Abstract:
A target outcome fund mimics an option in an underlying risky asset by holding a mix of the risky asset and a low-risk asset. The relative amount of the risky asset and the low risk asset held by the fund is rebalanced based on a comparison of a current target return and a current actual return of the fund. If the fund over-performs, the target outcome is increased accordingly to prevent the fund becoming overly invested in the risky asset, thereby protecting gains made.

Description:
CROSS-REFERENCE TO RELATED APPLICATIONS 
       [0001]    This is a continuation of U.S. patent application Ser. No. 13/460,562, filed Apr. 30, 2012, which claims the benefit of U.S. Provisional Application No. 61/480,378, filed Apr. 29, 2011, each of which is incorporated by reference in its entirety. 
     
    
     BACKGROUND 
       [0002]    This invention relates generally to financial services and products, and more particularly to funds that are managed with a goal of achieving a predefined dollar amount at a future date, while providing a potential upside return. 
         [0003]    Various investment options exist for defined contribution plans and other retirement accounts. Lifecycle funds, for example, follow a preset allocation path over a participants&#39; lifetime as they approach a predefined target or horizon date. This preset allocation is typically based on a model of expected labor income and investment risk and return. The most common goal for these funds is maximization of investment efficiency (information ratio). 
         [0004]    Existing investment products do not follow an investment strategy that attempts to achieve a predefined dollar amount at a specified future date. Thus, while the existing market provides different products for investors with different risk and reward trade-offs, there is a lack of products for investors who desire to target a specific outcome, rather than attempt to maximize potential and take the risks associated therewith. Such an investment product may be desirable in retirement accounts as well as other types of accounts (e.g., college savings accounts), where the investor can reasonably determine a target value they wish the fund to acquire, and where achieving that target is likely to be more important to the investor than maximizing investment potential. 
       SUMMARY 
       [0005]    A method for managing a target outcome fund that converts projected returns into an explicitly stated outcome is disclosed. In particular, the target outcome fund is managed so that the investment reaches a specific dollar amount at a specific point in the future, while also providing a potential upside return. 
         [0006]    In one embodiment, the target outcome fund holds a risky asset and a low-risk asset and is managed using an investment strategy that approximates a call option payout for the risky asset. The method generally involves the fund holding a balance of the risky and low-risk asset and periodically rebalancing the relative amount of each asset held. By mimicking a call option, the target outcome fund may be expected to reach (or approximately reach) a specific dollar amount at a specific point in the future. Moreover, this strategy may be implemented without holding the actual option itself, as derivatives can be undesirable or disallowed for certain accounts (such as a 401(k) retirement account). In one embodiment, the fund increases the allocated investment in the low-risk asset if the fund over-performs, a so-called “ratchet” technique, thereby locking in gains. 
         [0007]    Due to the uncertain outcome of investment returns, the target outcome cannot be guaranteed; however, the likelihood of reaching the target outcome can be significantly increased by following embodiments of the investment approach described herein. 
     
    
     
       BRIEF DESCRIPTIONS OF THE DRAWINGS 
         [0008]      FIG. 1  is a flow chart illustrating a method for managing a target outcome fund, in accordance with an embodiment. 
           [0009]      FIG. 2  is a block diagram illustrating a networked system in which a target outcome fund is managed, in accordance with an embodiment. 
           [0010]      FIG. 3  is a block diagram illustrating an example of a computer for use by the entities in  FIG. 2 , in accordance with an embodiment. 
       
    
    
     DETAILED DESCRIPTION 
       [0011]    In accordance with an embodiment of the invention, a target outcome fund is managed based on an observation from option theory such that the final value of the fund is likely to be in close proximity to a predefined target outcome. According to option theory, the results of holding an option in an underlying asset can be mimicked by dynamically balancing the proportion of the underlying asset and a risk-free asset in the fund&#39;s portfolio. In particular, the results of holding an option can be mimicked by maintaining the portfolio such that the proportion of the fund that is invested in the underlying asset is equivalent to the option&#39;s “delta” (which is constrained to be between 0 and 1) with the balance being invested in the risk-free asset. 
         [0012]    The delta of an option is defined to be the option&#39;s effective exposure to the underlying asset on which it is based. The delta value represents the degree to which the option price will move given a small change in the underlying stock price. For example, an option with a delta of 0.5 will move half a cent for every full cent movement in the underlying stock. A deeply out-of-the-money call will have a delta very close to zero; a deeply in-the-money call will have a delta very close to 1. In the case of a European style option, the delta, or δ, may be calculated using the original Black-Scholes formula: 
         [0000]    
       
         
           
             
               δ 
               = 
               
                 N 
                 ( 
                 
                   
                     
                       ln 
                        
                       
                         ( 
                         
                           S 
                           K 
                         
                         ) 
                       
                     
                     + 
                     
                       
                         ( 
                         
                           r 
                           + 
                           
                             
                               σ 
                               2 
                             
                             2 
                           
                         
                         ) 
                       
                        
                       
                         ( 
                         
                           T 
                           - 
                           t 
                         
                         ) 
                       
                     
                   
                   
                     σ 
                      
                     
                       
                         T 
                         - 
                         t 
                       
                     
                   
                 
                 ) 
               
             
             , 
           
         
       
     
         [0000]    where S is the current underlying asset value, K is the strike price of the option, r is the risk-free rate, σ is the volatility of the underlying asset, T is the time at expiration, t is the current time, and N signifies the cumulative normal distribution. Accordingly, a fund that holds δ (as a fraction of the portfolio) in an underlying risky asset and (1−δ) (i.e., the balance) in a risk-free asset mimics a fund that holds a 100% investment in an option for the underlying risky asset. 
         [0013]    To exactly replicate the outcome of an option, however, the fund would need to be traded continuously and cost-free such that the proportion of the fund invested in the risky underlying asset is kept equal to the simulated option&#39;s delta value at all times. Embodiments of the invention deviate from these assumptions and instead manage the fund in a way that balances the long-term goal of the fund with its short-term performance. In particular, the following two modifications are made to the theoretical strategy based on option theory:
       1. Rebalance periodically (e.g., monthly) instead of continuously.   2. Use a low-risk asset in place of the risk-free asset.
 
Accordingly, rather than exactly replicating the performance of an option, as discussed above, embodiments of the invention implement an investment strategy that approximates an option payout. This leads to several benefits over a fund that exactly replicates the option.
       
 
         [0016]    While rebalancing periodically introduces some additional variance to the final distribution of outcomes, it also considerably reduces complexity and transaction costs. Another benefit of rebalancing less often is that it does not require the same level of liquidity in the low-risk asset as a fund that is continuously rebalanced. Using a low-risk asset instead of a risk-free asset also has benefits, such as avoiding the cash trap that could result by using a risk-free asset. Moreover, the distributions that can be achieved using embodiments of the invention may improve upon the mean return of the low-risk asset employed while simultaneously reducing negative outcomes and creating a positive skew. This is consistent with behavioral finance theory that ascribes a much larger negative utility with losses than positive utility associated with gains, i.e., loss aversion. Accordingly, embodiments of the invention find a compromise between the long-term goal of the fund and short-term investment performance. 
         [0017]      FIG. 1  illustrates a process for establishing and managing a target outcome fund in accordance with one embodiment of the invention. The embodiment shown by  FIG. 1  includes a series of ordered steps. Some embodiments may perform these steps in parallel, perform the steps in different orders, or perform different steps. 
         [0018]    The process begins by choosing  110  an underlying risky asset for the fund based on one or more parameters, such as the volatility, information ratio (IR), and expected return for investment in the risky asset. In option theory, delta is related to volatility but not expected return. Therefore, by choosing  110  a risky asset associated with a high IR and a high expected return, the portion of the fund invested in the risky asset is likely to over-perform relative to the target value set. In various embodiments, the risky asset is chosen  110  manually by a fund manager or automatically by a computer system based on an algorithmic analysis of parameters associated with a plurality of risky assets. 
         [0019]    The process continues by choosing  120  a low-risk asset, such as a 1-3 Government/Credit Index fund (1-3 GovCred). As with the risky asset, the low-risk asset may be chosen  120  manually by a fund manager or automatically by a computer system based on an algorithmic analysis of parameters associated with a plurality of low risk assets. In one embodiment, the low-risk asset is a risk-free asset. The choice of a low-risk asset is based on factors including it&#39;s the asset&#39;s expected risk, expected return, and expected information ratio profile. For two assets with the same amount of expected risk, the asset with a higher expected return is generally more favorable. 
         [0020]    The process as illustrated also involves calculating  130  δ for an option in the chosen underlying risky asset. In one embodiment, the δ for the underlying risky asset can be calculated  130  using the original Black-Scholes formula, as described above. In other embodiments, other methods of determining δ are used. One of skill in the art will recognize that many such methods for calculating δ may be used without deviating from the spirit and scope of this disclosure. 
         [0021]    The process continues by setting  140  the initial allocation of the fund between the underlying risky asset and the low-risk asset. The initial allocation is set  140  by considering the calculated value of δ. In one embodiment, the proportion of the fund invested in the underlying asset is δ, with the remainder being invested in the low-risk asset. For example, if δ is equal to 0.6 for a particular risky asset, then a fund based on the particular risky asset will initially be allocated such that 60% is invested in the risky asset and 40% is invested in the low-risk asset. 
         [0022]    The process as illustrated then enters a loop in which a target return is calculated  150 , and the allocation of the fund between the underlying risky asset and the low-risk asset is rebalanced  160 . In one embodiment, the target return is calculated  150  and the assets rebalanced  160  monthly. In another embodiment, a fund manager chooses when to initiate a cycle of the loop based on fund parameters. In other embodiments, calculation  150  and rebalancing  160  occur in regular cycles of other durations (e.g., weekly, annually, etc.). 
         [0023]    In the first iteration of the loop, the target return is calculated  150  based on the historical performance of the low-risk asset and an expected performance for the underlying risky asset. In subsequent iterations, the method for calculating  150  the new target return may depend on the fund&#39;s performance since the last target calculation. For example, if the fund underperformed the target return for the previous iteration, the next iteration&#39;s target is calculated  150  by applying the expected return rate to the current target. For example, if the current target return represents a growth in value of the fund by 5%, but the fund has failed to achieve this, the new target return is calculated  150  based on the value the fund would have if the target had been met (i.e., 10.25% growth in fund value across the two iterations, or two consecutive iterations of 5% growth). 
         [0024]    Conversely, if the current target return is surpassed, the new target return is based on the newly achieved fund value—a so-called “ratchet.” In the case of the previous example, where the fund targets 5% growth per iteration, the new target return is calculated  150  to be a 5% growth from the fund&#39;s current value. This “ratchet” effect helps protect the fund&#39;s gains and improves the distribution of expected outcomes. If a ratchet were not employed and the fund substantially outperformed its targeted return then according to a simple option mimicking strategy it would be nearly fully invested in the underlying risky asset, and therefore at greater risk of losing a significant proportion of its total value. 
         [0025]      FIG. 2  illustrates a networked computing environment  200  for performing the process of  FIG. 1 . As illustrated, the networked computing environment  200  includes a fund management system  270 , a trading system  250 , and a secondary market  210  (e.g., a stock market), all of which are connected via a network  230 . The network  230  is typically the Internet, but may be any network that enables the components of the networked computing environment  200  to communicate, such as a WAN, MAN, LAN, and the like. 
         [0026]    The fund management system  270  includes a creation module  272 , a rebalancing module  274 , an accounting module  276 , a trading interface module  277 , and a computer readable medium for storing fund data  278 . The creation module  272  manages the creation of new funds. In one embodiment, the creation module  270  monitors the trading of potential risky and low-risk assets in a secondary market  210 . When a new fund is created, the creation module  272  facilitates the selection ( 110  and  120 ) of the assets, calculates  130  the delta for the underlying asset, and determines  140  the initial allocation of the fund between the assets. The creation module  272  interacts with the trading system  250  to obtain the required assets in the secondary market  210 . 
         [0027]    The rebalancing module  274  is responsible for periodically calculating  150  the fund&#39;s target return and rebalancing  160  the allocation of the fund between the risky and low-risk assets. In one embodiment, on a fixed day of each month (e.g., the first Monday), the rebalancing module compares the fund&#39;s actual performance with its expected performance to determine a new target return and desired asset balance, as described with reference to  FIG. 1  above. Once the new asset balance has been determined, the trading interface module  277  interacts with the trading system  250  to buy and sell assets in the secondary market  210  in order to achieve the desired balance for the fund. 
         [0028]    The accounting module  276  tracks the fund&#39;s holdings and its investors&#39; shares, and stores this data as part of the fund data  278 . In one embodiment, when investors buy and sell shares of the fund in the secondary market  210 , the accounting module  276  in notified and records the new share ownership information as part of the fund data  278 . In other embodiments, other methods of tracking the fund&#39;s holdings and investor information known in the art are used. 
         [0029]    Embodiments of the invention described above may be implemented in various types of funds, including mutual funds, grantor trusts, CTFs, and ETFs. Embodiments of the invention may also offer a series of funds, each as described herein, where each fund has a different horizon dates by investing in a horizon fund as the risky asset. The process flow and systems for trading ETFs are described in more detail in U.S. application Ser. No. 12/168,036, filed Jul. 3, 2008, and in U.S. Provisional Application No. 61/142,609, filed Jan. 5, 2009, each of which is incorporated by reference in its entirety. 
         [0030]      FIG. 3  is a high-level block diagram illustrating an example of a computer  300  for use by an AP  106 , the central intermediary  112  or investors  102 , or as part of a management facility for the trust, in accordance with embodiments of the invention. Illustrated are at least one processor  302  coupled to a chipset  304 . The chipset  304  includes a memory controller hub  350  and an input/output (I/O) controller hub  355 . A memory  306  and a graphics adapter  313  are coupled to the memory controller hub  350 , and a display device  318  is coupled to the graphics adapter  313 . A storage device  308 , keyboard  310 , pointing device  314 , and network adapter  316  are coupled to the I/O controller hub  355 . Other embodiments of the computer  300  have different architectures. For example, the memory  306  is directly coupled to the processor  302  in some embodiments. 
         [0031]    The storage device  308  is a computer-readable storage medium such as a hard drive, compact disk read-only memory (CD-ROM), DVD, or a solid-state memory device. The memory  306  holds instructions and data used by the processor  302 . The pointing device  314  is a mouse, track ball, or other type of pointing device, and in some embodiments is used in combination with the keyboard  310  to input data into the computer system  300 . The graphics adapter  313  displays images and other information on the display device  318 . In some embodiments, the display device  318  includes a touch screen capability for receiving user input and selections. The network adapter  316  couples the computer system  300  to the network  301 . Some embodiments of the computer  300  have different and/or other components than those shown in  FIG. 3 . 
         [0032]    The computer  300  is adapted to execute computer program modules for providing functionality described herein. As used herein, the term “module” refers to computer program instructions and other logic used to provide the specified functionality. Thus, a module can be implemented in hardware, firmware, and/or software. In one embodiment, program modules formed of executable computer program instructions are stored on the storage device  308 , loaded into the memory  306 , and executed by the processor  302 . 
         [0033]    The types of computers  300  used by the entities of  FIG. 1  can vary depending upon the embodiment and the processing power used by the entity. For example, the fund manager  108  may use a desktop PC, whereas an investor  102  may enter investment decision on a portable device with a small display  318  with touch screen capabilities but lack a keyboard  310  or pointing device  214 . 
         [0034]    The foregoing description of the embodiments of the invention has been presented for the purpose of illustration; it is not intended to be exhaustive or to limit the invention to the precise forms disclosed. Persons skilled in the relevant art can appreciate that many modifications and variations are possible in light of the above disclosure. For example, in situations where the fund over-performs, a mixture of the current target return and current value may be used to determine the new target return, rather than just the current value. 
         [0035]    Where specific time frames have been referenced, these represent current best practice with regards to regulation and market expectations. Such time frames should not be considered limiting and are presented purely to illustrate how the current invention can be implemented in current financial markets. 
         [0036]    Some portions of this description describe the embodiments of the invention in terms of algorithms and symbolic representations of operations on information. These algorithmic descriptions and representations are commonly used by those skilled in the art to convey the substance of their work effectively to others skilled in the art. These operations, while described functionally, computationally, or logically, may be understood to be implemented by computer programs or equivalent electrical circuits, microcode, or the like. Furthermore, it has also proven convenient at times, to refer to these arrangements of operations as modules, without loss of generality. The described operations and their associated modules may be embodied in software, firmware, hardware, or any combinations thereof. 
         [0037]    Any of the steps, operations, or processes described herein may be performed or implemented with one or more hardware or software modules, alone or in combination with other devices. In one embodiment, a software module is implemented with a computer program product comprising a computer-readable medium containing computer program code, which can be executed by a computer processor for performing any or all of the steps, operations, or processes described. Such a computer program may be stored in a tangible computer readable storage medium or any type of media suitable for storing electronic instructions. Embodiments of the invention may also relate to an apparatus for performing the operations described herein. This apparatus may be specially constructed for the required purposes, and/or it may comprise a general-purpose computing device selectively activated or reconfigured by a computer program stored in the computer. 
         [0038]    Finally, the language used in the specification has been principally selected for readability and instructional purposes, and it may not have been selected to delineate or circumscribe the inventive subject matter. It is therefore intended that the scope of the invention be limited not by this detailed description, but rather by any claims that issue on an application based hereon.