Deutsche Gesellschaft für Versicherungs- und Finanzmathematik e.V. (DGVFM)
Private old-age provision between normative expectations and empirical reality
Steffen Meyer, Chair of Financial Economics
2
The normative view on old-age provision
The positive (empirical) view on old-age provision
The potential value of remedies: Financial Advice and ETFs
Perspectives for German life insurances
3
Population aging is pervasive trend in all developed economies
Source: United Nations
0%
5%
10%
15%
20%
25%
30%
1980 1985 1990 1995 2000 2005 2010 2015 2020
United States
United KingdomCanadaAustralia
New Zealand
GermanyFrance
Japan
Percentage of the (total) Population Age 65 and Older
4
Governments have hence lowered replacement rates forcing households to save on their own
Gross replacement rates of public pension schemes for average earnings
0
20
40
60
80
100
Austr
ia
Fin
land
Fra
nce
Germ
any
Italy
Japan
Kore
a
Mexi
co
Pola
nd
Port
ugal
Slo
vak R
ep.
Sw
eden
UK
Pre-reform Post-reformSource: OECD (2007): Pensions at a glance
5
According to Markowitz and Tobin the composition ofthe risky portfolio should be identical for all investors
Different investors with different risk aversionswould choose the same stock portfolio T
aT
fTa
rµ
frµ σσ
+=
T
Efficient frontier
Capital allocation line
-
6
PF T
Capitalallocation line
Non-tradablelabor incomeof i
Privatebusinessof i
Realestateof i
xx PF T*
Non-tradable assets with a fixed weight in total PF
Capital allocation linefor investor i
Legend:
Newer literature acknowledges the presence of heterogeneity among investors induced by background risk
7
In traditional long-term life-cycle models, the main savings motive is consumption smoothing
Source: Modigliani/Brumberg (1954) and Börsch-Supan (mea 24-2002)
Savings patterns according to the traditional life-cycle (Merton style) model by
Assumptions & Criticism:
� No borrowing constraints for the youth (market imperfections)
� Low uncertainty regarding the time of death (growing „risk“ of longevity)
� Low income uncertainty over life cycle
� In reality, saving thus not only serves to offset the decline in income after retirement but also to shield consumption against income shocks)
� Uncertainty regarding future expenses (e.g. health costs make consumption smoothing difficult)
8
Because of the equity premium (and risk-diversification), equity needs to be part of the portfolio
Returns to US stocks and T-Bills
Source: Mehra and Prescott (1985).
9
ExpectedRisk Premium
ExpectedCost Premium
UnexpectedEvents
Historic Return
Total Premium
Risk Premium
Puzzle!?!
Asset Pricing Theory
The large equity premium is still a mystery to economists
Premium equal to preferring a certain payoff of $51,300 to a 50/50 bet paying either $50,000 or $100,000
10
New evidence on long-run risk premiums reveals substantial equity risk premiums
10
Annualized equity risk premiums 1900-2002
� Averaged across all 16 countries
� The (geometric) risk premium relative to bills was 4.5%
� The (geometric) risk premium relative to bonds was 3.8%
Source: Dimson/Marsh/Staunton (2003)
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Lesson from the normative perspective
(1) Broadly diversify across all assets available. Particuarly, make equity participation part of the investment portfolio.
(2) Pay attention to your personal background risk
(3) Do not engage in active trading as markets are fairly efficient
12
The normative view on old-age provision
The positive (empirical) view on old-age provision
The potential value of remedies: Financial Advice and ETFs
Perspectives for German life insurances
13
Fact 1: Participation in equity through stocks and mutual funds is low in all „Euro“ countries
Source: Eurosystem Household Finance and Consumption Survey
00
10
20
30
40
50
60
70
80
90
100
EURO BE DE GR ES FR IT CY LU MT NL AT PT SI SK FI
Financial Assets Deposits Risky Securities (stocks and bonds)
Participation rates of households in %
14
Participation remains low despite the current lowinterest rate environment
0
500
1,000
1,500
2,000
2,500
0.00
0.50
1.00
1.50
2.00
2.50
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 H12016
Millia
rde
n E
uro
in %
Zinssatz für Einlagen privater Haushalte Einlagen von Privatpersonen bei Banken
Source: Deutsche Bundesbank
Interests received and cash balances of private households (2003 – Q1 2016)
15
Fact 2: Investors’ portfolios are biased towards own industry
Hypothesis: Investors hold lower portfolio share in their job industry than peers
1. Changes in industry composition: robust2. Use of unweighted instead of value-weighted means: robust3. Variation of analysis date: robust
Robustness checks confirm a strong Industry Bias:
Industry Bias
0%
5%
10%
15%
20%
25%
Fin. Serv. IT Health Care Technology Aviation
Industry shares in investor portfolios (Dec 31,2007)
Averageinvestor
Investor fromsame industry
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Why might investors overweight their job industry?
� Overconfidence:Investors think they have more precise information than the market
� Works only when markets are inefficient� Common costly investment mistake (Barber & Odean (2000))
� Private information: Investors have information that is not yet public
� This information can be positive as well as negative so and insider might buy as well as sell a stock
� Typical insider information is short-lived and investors exploit it best in buying options – which are not included in this analysis
� Company stocks / executive compensation: Discounted price and lock-up periods for employees
� Retirement savings accounts in the US are invested to 1/3 in company stocks. (Benartzi(2001))
� Much less popular in Germany: About 1.5% of wealth held in company stock. (Skiera (2007))
� The bias is robust for exclusion of the largest security in the portfolio in case it is a stock – Investors overweight their industry not their company.
Industry Bias
17
Fact 3: Private investors overtrade and loose on net returns
Individual investor quintiles based on monthly turnover
Source: Barber and Odean (2000)
18
Net of transaction cost, investors perform poorly
Summary of percentage monthly abnormal return measures for the average household
These performance measures (regression coefficients) indicate significant underperformance of 19 to 31 basis points per month (corresponds to 2.3% to 3.7 % p.a.)
Source: Barber and Odean (2000)
Excess return(alpha)
Market premium(rM-rf)
Small - large(rs-rl)
Value - growth(rv-rg)
AdjustedR2
Dep
ende
ntva
riab
le a
lway
s:m
onth
lyfu
ndre
turn
min
us r
isk
free
rate
Independent variables (plus others not shown here)
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Rational expectation framework fails to explainhigh trading volume
� Theory of rational expectations (Grossman/Stieglitz (1980))� Investors will trade when the marginal benefit is equal to or exceeds the
marginal cost of the trade.
� Rational explanations for trading activity� Liquidity: Investors who face liquidity shocks will trade as a rational response to
those shocks.
� Rebalancing: Investors who desire a portfolio with certain risk characteristics will rationally rebalance their portfolio to maintain this risk profile.
� Taxes: Realizing losses can be used to shelter gains and reduce tax liability.
� Gambling: Investors may have a desire to gamble out of risk-seeking and entertainment aspects.
Conclusion: Even in combination, these motivations for trade cannot explain average annual turnover of more than 250% for households who trade most.
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As a result clients leave a lot of money „on the table“ and thus we need to care
Source: Own analysis
Annual volatility
Port
folio-
Ret
urn
sin
% p
.a.
Risk-return profile of German investors (3.400 Investors, Online Broker, 2003-2012)
DAX >80% underperformthe benchmark
DAX
21
(Neuro-) economics shows investors’ economic decisions are frequently based on impulsive heuristics
Impulsive System 1 – INTUITION• Easy, quick, simultaneous• Goal: Satisfy needs under the side condition that decisions
need to be plausible
Controlled System 2 – LOGIC• Exhausting, slow, sequentiell• Goal: Make „rational“ decisions
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Exogenous shocks to our mood alter trading decisions
Trading volume
Purchases
54,70%
54,04%
45,30%
45,96%
Source: Schmittmann/Pirschel/Meyer/Hackethal (2017).
Trading of private investors and local weather (N = 5.000, 2000 - 2007)
23
In principle, we could extend the list to many moreinvestment mistakes
Under-diversification
Home BiasDispositioneffect
Lottery stocks Overtrading
Trend chasing
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Household Finance is of great importance in research and is about devising solutions
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The normative view on old-age provision
The positive (empirical) view on old-age provision
The potential value of remedies: Financial Advice and ETFs
Perspectives for German life insurances
26
Financial advice is big business
1) In the U.S., the Financial Planning and Advice Industry is estimated to have a size of 37 billiondollars (2009).
2) In the U.S., the Investment Company Institute (2007) notes that over 80% of respondents statethat they obtain financial advice.
3) In Germany, Europe’s largest economy, a survey among retail investors indicates that more than80% of investors consult a financial advisor.
27
Financial advice is often conflicted and may do more harm than good
� Mutual Fund brokers:
� (Bergstresser et al. (2009)
� Research analysts: � Net returns barely statistically significantly different from zero
� Womack (1996), Metrick (1999), Barber, Lehavy, McNichols and Trueman (2001)
� Financial Advisors:� Net returns negative
� Hackethal et al. (2012)
Annual 4-factor-alphas of mutual funds
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The effects of the demand side are investigated usinga field study
E-mail to
8,195 active
customers
385 customers
have accepted
the offer
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Detailed Documentation Sent to Advisees
� Description of the idea of diversification
� Analysis of the existing and the recommended portfolio
� List of necessary transactions
� Detailed information about each security on recommendation list
E(r)
σ
Efficient frontier
Your portfolio
Optimized portfolio
E(r)
σ
Efficient frontier
Your portfolio
Optimized portfolio
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Recommendations Improve Portfolio Efficiency
� Portfolio share by asset class
� Share of fixed income and commodities increased
� More diversified across asset classes
� Equity share by region
� Reduced home bias
� More diversified across regions
� Portfolio share by instrument
� Clients are advised to invest 67% in well-diversified ETFs and mutual funds
Portfolio share
Instrument Investor Recommended
Single stocks 53% 27%
Funds 26% 57%
ETFs 4% 10%
Single bonds 4% 0%
Others 13% 6%
Total 100% 100%
Equity share
Region Investor Recommended
Germany 52% 31%
Europe 14% 24%
North America 12% 10%
Asia Pacific 9% 18%
World 8% 9%
CEE 2% 7%
Other EM 3% 2%
Total 100% 100%
Portfolio share
Asset class Investor Recommended
Equity 73% 59%
Fixed income 6% 15%
Commodities 1% 13%
Real estate 1% 8%
Others 19% 4%
Total 100% 100%
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Is the advice followed?Degree of implementation
32
Does Portfolio Efficiency Improve?
Herfindahl-Hirschmann Index in % Herfindahl-Hirschmann Index in %
HHI does not improve for the average advisee but would have improved for the average advisee had (s)he followed the advice
0
5
10
15
20
25
Non-advised Advised
0
5
10
15
20
25
Non-advised Buy & hold Advised Recommended
33
Currently, ETFs (and passive funds) gain in popularityand may be a solution to investment mistakes
Assets under Management with global exchange traded funds
Source: Economist (2014)
34
Despite its recent growth the market is still smallrelative to the AUM of actively managed funds
Index-linked securities As % of active mutual funds
# of products % AUM in € m % # of products AUM
Panel A: Index-linked securities in Germany1
Passive ETFs 826 86% 99,311 84%
Index mutual funds 135 14% 18,353 16%
Total 961 100% 117,664 100% 17% 20%
Panel B: Index-linked securities in the US2
Passive ETFs 1,028 73% 934,216 46%
Index mutual funds 383 27% 1,094,296 54%
Total 1,411 100% 2,028,512 100% 23% 21%
Sources:1 As of December 31, 2011. Sources: BVI, Deutsche Börse.
2 As of December 31, 2011. Source: Investment Company Institute Factbook 2012.
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Private investors in Germany have (also) embraced ETFs: Do they mitigate investment mistakes?
0
200
400
600
800
1000
1200
0
50
100
150
200
250
300
AuM in $BN (left axis)
# of distinct products (right axis)
01
00
200
300
400
500
C
oun
t
05
10
15
20
25
Perc
enta
ge
2006-09 2007-03 2007-09 2008-03 2008-09 2009-03
Date
Passive share in % - left hand axis
Number of users of passive products - right hand axis
Source: ETF Research & Implementation Strategy Team, Blackrock, Bloomberg
The market for ETFs in Europe ETF usage in our sample
36
The investors in our sample are comparable to those in other countries and studies
Age(1)
Gender(1)
Portfolio turnover(1)
Stock share(1)
Portfolio value in TEUR(1), (2)
Our sample Other sample (see source)
51,250,4
48,7
0 10 20 30 40 50 60
Swedish data (3)
79%81%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
46%60%
41%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
3557
56
0 10 20 30 40 50 60
6%7%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Source: (1) Barber and Odean (QJE, 2001); (2) $47,000 (portfolio value) / 60% (stock share) * 0.72 (exchange rate); (3) Laurent, Campbell and Sodini 2007
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Investors use a surprisingly large variety of ETFs in terms of asset classes and regional focus
By asset class By country By index
34,45%
2,53%
3,03%
3,19%
3,30%
3,67%
3,70%
4,19%
5,75%
11,19%
25,01%
Other (224…
STOXX Europe 600
MSCI Emerging…
EONIA
MSCI World
TecDAX TRI
MDAX
LevDAX
STOXX Europe…
STOXX Europe 50
DAX
2,18%
0,79%
0,91%
1,21%
1,84%
2,56%
3,19%
3,47%
6,19%
35,58%
42,08%
Other
Asia
India
Brazil
China
U.S.
Japan
World
Emergingmarkets
Germany
Europe
0,07%
2,98%
6,46%
90,50%
Other
Commo…
Bonds
Equity
ETFs used (value weighted)
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ETFs are good products as alpha is close to zero and significant and beta is roughly 1
0,84
0,67
Alpha in % p.a.
All ETF Equity ETF
0.88
1.05
Beta
All ETF Equity ETF
Alphas and Betas of ETFs used
39
Passive but still aggressive: Private investors use of ETFs
1,84 2,18
5,09
7,34
16,20
2,80
4,60
5,98
7,95
15,94
1,71 1,69
4,33
6,35
15,67
0
2
4
6
8
10
12
14
16
18
Q1F Q2 Q3 Q4 Q5F
Portfolioumschlag nach Nutzungsbeginn
ETF-Umschlag nach Nutzung
Nicht-ETF Umschlag nach Nutzung
% p
er m
onth
Quintiles of portfolio turnover before use
Trading of ETF users (N = 1.061)
Portfolio turnover after use
ETF turnover after use
Non-ETF turnover after use
40
Even good products do not solve the problem if investors continue to use them unwisely
-1,00
0,00
1,00
2,00
3,00
4,00
5,00
20 20,5 21 21,5 22 22,5 23 23,5 24 24,5 25
Risk (Volatility)
Ret
urn
p.
a.
Non-ETF part
ETF part
Source: Bhattacharya, Loos, Meyer, Hackethal (2017)
Investor portfolio
Investor portfolio without trading in the MSCI World
Investor portfolio with trading in the MSCI World
Effect due to avoidance of market timing
41
The normative view on old-age provision
The positive (empirical) view on old-age provision
The potential value of remedies: Financial Advice and ETFs
Perspectives for German life insurances
42
Options for old-age provision – View of the German population
0
2%
3%
7%
7%
19%
14%
3%
8%
10%
17%
26%
35%
37%
11%
23%
26%
31%
37%
23%
28%
40%
43%
43%
31%
25%
17%
16%
46%
24%
18%
14%
5%
6%
5%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Real estate
Corporate pensions
Life Insurance and private pensions
Riester
Bonds
Equity
National pension
Anteil der Befragten
Not all suited Not suited Suited Well suited Very suited
Seite 2
Life insurances are still seen as an important partner for old-age provisions
Source: Die Welt (2010)
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Life insurance plays an important role in old-age provision as a risk management tool, not an investment
Task Options available & Role of life insurance
Risk Management Insurances in general� Disability insurance – To cope with inability to work� Life insurance (Term life) – Avoid the financial consequence of a loss
of life� Other insuances to avoid detrimental losses
Capital Accumulation
General principles:� Diversification� Investment plans with cost-efficient ETFs� Cost efficient Riester plans
Role of life insurances:� Relatively expensive tool, low guaranteed interest, low liquidity� But: Investors make investment mistakes and might benefit from
delegation of investment management and information about their current state of old-age provisions (Deutsche Renten Information)
In retirement -> Longevity risk
� Classic insurance product� However, annuities are not much liked and bought by private investors
44
Contact
Prof. Dr. Steffen Meyer
Institute of Money and International Finance
Chair of Financial Economics
Leibniz Universität Hannover
Königsworther Platz 1
30167 Hannover
E-Mail: [email protected]
