Featured strategy | September 2021

Reengineering Retirement Risk Management With Buffers


Taylor Krystkowiak Vice President, Product Management

Traditionally, retirement asset allocations have relied on the characteristics of two assets: stocks and bonds. In general, stocks fuel returns during the accumulation of retirement assets, while bonds hedge the risk of loss during the decumulation/distribution of assets in retirement.

However, this framework may not be as effective in the future as it has been in the past. This paper will analyze the current challenges facing existing retirement models and provide potential solutions for future retirement risk management.

Part I: Bonds Are Breaking

  • Bonds are critically challenged, and their future outlook has deteriorated dramatically.
  • Due to a variety of macroeconomic factors, evidence suggests that bonds may no longer be effective hedges to equity volatility.
  • Bonds are projected to have significantly lower future returns relative to their historical performance, which will likely pose a substantial drag on portfolios in the future.

Part II: Form a New Foundation Built With Buffers

  • Cboe Vest has developed two strategies for retirement risk management that utilize the contractual certainty of stock options to achieve a desired level of risk while deriving underlying returns from “buffered” stock exposure.

Part III: Reengineering Retirement Portfolios With Buffers

  • Combining the two strategies has the potential to provide better hedging qualities relative to bonds, as well as lower volatility relative to stocks.
  • Given that current capital market assumptions indicate that stocks will provide lower returns with higher volatility in the future, the strategies may capture most of the upside of stocks while hedging excess volatility.
  • In short, these buffer strategies may offer an effective potential solution to low bond returns and increased risks from high stock allocations within existing retirement glide paths.

Part I: Bonds Are Breaking

  • Bonds are critically challenged, and their future outlook has deteriorated dramatically.
  • Due to a variety of macroeconomic factors, evidence suggests that bonds may no longer be effective hedges to equity volatility.
  • Bonds are projected to have significantly lower future returns relative to their historical performance, which will likely pose a substantial drag on portfolios in the future.

Part II: Form a New Foundation Built With Buffers

  • Cboe Vest has developed two strategies for retirement risk management that utilize the contractual certainty of stock options to achieve a desired level of risk while deriving underlying returns from “buffered” stock exposure.

Part III: Reengineering Retirement Portfolios With Buffers

  • Combining the two strategies has the potential to provide better hedging qualities relative to bonds, as well as lower volatility relative to stocks.
  • Given that current capital market assumptions indicate that stocks will provide lower returns with higher volatility in the future, the strategies may capture most of the upside of stocks while hedging excess volatility.
  • In short, these buffer strategies may offer an effective potential solution to low bond returns and increased risks from high stock allocations within existing retirement glide paths.

Part I: Bonds Are Breaking


Bonds have been the bedrock of retirement risk management

A successful retirement plan requires an effective asset allocation. Risk and return must be carefully balanced in order to attain a desired outcome.

Traditionally, asset allocations have centered on the characteristics of two assets: stocks and bonds. In general, stocks fuel returns during the accumulation of retirement assets, while bonds hedge the risk of loss during the decumulation/distribution of assets in retirement. The percentage of the portfolio allocated to each asset changes over time. Early in the accumulation phase of a retirement plan, a high percentage of the portfolio is allocated to stocks. As an individual nears retirement, the percentage of stock holdings steadily declines as an incrementally greater percentage of the portfolio is allocated to bonds.

When displayed graphically, the “path” that stock allocations follow appears to “glide” downwards over time, thus the term “glide path.” In essence, the retirement glide path is an expression of a typical individual’s risk tolerance over time (see Figure 1).

Figure 1: Hypothetical Glide Path

While retirement assets have typically been allocated to stocks and bonds, adding a new risk management strategy has the potential to improve the current balance of risk and return. Risk management strategies that use options to offer exposure to “buffered” stock returns can provide a risk/return profile that falls between stocks and bonds. These strategies have the potential to offer better hedging qualities and improved returns relative to bonds, as well as lower volatility relative to stocks.

The bond bedrock is breaking down a mid seismic
shifts in macroeconomics

For the better part of the past half-century, bonds have effectively hedged stock declines during waves of market volatility and provided relatively consistent annualized returns greater than 3%. These two factors have helped bonds balance portfolios without dragging down performance, making them a staple in nearly every retirement portfolio.

However, bonds are now critically challenged and their future outlook has deteriorated dramatically. Due to a variety of macroeconomic factors, there is now ample evidence to suggest that bonds will no longer be effective hedges to equity volatility, nor will they provide future annualized returns that exceed 3%.

For Financial Professionals Only

Important information The materials on this portion of our website are directed at persons having professional experience related to investments who use such materials in their role as a fiduciary to an investment client, and are not intended, and shall not be used, by individuals without the assistance of such investment professional. By checking the box, you represent and warrant that you are a financial professional with professional experience related to investments. Individuals who are not experienced financial services professionals as described above, may visit our website at www.cboevest.com and are encouraged to seek individual advice from their personal, financial, legal, tax and other appropriate advisers before making any investment or financial decisions or purchasing any financial securities or investment related service or product, including any financial securities or investment related service described in these materials.