Practical analysis for investment professionals
21 January 2021

Book Review: Advances in Retirement Investing

Advances in Retirement Investing. 2020. Lionel Martellini and Vincent Milhau. Cambridge University Press, Elements in Quantitative Finance Series.


This is an essential source for cohesive retirement investment strategies based on the accumulation and decumulation of wealth, viewed as a continuum. It compares and contrasts its strategies with those of traditional investments used for retirement, such as target date funds, balanced mutual funds, and annuities. It suggests the launch of new forms of retirement investment solutions that better serve the goal of generating replacement income than do existing products with a retirement label.

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Huge challenges related to acquiring adequate savings for retirement face almost every working person. Individuals must consider a multitude of variables, from estimating how much retirement will cost to gauging how long retirement funding will be needed. Recognizing that public retirement systems are inadequate to support the lifestyle that retirees desire and require is also essential.

Lionel Martellini, professor of finance, and Vincent Milhau, research director, both at EDHEC-Risk Institute in Nice, France, have created this accessible guide, distinguished by a strong mathematical basis. They define consistent investment strategies, grounded in risk tolerance and a specified time horizon, that combine the wealth accumulation and decumulation phases. Their strategy differs from the quest for the “retirement number” or targeted wealth. It is founded instead on an investment strategy in accumulation whose objective is generating replacement income determined by targeted spending, following the principles of goal-based investing.

The authors begin their analysis with a discussion of retirement systems, focusing on the United States, the United Kingdom, and France. They break the systems down into three pillars:

  • The universal core of pension coverage, which addresses basic consumption needs in retirement (the social security system).
  • Public or private occupational pension plans that require mandatory enrollment (defined benefit plans).
  • Voluntary arrangements, such as defined contribution plans
Secure Retirement graphic

Each pillar is associated with a number of positives and negatives that set the stage for the authors to launch their strategies. They consider the burdens that the aging population will place on social security, the underfunding of defined benefit pension plans, and the possibility of individuals going broke in retirement if their savings are inadequate. Finally, the possibility of outliving one’s well-planned savings also exists.

The authors acknowledge the abundance of traditional investment solutions for retirement funding (e.g., target date funds, mutual funds with numerous investment objectives and defined risk parameters, and annuities). They then raise many questions in reviewing these vehicles, such as insufficient retirement income, in the case of target date funds and mutual funds, and the inflexibility of structure and costs associated with annuities. Retirement investing is further complicated by the persistence of low or non-positive interest rates globally. Market volatility at the point of retirement is another challenge. Spending interest only, a specified percentage of principal, or a combination of interest and a predetermined percentage of principal proves to be a weak plan of action, based on varying interest rates and principal values. What is an investor to do?

A differentiator of Martellini and Milhau’s strategy is the introduction of the retirement bond. What is a retirement bond? It is a liquid asset that can be replicated using bonds and other interest rate products and that delivers cash flows over the period of stated retirement. A simple way to look at the retirement bond option is in phases of one’s life — for example, 20 years of saving for one’s retirement and 20 years of spending during it. The retirement bond is a critical component of a truly long-term investment strategy — 40 years, in this case — that includes a performance-seeking portfolio. It becomes a building block for new forms of balanced funds and target date funds.

In contrast to an ordinary bond, a retirement bond has a deferred starting date for interest payments. It has no principal payment at maturity because it spreads interest payments and principal redemption over time in such a way that the annuity is constant. Alternatively, it can be cost-of-living adjusted to generate a pattern of increasing cash flows over the investor’s retirement years.

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How is a retirement bond constructed and priced? The authors provide clear answers, based on the construction of a basket of zero-coupon bonds with laddered maturity dates in a no-arbitrage setting. In the course of this discussion, they admit their strategy is not unique (see page 25).

What could go awry with this strategy? The risk of short-term losses is ever present. To protect against this risk, the investor should use a suitable portfolio insurance strategy. Consider the example of the impact on asset values of the equity bear markets in 2000, 2002, 2008, and 2011, as well as the less severe declines in 2015 and 2018. The authors address the positive impact of frequent rebalancing on gap risk, aimed at preventing the portfolio from going “beneath the floor.” They also discuss the impact of using a stop-gain decision, whereby an income stream can be secured at any point in the accumulation phase by transferring assets into the retirement bond.

Why is this sort of strategy so important to consider at present? US workers born after 1970 (and workers in other countries addressed in the book’s introduction) must rely on their own retirement savings for the largest part of their retirement funding. The 2020 annual report on the status of the US Social Security and Medicare programs stated that both face long-term financing shortfalls under currently scheduled benefits and financing: “Both programs will experience cost growth substantially in excess [of] GDP growth through the mid-2030s due to rapid population aging.” In 2035, the trust funds’ reserves will become depleted, and continuing tax income will be sufficient to pay only 76% of scheduled benefits. Moreover, these projections do not reflect the potential effects of the COVID-19 pandemic on the US Social Security and Medicare programs. The key message is that all individuals should begin saving for retirement as early and as much as possible — and make adjustments to investment policy as appropriate, armed with full knowledge of the implications of their choices.

Little is wanting in this compact, comprehensive guide, though I would have liked a more extensive exposition on income coverage in “later life,” defined as the lifetime beyond life expectancy. Also, an index is clearly needed, especially for references to such classic portfolio theorists as Malkiel, Markowitz, Merton, and Modigliani (“the 4 Ms”). Nonetheless, the appendices and references provide excellent tools for further research. This is a book for all investment professionals and for anyone interested in creating approaches and products that enable clients to fully fund their futures well in advance of retirement.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Janet J. Mangano

Janet J. Mangano, formerly a senior portfolio manager with PNC Wealth, is in Short Hills, New Jersey.

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