is higher than the minimum, the future income can be adjusted higher through the proportionate purchase of additional NAOs or as a consequence of the higher minimum value at the time of annuity conversion.
- IPPS or COPP fund The general principal of an IPPS fund or of a COPP fund is to participate in upside, but have a NAV and a time defined in the future that holders can have confidence that the NAV will meet or exceed the target at that time.
- Treating the IPPS or COPP fund as having multiple sub- portfolios allows each sub-portfolio to have its own investment period. This is similar to a ) "laddered portfolio" of bonds.
- a laddered IPPS or COPP fund will not have risk that follows the "sawtooth wave” or down-ramping of a non-laddered IPPS/COPP.
- the investment characteristics such as expected return and expected risk are relatively consistent over time, rather than jumping at the end of an investment period.
- the effective time to the end of the investment period now becomes more a constant, and the investment responses more 5 consistent over time.
- the portfolio need not be literally subdivided, but a management method that works the same as the combined effect of multiple sub-portfolios would also work.
- Laddered IPPS or COPP funds have limited downside volatility, they are good vehicles for post-retirement investing. Just as volatility works for a saver during accumulation (additional investments benefit from dollar cost averaging), volatility is very dangerous during ) withdrawals (the effect of withdrawal when prices are low are magnified because the withdrawals consume a larger amount of the assets, which is then not available to benefit from a subsequent rise in values).
- IPPS and COPP funds can be employed in systematic withdrawal plans to form the basis of a non-annuity payout, or employed in an annuity to pool the longevity risk for the benefit of the longer-lived pool members (i.e., like an annuity, payments cease upon death of a pool member, but the assets can then be used to further fund payouts of the surviving members).
- Investment management strategies other than immunized bond portfolios (as in Methods 1 through 3) and call options plus zeroes (as in Method 4) can be employed, such as market neutral or absolute returns.
- Market neutral is simultaneously selling short a portfolio of "overvalued" stocks that correlates with a long portfolio to neutralize market risk; absolute returns are more exotic methods such as shorting the stock while holding convertible bonds of the same issuer. These methods are employed on the supposition that the returns are greater than for long-only strategies with the same level of risk. In either case, if a party can be found who will guarantee a minimum return from either strategy at a cost such that some of the 'alpha' is preserved, then PensionShares products can be made that have higher returns than more conventional approaches.
- a straightforward approach to meeting the target NAV when the ultimate return of assets cannot be guaranteed is to hold assets in excess of the target as indicated at 116. Simply, if the yield to maturity net of expenses indicates that $60 of assets now will meet the target of $200 in twenty years, given a 10%> default estimate, $66 in assets could be held in reserve to allow for defaults and unforeseen adverse events and expenses.
- the advantages are simplicity, understandability and transparency (shareholders will see that this approach increases the likelihood of meeting the target, and gives them an opportunity for additional returns if the reserve is larger than needed).
- the downside to setting aside a reserve is that the apparent return of the shares to target NAV is reduced, and may not be competitive if the comparative analysis is superficial and does not account for default risk.
- Y R [(1 + Y G )" (1 - RDM )] UM - 1 , where YR is Yield with Reserves,
- D M is cumulative default rate over My ears
- R is the Reserve Factor, or the multiple of the cumulative default rate to be reserved, is the number of years to maturity.
- Maturity Date Each Pension Share matures on June 30th of the maturity year for that issue. Adjustments to the lump sum and NAO for holders may be specified for holders who wish to redeem or convert their shares on other dates within the maturity year.
- Lump Sum Amount Each maturity may have a different lump sum amount specified. The lump sum amount is determined based on the cash needed to fund a normalized annuity.
- Payout Adjustments The Pension Share would specify adjustments to the $1 per month per share payout based on the annuitants' age(s) at conversion, relative to the full benefit age. Also, adjustments are specified for a single-life annuity if selected instead of joint-and-survivor annuity.
- Full Benefit Age The Pension Share specifies the age (typically the Social Security Full Retirement Age) of each of two co-annuitants at which the payout will be $1 per month per share. Adjustments are relative to this age.
- Annuity Contract The NAO, if exercised, requires delivery of either a fixed-rate 100% joint-and-survivor immediate Annuity, or a fixed-rate single life annuity, depending on holder's choice, with payout adjusted based on annuitant(s)' age(s).
- the contract is funded by the lump sum amount, which is not adjusted.
- the Pension Share specifies the minimum number of shares (or total lump sum) that can be converted by a holder.
- the Pension Share may specify a defined per-annuity conversion fee that pays the underwriterfor the expenses of issuing and servicing the contract.
- NAO Premium This is the price paid by the Pension Share issuer to the annuity option writer when a Pension Share is issued.
- the Pension Share specifies what happens in the event of unwelcome circumstances (e.g., the NAO underwriter fails to meet certain covenants, such as credit rating, before or at maturity; or the Pension Share fund fails or is prematurely dissolved.
- the master NAO contract is preferably a dynamic or continuous contract, where the balance of the NAOs underwritten can change daily.
- the change in the balance occurs at a price set daily.
- the price is set competitively.
- the fund must hold one NAO unit for each Pension Share or unit issued. This means that the issuer must be able to buy NAOs each business day, and potentially to sell back a portion of the NAOs written on some days, so the balance must be able to contract as well as expand.
- This NAO premium or price is set competitively by normalized annuity option writers, and represents the present value of the risk that at the time of conversion the lump sum will be inadequate to fully fund, in actuarial terms, the adjusted annuity payout. Because the premium is set this way, it doesn't matter if the lump sum is set 'incorrectly'.
- the premium is the market price for the obligation to deliver annuities under the terms of the NAO contract for that maturity, so if the lump sum is set too high, the premium will be low, and vice versa. It can be thought of as a premium for an interest rate put, with a strike equal to the benchmark interest rate implied in the normalized annuity in a particular maturity. It also has an aspect of being a 'call on longevity' for the holder, with a strike equal to the implied median life expectancy in the normalized annuity.
- a is the immediate annuity premium
- age is the annuitants' age at inception of the annuity contract
- q is the mortality table
- load is the expense of writing the contract
- rates a vector representing the yield curve
- spread is the profit spread
- / is the interest rate at the time the annuity commences payments, with duration equal to median life expectancy and x is the median (joint) life expectancy of annuitants (in months in the function notation),
- x is the median (joint) life expectancy of annuitants (in months in the function notation)
- the immediate life annuity premium is approximately the present value of the payments over the median life expectancy.
- the option to purchase a normalized annuity defined with a benchmark interest rate (say, 3%) and life expectancy median assumption (say, 30 years) will be valueless at maturity if prevailing interest rates are greater than the benchmark (and competitive annuities are priced on similar life assumptions), because the holder could buy with the lump sum an annuity on the market that has a higher payout than the annuity delivered by the option.
- an annuity underwriter would be taking a loss to write a normalized annuity contract. Therefore, the NA option behaves like a European-style interest rate put with a strike equal to the benchmark interest rate and a term equal to the maturity. For this discussion we are dropping the load and the spread for simplification.
- a theoretical minimum value of the normalized annuity option can be made from the present value of exercise-probability- eighted cost of funding the annuity when future interest rates are below the benchmark.
- the current price of the option, P may be calculated using the following equation:
- P (1 + if 7 ⁇ Pr(r) r • (pv(r, x,l) - L) — , o " ⁇ where P is the current price of the option, i is the long-term discount rate when the NAO is priced, r is the time to maturity, b is the benchmark interest rate, Pr(r)r is the probability of rates equaling r at maturity, pv(r,x,l) is the present value of the unit payment at rate r, i.e., the market price of the annuity under prevailing interest rates, and L is the lump sum value, defined as approximately pv(b,x,l).
- V(M) ⁇ -L-V(I) .
- a liquid market in this richer set of contracts would allow participating firms to efficiently hedge their portfolio of risks or earn additional income from their asset and liability portfolios.
- NAO is a call on or other derivative of a Normalized Annuity Price Index, an index that tracks the current market price of the benchmark annuity.
- a holder can be sure that no matter what happens, the Pension Shares will have a value at maturity assured to be able to pay for an annuity in the marketplace.
- a service of effecting the. purchase of annuities could be provided separately to shareholders for convenience, but the Pension Share issuer need never directly be involved with annuities, thus possibly relieving Pension Shares security issuers from insurance regulation and licensing.
- the logical counterparties in this alternate NAO would be insurance companies who face the identical financial risk in their ordinary annuity business and can now securitize it (in fact, in a more direct and elegant way than with full NAOs).
- the curve 313 shown in Fig. 3 depicts the historical probability of the interest rate, using Moody' s 10-year AA corporate interest rates as a proxy for the annuitization rate (the vertical axis is unitless for this quantity). In the last century, these rates were below 3% for only 10 years, roughly from 1940 to 1950.
- the curve at 315 is a surmised value to show the reduction in adverse selection in terms of the median life expectancy of the annuitants, in months.
- the curve at 317 recalculates the price of the annuity based on the changed life expectancy assumption. The assertion is that with interest rates falling below the benchmark rate, the annuity option will look increasingly better than the lump sum. The last factor needed to complete the estimation is the probability of exercise shown as curve 319. Since the normalized annuity is defined conservatively, it is not certain that just because interest rates are below the benchmark and the annuity is theoretically a better value than the lump sum, that holders will exercise the option. It may be estimated that exercise rates would rise from less than 10%) at the benchmark interest rate, based on current rates of conversion, to perhaps 80% or 90% when interest rates approach zero. (The scale for this quantity is not shown on the graph.)
- a deferred annuity is an insurance contract in which a premium is paid some time in advance of the commencement of annuity payments. (In an immediate annuity, the payments begin immediately or at the end of the first regular payment interval.) Variations on a deferred annuity include:
- withdrawals (earlier premiums plus credited interest or investment returns may be withdrawn before maturity, or at maturity as an alternative to annuity payments)
- investment returns based on units of investment in vehicles without a fixed return, including stock or bond funds, or investment indexes.
- the investment may be kept segregated in a collective trust or separate account.
- the Normalized Annuity Option allows the features of a deferred annuity to be provided
- the SDA parallels the innovation of the synthetic guaranteed investment contract (synthetic GIC).
- GIC originally was an insurance contract allowing deposits and withdrawals on an account with interest rates (crediting rates) guaranteed for some period.
- a class of investment products including PensionShares, based on the concept of synthetic deferred annuity (SDA), allow the holder to know the minimum value of the investment at the instrument's maturity, and to know the minimum income that the instrument can provide. Since knowing this target value and target or minimum income is important to the plan participant, it is a good idea to periodically report the value and income of the participant's holdings to the participant, or to make such values easily obtainable by phone through a voice response or operator assisted system, by computer via the web, etc.. Especially valuable is to show the value and income in the context of any other holdings. Retirement plans routinely provide reports of current investment holdings to the participants, with the reports showing the individual participant's shares, current values, and other asset balances. Such reports can be extended to show the maturity value and income from that participant's holdings of SDA products.
- SDA synthetic deferred annuity
- Additional features could include estimates based on participant-provided or default assumptions about future investment in the SDA products.
- Interactive computer software can let the user estimate the results of different levels of continued investment, the results of mixing SDA products with stocks, bonds, and other investments, or provide advice on same, or optimize savings rates and allocations including SDA products.
- Investment companies base many of their fees on a percentage of the assets in an account or in a fund. This can be a problem in that many of their costs are fixed or otherwise do not correlate with changes in the market value of the assets managed or serviced. With targeted value investments such as PensionShares, it is possible to base the fees on a constant discount from the target value rather than a current market value, thus removing the variability of the fees paid. This makes for more stable conditions for business planning, and could allow the service providers to offer lower rates since much of the variability of fees has been removed.
- the fees can themselves be converted to assets (managed in the form of securities, or "seeuritized”).
- assets managed in the form of securities, or "seeuritized”
- the management, distribution, custodial, accounting, and other fees are taken from the assets.
- the fees are taken into account when the NAV (net asset value per share) is computed daily. Variability of fees are particularly a problem with targeted value products such as
- Securitization of fees can take place as follows: a contract or security issued such that one unit of the security matches one unit or share of the mutual fund, and represents the obligation of the service provider (issuer) to provide stated services until maturity of the fund.
- the security has a matching maturity or expiration.
- the provider has the right to set the price daily, and the fund has the right to buy or sell (extend or reduce) the number of units outstanding daily.
- the fund can maintain (in fact it must maintain) an exact match between the number of service units held with the number of mutual fund shares that have been issued. Increases in service units requires the fund to pay the provider delta units * price; decreases in units, the provider pays the fund delta units * -price.
- the provider's price can be thought of as the net present value of all future services that are covered by the contract.
- a spread can be allowed to reward the provider for creating liquidity (a spread is a higher price for increasing units than for decreasing units).
- the fund has a target NAV of $200 in 20 years. It simply invests in zero coupon bonds, now yielding 6% for maturity in years. A provider estimates that it will cost $ 1 per year to provide services, and the costs are subject to increases with inflation. It will agree to provide the services for a single payment now of $11.47 (the present value at 6% of $l/year for 20 years). The bonds need to meet a target of $200 are now worth $62.36 (present value of $200 discounted at 6% for 20 years).
- the fund must start by buying $62.36 of bonds for each 5 fund share it issues, and buying one service unit at $ 11.47 for each share it issues.
- the fund has an initial NAV of $73.83.
- a prepaid expense is an asset. This seems weird, what advantages does it have?
- the service provider has locked in a stable source of revenue that doesn't vary with the market price of the assets in the fund.
- the fund can redeem all the services units from the first provider, and buy an equal number from the new provider.
- the difference in price is a profit to the fund, for the benefit of the shareholders.
- This securitization technique can be used in many ways, and is analogous to the !5 securitization of the right to annuitize in the NAO, which would ordinarily be thought of as a continuing expense in a deferred annuity contract.
- the combination of a guaranteeable rate of return on investment accumulation coupled with an optional conversion to a guaranteeable payout is very powerful, particularly when the investment is liquid during the accumulation. Further, unitizing the relationship between the payout and the current value during accumulation has the benefits of making the liquidity practical (i.e., additions or withdrawals can be made in terms of units or shares) and in exposing the value of the investment in a new and useful way: the investment can be said to be denominated in terms of future income (the payout) as well as a value today.
- the unitized relationship facilitates reporting of the future payout to the investor, and enables the investor to make informed savings vs. consumption decisions without having to consult a financial planning calculator.
- the unitized relationship can be expressed such as "an income of $ 1 per month for life costs $60 today; $60 today is worth at least $1 per month for life of retirement income". (The example assumes a retirement age of about 65 in 20 years, with guaranteeable compound accumulation rates of about 6.2%.)
- Financial instruments that benefit from this effect of relating future income to current values can include but is not limited to securities such as mutual funds, insurance products such as deferred annuities, and accounts such as a retirement account or bank account. Further, some of the benefits occur even without a financial instrument; later, we detail a Benchmark which estimates the relation for various horizons into the future, allowing very easy savings/consumption planning and enabling a new understanding of the nature and impact of investment risk.
- Unitization and the expression of products as shares or units is not necessary for liquidity of financial products, but it is a good model for implementing products and to aid investor's understanding of the products and the liquidity feature.
- the first category has the practical risk that from time to time, institutions that have guaranteed results will fail and must default on their obligation. In these cases, some or all of the value of the guarantee or the guaranteed investment can be lost.
- the second category is subjective, but we mean that the probabilistic distribution of likely outcomes is at least asymmetrical, and, preferably, has a pronounced "cliff in the distribution. For example, a combination of a long position in a security and a put contract on the same security can be said to have a distribution of ultimate values, none of which are less than the strike price of the put contract (net of expenses to exercise, etc.). However, in extreme situations, the put contract writer could fail and other obligated institutions could also fail, in which case the ultimate value is less than the strike. So rather than a cliff distribution with nothing to the left of the cliff, there is a distributional "rubble" at the foot of the cliff to represent the extreme outcomes.
- Another way to quantify guaranteeability could be in the form "a less than x% chance of falling below result R, and the conditional tail expectation (the distribution-weighted average value of outcomes below R) is greater than y% ofR.
- a deferred fixed-rate annuity can include a guaranteed accumulation return and an option guaranteeing conversion to payout at predetermined minimum rates.
- Such products can include liquidity features such as the ability to add to or withdraw from the investment where the guaranteed accumulation is subject to a "market value adjustment" which reflects current interest rates at the time of the addition or withdrawal before maturity.
- NAOs use of NAO contracts or securities to provide the payout conversion option, with the other benefits of financial transparency provided by NAOs
- a deferred variable annuity can include a guaranteed accumulation return and an option guaranteeing conversion to payout at predetermined minimum rates (frequently referred to as Guaranteed Minimum Accumulation Benefit and Guaranteed Minimum Income Benefit, respectively).
- Such products can include liquidity features such as the ability to add to or withdraw from the investment. To products like this we add one or more of:
- variable annuity products the investor is allowed to choose and from time to time to
- variable returns assets, indexes, or formulas with variable returns
- other instruments may reflect direct ownership of underlying assets, ownership of derivative securities or contracts, or may reflect an obligation of the issuer to track the performance of
- the guaranteed accumulation and guaranteed income conversion have a fixed price (in percent of assets charged per year) and a fixed rate (e.g., 3% per year). Since the investor can choose the allocation and timing, within limitations, the guarantor is facing risks for which he may not be adequately compensated (many untrained investors
- a preferred implementation would allow adjustment of pricing or guarantees based on the measurable risk of the guaranteed portfolio.
- the guaranteed portfolio can be the variable
- a good addition would be to publish or provide the prices and/or guarantee rates given a hypothetical allocation so that the investor could make an informed decision.
- Another preferred implementation would be to apply separately priced and separately set guarantees on each investment option available within the annuity. This model could also be
- a PensionShares mutual fund based on a defined portfolio which can be a managed portfolio or an index.
- the guarantee can be to a maturity, or their can be a series of guarantee periods. In the presence of a payout guarantee, these products can be future income denominated.
- the accumulation is defined by a formula based on the performance of some other investment instrument, usually an index such as the S&P 500.
- the formulas that define the return to the annuity holder typically could be a dynamic hedge, of which option pricing models are an example. This means that the annuity issuer can easily implement a hedge against the liability represented by the income due to the annuity holder.
- the IPPS funds discussed elsewhere can be thought of as seeuritized versions of an equity-indexed annuity. Using the techniques of IPPS and COPP brings liquidity features to such equity- indexed annuity products. Further, the investment in the annuity can be contained in a separate account or trust to provide transparency and limit the risk of default by the issuer.
- Retirement benefit statements can include forecasts of retirement income based on reasonable assumptions. When there is an external guarantor of results, such as a the sponsor of a defined benefit retirement plan, the user can look at such forecasts with whatever confidence is inspired by the creditworthiness of the sponsor. Investment returns may not even be an assumption in determining the outcomes. However, if there is no guarantor and the outcomes depend on the investment results of assets with variable returns, such as stocks, then a hypothetical illustration of outcomes becomes very sensitive to assumed returns, and the statement may have no way of adequately expressing the downside risks of variable returns.
- an annuity Most of the financial instruments described here include an option to convert the accumulated value to a stream of payments (an annuity). Variations on these instruments can be made where the annuitization is not an option. These could still allow discretion as to timing of the conversion which may occur at times other than a set maturity date, usually with a concomitant adjustment in the payout based on normal actuarial procedures and based on the actual accumulated value. These mandated conversion instruments have the advantage that the payout rates can be higher than with optional convertibility. This is due to the fact that any option has a cost, and removal of the option eliminates adverse selection. Such instruments 5 necessarily have reduced liquidity, since being able to liquidate, redeem, or withdraw funds from the instrument before conversion in effect recreates the option to not annuitize. A useful feature with such instruments is to structure the annuity to have a guaranteed minimum total payout to address those purchasers who would have concerns about not living to receive at least that minimum payout which is one cause of adverse selection in annuity options.
- a retirement funding benchmark will both show savers an alternative with certain outcomes and place it in the context of their individual risk sensitivities.
- the benchmark will allow us to estimate the certain price of retirement income for retirement savers. Estimates can be made for the past (e.g., what was the risk-free retirement funding performance for savers in 1980 expecting to retire in 2003), but more interestingly, we can make estimates for the future, with these benefits:
- ⁇ a saver can know the amount of a risk free retirement income given an investment today
- ⁇ a saver can measure the impact and probability of shortfalls that occur from higher return but higher risk strategies.
- the Benchmark is simply a determination of the present cost of providing a unit of life income with quantifiable, limited risk of shortfall. A few items must be specified:
- each unit of life income is funded with a single investment.
- the benchmark value for a particular year is the present price of the unit of income, which can also be expressed as the expected yield to maturity.
- the unit we choose is $1 /month, so that the result most closely matches the environment in which retirement savers do their planning (i.e., monthly budgets).
- a retirement saver now has a beacon shining through the fog of uncertainty.
- the Benchmark shows what can reasonably expected for retirement income without shortfall.
- As the "risk free" retirement result it also works as a comparison for strategies with a higher risk of shortfall.
- a saver involved in a higher risk investment program, but who is especially sensitive to the risk of shortfall can quantify that risk and compare uncertain, risky outcomes with certain, relatively riskless outcomes.
- the mean- variance framework allows us to estimate distribution of outcomes of an investment program, as do related simulation techniques. This is easy for the accumulation phase before retirement, but the retirement event requires an important decision for most savers regarding the continued management of the investments: should any or all of the accumulated savings be annuitized? After all, a life annuity is the way to guarantee lifetime income.
- the saver can reasonably expect the assets to last through retirement, and can contemplate continued direct investment. However, if the assets are below this level, the saver should consider annuitization to avoid longevity risk. Statistics show that the majority of retirement savers fall into the latter category.
- Figure 4 shows the distribution of payouts estimated by applying historical interest rates with a minimum of 3%. The minimum payout is $ 1/month and the average is $1.36.
- Figure 5 shows a simulation of results for investing $1,000 for 20 years in a portfolio with a mean return of 8% and annual standard deviation of 12%, a plausible expectation for a 50/50 equity/fixed income portfolio. This "conservative" approach still has tremendous variation in terminal wealth.
- the Benchmark shows at any time what a saver could reasonably expect as a minimum retirement income result, and the saver can compare that guaranteeable minimum with his alternatives, and make a judgment for himself as to the impact of shortfalls below the Benchmark or risk free retirement income result.
- the advantage of the Benchmark is that the minimum or guaranteeable retirement income can be known with high certainty at any time, while the portfolio of "mean-variant assets” will always be a probability distribution with a wide range of results even for very conservative portfolios. This helps "value” the two strategies at any time.
- Investment science such as it is currently, doesn't let us move the portfolio distribution curve up or down based on current market conditions, though most investment managers will always have an opinion about which side of the scale to rest their thumb.
- the Benchmark minimum is an observable fact at any time.
- the Benchmark yield to maturity is a close approximation of the "risk free" rate of return for retirement savings.
- the risk free rate should match the period of analysis. If you consider time to retirement as the period, then the risk free rate is not the Treasury bill rate used in most such analyses, but a zero-coupon instrument or an immunized fixed income portfolio with duration matching the period.
- a retirement saver will have two concerns:
- Fig. 8 shows a simulation of a number of possible outcomes from investing $1,000 for 20 years in a balanced, moderate risk portfolio. The investment growth is shown year by year. We express the results not in dollars accumulated but in retirement income (dollars per month). Notice the wide range, with most results falling in the range of about $10 to $30/month for the $1,000 invested.
- Fig. 9 shows the same results, but with the GRInS Benchmark superimposed. While the risk portfolio might provide higher outcomes, it can just as well provide worse outcomes. If you need a certain income, and would be damaged by a shortfall, you can vastly increase your confidence in a retirement plan by investing like the Benchmark.
- the advantage of the Benchmark is that the minimum or guaranteeable retirement income can be known with high certainty at any time, while the income resulting from a portfolio of "mean-variant assets” will always be a probability distribution with a wide range of results even for very conservative portfolios.
- the comparison helps "value" the two strategies at any time.
- Investment science such as it is currently, doesn't let us move the portfolio's distribution curve up or down based on current market conditions, though most investment managers will always have an opinion about which side of the scale to rest their thumb.
- the Benchmark minimum is an observable fact at any time.
- the Benchmark in its yield to maturity form helps savers allocate between equities and fixed income, by exposing a dramatic measure of the price of risk. Sometimes, the risk free alternative will stand out; sometimes, the risky portfolio will look better. At all times, though, the saver can view the probability and impact of shortfalls.
- Benchmark return for the same horizon can be used to show both:
- a saver could see that there is a 40% chance of shortfall, and the average shortfall, expressed in retirement income, is far below needs. That saver could shift assets to a vehicle or strategy that implements the methods the of the Benchmark. Another case could be that the saver sees a probability of shortfall of less than 10%, and determine that that probability is small enough to justify the higher expected returns and income from a riskier strategy. The problem is that while the Benchmark outcome is knowable with high confidence, the risky returns are by definition not knowable. Further, in this application of estimating risk and degree of shortfall, the expected mean and variance of the risky returns are critically important.
- PensionShares will be offered by a series of mutual funds. Each fund has a stated maturity and a target net asset value at that maturity. At maturity, the shareholder can redeem the net asset value in cash or convert to the annuity. As mutual funds, PensionShares are liquid (purchasable or redeemable daily), and the structure is transparent, meaning that shareholders can 'see' the assets of the fund that back up the shares' net asset value. Our research shows that ordinary plan participants easily understand the concept and like it.
- Figure 11 compares the income results from a portfolio that includes 50% PensionShares (green), versus the portfolio of mean- variant assets (red). Shortfalls below the benchmark return, occur, but the impact of the shortfalls has been sharply limited.
- the benchmark can be computed historically (i.e., what was the risk free return/income estimate for retiring in 2002 in the year 1982), but is most interesting because it is a forward looking benchmark, were most benchmarks are descriptions of the past.
- the benchmark can be computed and published at regular, frequent intervals. Such publication would include a range of maturities such as 1 to 30 years, or every 5 years, etc..
- Benchmark Appendix 1 Construction of the GRInSTM Benchmark
- Annuity price is a function primarily of two inputs: a mortality curve and an interest rate yield curve. The price must also include the overhead costs of administering the annuity, a profit for the underwriter, and an adjustment for adverse selection (assuming that the retirement saver will have an option to not annuitize his savings, but rather take a lump sum for alternate investment or spending).
- annuity price we can simplify it to a function of median life expectancy from the benchmark age and the interest rate for that duration.
- the benchmark age will be defined as the 'normal retirement age', which has been 65 in the U.S., but is increasing; we will use the Social Security full-benefit age for future years. Users of the benchmark will understand that the actual payout is adjusted for the age, number, sex, and perhaps other factors true of the annuity beneficiaries at the time the annuity begins. How can the mortality curve be estimated in the future? What if there are significant advances in healthcare that dramatically alter life expectancies? We should remember that the fountain of youth scenario is offset by some other possibilities, including decreased life expectancy due to the side effects of obesity, and new infectious diseases rapidly spread through increased world travel. These are real concerns, but insurers are already taking and pricing that risk, which is all we need for the Benchmark.
- the fixed income returns include a premium for the market's estimate of inflation.
- a practical, easy-to-build and price annuity would feature 10 escalating payments.
- a 3% annual step in payout would mitigate the effects of inflation for annuitants who live beyond the median life expectancy for all but the worst historical periods of inflation.
- the price today for a couple's (both age 67) retirement income of at least $ 1/month 50 (100% joint and survivor) beginning in the year 2023 is about $68.15 today (October 31, 2003).
- the actual payout could be higher, based on interest rates prevailing in 2023.
- This price includes an option to take a lump sum of $210.88 for spending or alternative investment.
- the payout would be subject to standard adjustments based on the actual ages of the couple, and would be higher for a single person. 5 Once the details are understood, this could be shortened to "the standard price of
- $ 1/month retirement income in 2023 is now about $68.15", or a yield to maturity in 2023 of 5.81%.
- this includes estimates of:
- GRInSTM Guaranteed Retirement Income Security
- FIG. 12 shows the screen display form presented to the consumer. This calculator is intended to help the consumer make savings decisions and understand the value of what they have already saved.
- the consumer enters her current age at 1201, a currently available sum in dollars that might be saved or spent at 1203, and the calculator then displays the equivalent monthly retirement income at 1205 which that sum would generate if invested in GRInS PensionSharesTM.
- FIG. 13 A Detailed GRInS Benchmark Retirement Income Calculator is illustrated by the Web forms shown in Figs. 13 and 14. This calculator provides an interactive way for the consumer to see a more comprehensive estimate of the retirement income that would be produced by current savings.
- the consumer first enters background information in Step 1 as indicated at 1301, including the years in which she and her spouse were bom.
- the calculator then inserts default values for their assumed year of retirement and their respective retirement ages, but these default values may be overridden if desired.
- Step 2 as illustrated at 1303, the consumer enters a current investment amount to see the Benchmark monthly income, or in the alternative, enters a desired monthly income to see the current investment that would be required to fund such an income.
- Step 3 shown in Fig. 14, the manner in which investment in a PensionShares fund can be used to lock in a desired income is described, and the calculator displays (1) the year in which the fund will mature, (2) the current estimated price per share, (3) the estimated yield the fund will realize to maturity, (4) the target lump sum value each share at maturity, and (5) the target minimum monthly pension payout per share, adjusted for the number of beneficiaries and their ages at maturity.
- Fig. 15 shows a Web page which provides periodically (e.g., daily) updated information to consumers on the yield to maturity and current price of a $ 1/month pension payout. This GRInS Benchmark estimate provides information regarding the "guaranteeable" rate of return on the customers savings, and the minimum income those savings can provide.
- the preferred method for creating the duration-specific portfolios needed to back Pension Shares utilizes, as its basic component, a Fixed Terminal Value (FTV) security with standardized features regarding maturity and creditworthiness.
- FTV Fixed Terminal Value
- the FTV component of a Pension Share is a zero-coupon bond.
- FTVs can be written by underwriters such as insurance companies, or can be created as asset-backed securities (ABS).
- ABS asset-backed securities
- An exchange mechanism may be employed to aggregate raw FTV-like contracts or securities, reinsure the pools against default risk, and write standardized, insured FTVs for use by Pension Share issuers.
- CDOs are structured investment vehicles that allow the "tranching" of risk attributable to a portfolio of fixed income securities.
- the capital structure of a CDO closely resembles that of a conventional finance company or a bank in that it typically consists of senior and subordinated debt, as well as equity.
- Substantially all of the debt issued by a CDO is typically rated by one or more rating agencies and is secured, in order of priority, by the underlying portfolio, which is frequently referred to as "collateral.”
- a CDO manager is responsible for selecting and monitoring the credit quality of the portfolio during the life of a CDO.
- the term “longitudinal” refers to the fact that the tranches are segregated by maturity rather than by repayment seniority.
- the stripping function of the Longitudinal CDO can be accomplished by cooperating Pension Share issuers. While it is less elegant for the Pension Share issuers to be performing these functions (an issuer is expected to be a mutual fund, and the process seems excess for a mutual fund), it should avoid prohibited related party transactions.
- a Pension Share issuer can simulate the purchase of FTVs by managing a pool of non- callable fixed-income securities, insuring the pool against default risk, and selling any coupons or principal repayments that are not needed to back that issuer's particular Pension Share maturity.
- Multiple issuers may cooperate in the sense that, since they are each issuing a different maturity, each can use the parts of the portfolio that the more distant maturity issuers sell.
- the 2022 fund will sell the coupons due in 2021 for $51,220 (the present value of the $129,429 in coupons discounted at 5%).
- the fund sells the 2020 coupons for $53,780, and so on down to the first coupons payable.
- the total receipts for the stripped coupons are $1,693,620, which happens to equal $2,693,620 minus $1,000,000. So the fund has a net investment equal to the inflow (the net share purchases for the day), and at maturity the fund has $2,693,620 in principal, the face amount of the bonds, to pay the lump sum amount for that day's newly issued Pension Shares (a 5% return compounded).
- the 2021 fund is a buyer of the 2021 coupons, but still has $948,780 to invest. It buys $2,564,190 face amount of bonds due in 2021, and repeats the same stripping process as the 2022 fund. And so on down to the nearest maturing fund.
- a three- or even four-tiered portfolio may be needed consisting of cash, a Zeroes Portfolio of treasury and agency zero- coupon STRIPS, a Core Portfolio of insured corporates and forward contracts and liquid FTVs, and illiquid no-put FTVs and Bullet GICs (Guaranteed Investment Certificates).
- the redemption fee can be smaller than 1 %.
- To estimate the minimum fair redemption fee use a relation such as: ⁇ >j s(r d )
- K is the redemption cost estimated by looking ahead (or back) n days and taking the net redemption dollars r times the average asset-price spread encountered to meet that level of redemptions s(r) as a ratio to all redemption dollars R that day.
- the size of the fund has an impact on the allocation, so that a fund with only $1M in assets would be required to hold all cash and STRIPS. It will be important to grow the assets quickly to minimize the percentage of inefficient, low yield assets.
- the Zeroes portfolio needs to be only large enough to meet the maximum short-term cumulative net redemption discussed above, i.e., it acts as a buffer to protect the Core portfolio from inconvenient or untimely redemptions.
- the Core portfolio will preferably be the largest component and will consist of diverse investment grade corporate bonds and duration-matched forward contracts.
- the bonds are stripped by selling the coupons as forward contracts.
- the forward contracts for a particular fund are bought from longer maturity Pension Share funds or third parties willing to meet the credit requirements and contract terms, and sold to third parties or Pension Share funds with nearer maturities.
- the corporate bonds (and the bonds' coupons) are insured against default by financial guarantors.
- the corporate bonds will be limited to 5% of the fund's total portfolio in any one bond issuer. The guarantor may have additional requirements and limitations.
- the forward contracts are simply a payment now in exchange for a single repayment at a specific date in the future.
- the contract is backed only by the insured Core portfolio, and not by the full faith and credit of the fund, so that the contract defaults if some securities in the Core portfolio default and the guarantor also defaults.
- a forward contract backed by the coupons of diverse issuers may also be considered diverse by regulators.
- the fund can maintain a limited illiquid portfolio, in order to benefit from higher yields on illiquid contracts for long-term debt.
- the portfolios will contain a portion of highly liquid and efficiently traded securities to meet the majority of days with net redemptions;
- the fund can impose a redemption fee that is paid into the portfolio.
- the redemption fee probably does not have to be large to protect the fund and the remaining shareholders.
- the fee can be estimated based on the probability of days of net redemption, and the mix of assets in the fund, as described above. It is estimated that the fee need only to be a fraction of 1%, but may be set to 1% to emphasize the long-term character of Pension Share investments.
- the redemption fee may be made inapplicable to exchanges between Pension Share funds, as exchanging is likely to be an important feature for shareholders, and because exchanges will tend to balance out. However, some limit on the number of exchanges will be needed; otherwise, someone intent on using Pension Shares for interest rate speculations could switch between the nearest maturity as a cash equivalent and the farthest maturity as a way to short rates.
- NAOs Normalized Annuity Options
- the standard contract between Pension Share funds and the NAO underwriters that creates NAOs will need to specify terms for premature redemption or a put feature.
- the underwriters will create a market by publishing competitive bids and offers for new NAO units. Each business day, the inside spread set by the underwriters is used to value the NAO units held by the funds.
- NAO spreads are large (10% or more?) and NAO values become large compared to the NAV. For example, if long-term interest rates drop to 0%, the NAO will be worth about $50 compared to the lump sum value of $200-250, so the NAO spread itself would be around 1% of NAV. Note that in the U.S., historically, the lowest long-term rates for valuing NAOs has been about 2.5%.
- the Fund seeks to preserve principal and achieve a target payout to shareholders upon the Fund's planned liquidation in 2022.
- the Fund invests primarily in a combination of- o Zero coupon bonds and other instruments known generally as "STRIPS" - investments based on the separately traded interest and principal components of securities issued by the U.S. Treasury or U.S. Government agencies and guaranteed by the full faith and credit of the U.S. Government.
- STRIPS Zero coupon bonds and other instruments
- o Investment grade fixed-income securities such as long-term corporate bonds and other corporate fixed-income obligations.
- Investment grade bonds are those rated Baa3 or better by Moody's Investors Service, Inc., BBB- by Standard & Poor's ("S&P”), or the equivalent by another independent rating agency.
- the Fund will purchase sufficient options for future delivery of annuity life insurance policies to provide the Shareholder Annuity Option described below.
- the Fund's investment adviser manages the Fund's portfolio to achieve a minimum target payout of $197 per share at the time of the Fund's planned liquidation on June 30, 2022, which is referred to in this prospectus as the "Fund Maturity Date".
- the target payout while not guaranteed by the Fund, is supported by a conservative investment philosophy of investing substantially all of the Fund's portfolio in a combination of U.S. Government and related securities, and investment grade fixed-income securities and related instruments.
- the ability of the Fund to achieve the target payout is further enhanced by the Fund's purchase of insurance supporting the credit quality of certain of the non-U.S. Government fixed-income securities in the Fund's portfolio. This insurance essentially insulates these investments from the types of credit risks described below.
- the Fund's investments are focused on achieving the minimum target payout on the Fund Maturity Date, and are managed without regard to current income.
- the option to purchase a life annuity contract paying $1.00 per month for each share you own is based on two assumptions in addition to your Fund achieving its minimum target payout: (1) that there are two spousal annuitants (or beneficiaries), and (2) that both annuitants are [67] years old on the Fund Maturity Date. Your actual contract payments will be adjusted based on your situation at the time the contract is issued. For example, if you are single with no spousal beneficiary, the contract payments will be increased. Likewise, if you older than [67] the payments will be increased, but if you are younger than [67] the payments will be decreased.
- the Funds are designed with the expectation that most investors will choose a Fund with a Fund Maturity Date closest to the time when they will actually turn 67 to minimize the adjustments to the annuity contract payments from $ 1.00 per month per share.
- the table below shows in more detail how any adjustments will be made.
- Credit risk which is the chance that a bond issuer will fail to pay interest and principal in a timely manner. Credit risk should be low for the Fund because it invests mainly in U.S. Govemment securities and corporate bonds that are considered investment grade.
- the Fund may at times purchase insurance supporting the credit quality of certain of the non-U.S. Government ) fixed-income securities in the Fund's portfolio. This insurance essentially insulates these investments from credit risk.
- Liquidity risk which is the risk that certain securities held by the Fund may be difficult to sell for a variety of reasons, such as the lack of an active trading market.
- the Fund may be a suitable investment for you if you -
- a redemption fee is assessed by the Fund as follows: 1% on all redemptions prior to [June 30, 20 ], 0.75% on all redemptions prior to [June 30, 20 ], and 0.5% thereafter on all redemptions prior to June 30, 2022.
- the redemption fee does not include a one time service fee of up to [$500] that may be assessed by the insurance provider for each annuity life insurance contract you purchase following liquidation of the Fund.
- the Funds' Board of Trustees which oversees the Funds' investment adviser, may change investment strategies or policies without a shareholder vote, unless those strategies or policies are designated as fundamental. Note that each Fund's investment objective is not fundamental and may be changed without a shareholder vote.
- the balance of the prospectus includes information on other important features of the Funds.
- INVESTMENT STRATEGIES AND PORTFOLIO MANAGEMENT The investment adviser manages each Fund's portfolio to protect principal while achieving the target payout for that Fund at its planned liquidation date (June 30 of the year for which the Fund is named), as described above in the Fund's summary under "Principal Investment Strategies".
- substantially all of a Fund's portfolio will be invested in a combination of cash, U.S. Government securities, investment grade corporate bonds, and related derivative securities (generally forward contracts for bond coupon payments). These investments are meant to financially replicate a "zero coupon" security sufficient in value to at least meet the target payout.
- the expected likelihood of a Fund achieving its target payout is based on the ⁇ conservative use of investments described above, and is further enhanced by the Fund's purchase of insurance supporting the credit quality of certain of the non-U.S. Government fixed-income securities in the Fund's portfolio. This insurance essentially insulates these investments from the types of credit risks described below.
- Each Fund will purchase sufficient options for future delivery of annuity insurance i policies to provide the Shareholder Annuity Option. Absent unusually low market interest rates at the time of the Fund Maturity Date, the value of these options is not expected to represent a significant portion of the value the Fund's portfolio. The options will be issued by various insurance providers selected by the Fund's investment adviser.
- a Fund may use derivative securities for other non-speculative purposes as described ) below under "Derivatives Risk”.
- the Funds are generally managed without regard to tax ramifications.
- Each Fund may temporarily depart from its normal investment policies - for instance, by allocating substantial assets to cash investments - in response to extraordinary market, economic, political, or other conditions. In doing so, the Fund may succeed in avoiding losses but otherwise fail to achieve its investment objective.
- the Funds invest mainly in bonds. As a result, they are subject to certain risks. Bonds And Interest Rates o As a rule, when interest rates rise, bond prices fall. The opposite is also true:
- Bond prices go up when interest rates fall. Therefore, each Fund is subject to Interest Rate Risk, which is the chance that bond prices overall will decline over short or even long periods because of rising interest rates. Depending on the planned liquidation date of a Fund, Interest Rate Risk will tend to vary ⁇ it should be low for short-term Funds, moderate for intermediate-term funds, and higher for long-term Funds. o Why do bond prices and interest rates move in opposite directions? Let's assume that you hold a bond offering a 5% yield. A year later, interest rates are on the rise and bonds of comparable quality and maturity are offered with a 6% yield. With higher-yielding bonds available, you would have trouble selling your 5% bond for the price you paid— you would probably have to lower your asking price. On the other hand, if interest rates were falling and 4% bonds were being offered, you should be able to sell your 5% bond for more than you paid.
- a bond's credit quality depends on the issuer's ability to pay interest on the bond and, ultimately, to repay the principal. Credit quality is evaluated by one of the independent bond-rating agencies (for example, Moody's or Standard & Poor's). The lower the rating, the greater the chance - in the rating agency's opinion - that the bond issuer will default, or fail to meet its payment obligations. All things being equal, the lower a bond's credit rating, the higher its yield should be to compensate investors for assuming additional risk. Bonds rated Baa3 or better by Moody's, BBB- by S&P, or the equivalent by another independent rating agency are considered investment grade and are eligible for purchase by the Funds. o All of the Funds are therefore subject to Credit Risk, which is the chance that a bond issuer will fail to pay interest and principal in a timely manner.
- Moody's or Standard & Poor's The lower the rating, the greater the chance - in the rating agency's opinion - that the bond issuer will default, or fail to meet its payment
- a derivative is a financial contract whose value is based on (or "derived” from) a traditional security (such as a stock or a bond), an asset (such as a commodity like gold), or a market index (such as the S&P 500 Index).
- a traditional security such as a stock or a bond
- an asset such as a commodity like gold
- a market index such as the S&P 500 Index.
- Some forms of derivatives such as exchange-traded futures and options on securities, commodities, or indexes, have been trading on regulated exchanges for more than two decades. These types of derivatives are standardized contracts that can easily be bought and sold, and whose market values are determined and published daily.
- Nonstandardized derivatives (such as swap agreements or forward contracts), on the other hand, tend to be more specialized or complex, and may be harder to value. If used for speculation or as leveraged investments, derivatives can carry considerable risks.
- the Funds will use forward contracts based on the interest coupons payable on investment grade corporate and other bonds.
- Forward contracts, futures, options, and other derivatives may represent up to [ ]% of a Fund's total assets.
- these investments may be in bond futures contracts, options, credit swaps, interest rate swaps, and other types of derivatives. Losses (or gains) involving futures can sometimes be substantial - in part because a relatively small price movement in a futures contract may result in an immediate and substantial loss (or gain) for a Fund. Similar risks exist for other types of derivatives.
- a Fund may invest in futures, options and other derivatives to keep cash on hand to meet shareholder redemptions or other needs while simulating full investment in bonds; to reduce the Fund's transaction costs; for hedging purposes; or to add value when these instruments are favorably priced.
- Illiquid securities are securities that a Fund may not be able to sell in the ordinary course of business. Each Fund may invest up to 15% of its net assets in these securities. Restricted securities are a special type of illiquid security; these securities have not been publicly-issued and legally can be resold only to qualified institutional buyers. From time to time, the Board of Trustees may determine that particular restricted securities are NOT illiquid, and those securities may then be purchased by a Fund without limit.
- Management Risk is the risk that the Fund's investment adviser may choose not to use a particular investment strategy or type of security for a variety of reasons. These choices may cause the Fund to miss opportunities, lose money or not achieve its investment objective.
- Portfolio Turnover o Although the Funds normally seek to invest for the long term and portfolio turnover is not expected to exceed 100% annually (and may be much lower), each Fund may sell securities regardless of how long they have been held. Portfolio turnover contributes to transaction costs, such as brokerage commissions, that may affect a Fund's performance. Higher turnover rates may also be more likely to generate capital gains that must be distributed to shareholders as taxable income.
- Each Fund reserves the right to reject any purchase request - including exchanges from other Funds - which it regards as disruptive to efficient portfolio management. A purchase request could be rejected because of the timing of the investment or because of a history of excessive trading by the investor.
- Each Fund limits the number of times that an investor can exchange into and out of the fund (presently once in any 12 month period).
- FUND DISTRIBUTIONS Each Fund distributes to shareholders virtually all of its net income (interest less expenses), as well as any capital gains realized from the sale of its holdings.
- the Funds' income dividends accrue daily and are distributed, together with capital gains, once each year in December.
- the Funds may occasionally be required to make supplemental capital gains distributions at other times during the year.
- the share price decreases by the amount of the per-share distribution.
- Your distribution is automatically reinvested in the Funds 5 shares, so that your total Fund holdings have the same value as before the distribution.
- the Fund's Board of Trustees also declares a reverse share split that offsets the per-share amount of the distribution. This is important so that the target payout and the monthly benefit per share also remain unchanged after a distribution.
- NAV net asset value
- Bonds held by a Fund are valued based on information furnished by an independent pricing service or market quotations. Certain short-term debt instruments used to manage a fund's cash are valued on the basis of amortized cost.
- a Fund When pricing service information or market quotations are not readily available, securities are priced at their fair value, calculated according to procedures adopted by the Board of Trustees. A Fund also may use fair- value pricing if the value of a security it holds is materially affected by events occurring after the close of the primary markets or exchanges on which the security is traded. This most commonly occurs with foreign securities, but may occur in other cases as well. When fair-value pricing is used, the prices of securities used by a fund to calculate its net asset value may differ from quoted or published prices for the same securities. PURCHASE OF SHARES
- Each Fund reserves the right in its sole discretion to reduce or waive the minimum investment for or any other restrictions on initial and subsequent investments for certain fiduciary accounts such as employee benefit plans or under circumstances where certain 5 economies can be achieved in sales of the Fund's shares.
- the value of the actual annuity payments will be set at the time the contract is issued, and may be adjusted at that time based on your age and the number of beneficiaries as described in the "Annuity Payment Adjustments" section in the Fund's summary above.
- Each Fund may suspend redemption privileges or postpone the date of payment: (i) during any period that the New York Stock Exchange is closed, or trading on the Exchange is restricted as determined by the Securities and Exchange Commission (the "SEC"), (ii) during any period when an emergency exists as defined by the SEC as a result of which it is not reasonably practicable for a Fund to dispose of securities owned by it, or fairly to determine the value of its assets, and (iii) for such other periods as the SEC may permit.
- SEC Securities and Exchange Commission
- Each Fund generally will make all redemption payments in cash, but reserves the right to make redemptions wholly or partly in-kind if the investment advisers determines, in its sole discretion, that it would be detrimental to the Fund's remaining shareholders to make a particular redemption wholly or partly in cash. Any redemption in-kind will be in the form of readily marketable securities selected by the Fund's investment adviser from the Fund's portfolio. These securities would be valued in the same way the Fund determines its NAV. In-kind distributions may be made without prior notice, and you may have to pay brokerage or other transaction costs to convert the securities to cash.
- the Funds are intended for purchase by investors through tax-deferred accounts such as IRA and 40 l(k) accounts. However, if you are a taxable investor, the Fund will send you a statement each year showing the tax status of all your distributions. In addition, taxable investors should be aware of the following basic tax points:
- Distributions are taxable to you for federal income tax purposes whether or not you reinvest these amounts in additional Fund shares. o Distributions declared in December - if paid to you by the end of January - are taxable for federal income tax purposes as if received in December. o Any dividends and short-term capital gains that you receive are taxable to you as ordinary income for federal income tax purposes. o Any distributions of net long-term capital gains are taxable to you as long- term capital gains for federal income tax purposes, no matter how long you've owned shares in the Fund.
- a sale or exchange of Fund shares is a taxable event. This means that you may have a capital gain to report as income, or a capital loss to report as a deduction, when you complete your federal income tax return.
- Each Fund intends to continue to qualify as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986, as amended.
- This special tax status means that a Fund will not be liable for federal tax on income and capital gains distributed to shareholders.
- each Fund In order to preserve its tax status, each Fund must comply with certain requirements. If a Fund fails to meet these requirements in any taxable year, it will be subject to tax on its taxable income at corporate rates, and all distributions from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gains, will be taxable to shareholders as ordinary income.
- a Fund could be required to recognize unrealized gains, pay substantial taxes and interest, and make substantial distributions before regaining its tax status as a regulated investment company.
- AVERAGE MATURITY The average length of time until bonds held by a fund reach maturity (or are called) and are repaid. In general, the longer the average maturity, the more a fund's share price will fluctuate in response to changes in market interest rates.
- IOU debt security
- BOND IMMUNIZATION This describes the selection of a bond portfolio so that the ultimate value of the portfolio over a specified period of time is immune to changes in interest rates, even though the day-to-day value of the portfolio will change because of interest rate changes. If the portfolio is not immunized, there is risk that the reinvestment of bond interest payments at lower interest rates would cause the ultimate value of the portfolio to be lower than expected based on the interest rate structure at inception.
- a condition for a Fund's portfolio to be immunized is that the duration of the portfolio is the same as the time to maturity for the fund.
- CAPITAL GAINS DISTRIBUTION Payment to mutual fund shareholders of gains realized on securities that a fund has sold at a profit, minus any realized losses.
- CASH INVESTMENTS Cash deposits, short-term bank deposits, and money market instruments that include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase agreements, commercial paper, and banker's acceptances.
- DIVIDEND INCOME Payment to shareholders of income from interest or dividends generated by a fund's investments.
- the duration of a bond portfolio is the average time to repayment of the bonds, including interest payments as well as the final principal repayments. Duration will be less than the average maturity if the bond pays interest; for zero-coupon bonds, duration equals time to maturity. Duration is also a measure of the volatility of the portfolio, so long-duration is the same as highly-volatile.
- EXPENSE RATIO The percentage of a fund's average net assets used to pay its expenses during a fiscal year.
- the expense ratio includes management fees, administrative fees, 5 and any 12b-l distribution fees.
- FACE VALUE The amount to be paid at a bond's maturity; also known as the par value or principal.
- FIXED-INCOME SECURITIES Investments, such as bonds, that have a fixed payment schedule. While the level of income offered by these securities is predetermined, their 0 prices may fluctuate.
- INVESTMENT ADVISER An organization that makes the day-to-day decisions regarding a fund's investments.
- INVESTMENT GRADE A bond whose credit quality is considered by any independent bond-rating agency to be sufficient to ensure timely payment of principal and 5 interest under current economic circumstances. Bonds rated Baa3 or better by Moody's Investors Service, Inc., BBB- by Standard & Poor's ("S&P"), or the equivalent by another independent rating agency are considered investment grade.
- MATURITY The date when a bond issuer agrees to repay the bond's principal, or face value, to the bond's buyer. :0 NET ASSET VALUE (NAV): The market value of a mutual fund's total assets, minus liabilities, divided by the number of shares outstanding. The value of a single share is also called its share value or share price.
- PRINCIPAL The amount of money you put into an investment.
- TOTAL RETURN A percentage change, over a specified time period, in a mutual _5 fund's net asset value, assuming the reinvestment of all distributions of dividends and capital gains.
- VOLATILITY The fluctuations in value of a mutual fund or other security. The greater a fund's volatility, the greater the change in day-to-day values, and the less reliable the fund is for short-term investment. >0 YIELD: Income (interest or dividends) earned by an investment, expressed as a percentage of the investment's price. - - End of PENSIONSHARES 2022 FUND EXAMPLE - -
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Abstract
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Priority Applications (1)
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AU2004219204A AU2004219204A1 (en) | 2003-03-10 | 2004-03-10 | Methods of issuing, distributing, managing and redeeming investment instruments providing securitized annuity options |
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US45316403P | 2003-03-10 | 2003-03-10 | |
US60/453,164 | 2003-03-10 | ||
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WO2004081748A2 true WO2004081748A2 (en) | 2004-09-23 |
WO2004081748A3 WO2004081748A3 (en) | 2005-06-16 |
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PCT/US2004/007363 WO2004081748A2 (en) | 2003-03-10 | 2004-03-10 | Methods of issuing, distributing, managing and redeeming investment instruments providing securitized annuity options |
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WO (1) | WO2004081748A2 (en) |
Cited By (5)
Publication number | Priority date | Publication date | Assignee | Title |
---|---|---|---|---|
US7219079B2 (en) | 2001-08-10 | 2007-05-15 | Birle Jr James R | Convertible financial instruments with contingent payments |
US7987129B2 (en) | 2001-08-10 | 2011-07-26 | Bank Of America Corporation | Convertible financial instruments with contingent payments |
US8429043B2 (en) | 2003-06-18 | 2013-04-23 | Barclays Capital Inc. | Financial data processor system and method for implementing equity-credit linked investment vehicles |
US8521633B2 (en) | 2011-01-19 | 2013-08-27 | Financial Engines, Inc. | Creating and maintaining a payout-ready portfolio within an investment plan to generate a sustainable income stream |
US10943299B2 (en) * | 2014-06-18 | 2021-03-09 | Qarasoft Inc. | Adjusting and distributing liquidity |
Citations (1)
Publication number | Priority date | Publication date | Assignee | Title |
---|---|---|---|---|
US20030014343A1 (en) * | 2001-07-16 | 2003-01-16 | Jones W. Richard | Long-term investing |
-
2004
- 2004-03-10 AU AU2004219204A patent/AU2004219204A1/en not_active Abandoned
- 2004-03-10 WO PCT/US2004/007363 patent/WO2004081748A2/en active Application Filing
Patent Citations (1)
Publication number | Priority date | Publication date | Assignee | Title |
---|---|---|---|---|
US20030014343A1 (en) * | 2001-07-16 | 2003-01-16 | Jones W. Richard | Long-term investing |
Cited By (6)
Publication number | Priority date | Publication date | Assignee | Title |
---|---|---|---|---|
US7219079B2 (en) | 2001-08-10 | 2007-05-15 | Birle Jr James R | Convertible financial instruments with contingent payments |
US7987129B2 (en) | 2001-08-10 | 2011-07-26 | Bank Of America Corporation | Convertible financial instruments with contingent payments |
US8429043B2 (en) | 2003-06-18 | 2013-04-23 | Barclays Capital Inc. | Financial data processor system and method for implementing equity-credit linked investment vehicles |
US8521633B2 (en) | 2011-01-19 | 2013-08-27 | Financial Engines, Inc. | Creating and maintaining a payout-ready portfolio within an investment plan to generate a sustainable income stream |
US8725614B2 (en) | 2011-01-19 | 2014-05-13 | Financial Engines, Inc. | Creating and maintaining a payout-ready portfolio within an investment plan to generate a sustainable income stream |
US10943299B2 (en) * | 2014-06-18 | 2021-03-09 | Qarasoft Inc. | Adjusting and distributing liquidity |
Also Published As
Publication number | Publication date |
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AU2004219204A1 (en) | 2004-09-23 |
WO2004081748A3 (en) | 2005-06-16 |
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