Reshaping Equity Risk: Defined Outcome Strategies for Retirement Portfolios

Marketing Communication. Capital at risk. For Professional Investors Only.

For pension investors, managing risk approaching retirement has traditionally meant a steady shift from equities into fixed income as the time horizon shortens, trading growth potential for capital preservation, income and diversification.

That approach is increasingly being challenged by elevated stock-bond correlations.¹ On the equity side, US benchmarks remain concentrated in a relatively small group of technology and AI-related companies following a period of strong growth.² High valuations do not themselves cause market corrections, but they can leave portfolios more sensitive to changes in liquidity, discount rates and investor positioning. At the same time, the long end of global sovereign bond markets continues to face pressure from elevated government borrowing requirements, inflationary pressures and rising term premia.³

For pension schemes and retirement portfolios, this challenge is only becoming more pressing. A wave of pension reforms is underway across Europe, including Germany's Altersvorsorgedepot, replacing the Riester pension from January 2027, set to bring millions of new savers into equity-linked pension products.⁴

This paper explores why defined outcome strategies may be a useful tool in pension portfolios, building on our earlier paper Staying Put: Redefining Portfolio Protection with Defined Outcome Strategies which sets out the correlation breakdown behind the case, the mechanics of how the strategies work, and the growth in institutional adoption driving the category.

Key Takeaways:

• The Pension De-Risking Dilemma - The hedge pension investors have relied on for decades no longer offsets equity risk the way it used to.⁵

• A Third Path Between Equity Risk and Duration Risk - Defined outcome strategies trade a portion of equity upside for a pre-set level of downside protection, without adding duration exposure.

• Risk-Adjusted Outcomes Matter More Than Headline Returns - Buffer strategies match the S&P 500 on a risk-adjusted basis while cutting maximum drawdown nearly in half.⁶

The Pension De-Risking Dilemma

Central banks are no longer providing the balance-sheet support markets grew used to after the GFC and Covid, leaving a steeper curve and more volatility in exactly the part of the bond market pension investors have relied on to de-risk.⁷,⁸

Historically, the 60/40 model rested on high-quality bonds offsetting equity weakness. That relationship has weakened as inflation and rate volatility have increased. Between 2017 and 2020, the rolling correlation between US bonds and the S&P 500 sat around zero or slightly negative, the pattern the model is built on.⁹ That changed once inflation took hold and central banks moved into the sharpest rate-hiking cycle in forty years, pushing the 6-month rolling correlation above 0.5 as both asset classes sold off together at the moment diversification was needed most.¹⁰ Even the partial decline in correlation since then has not restored the hedge, bonds provided no offsetting protection during the equity sell-off tied to the tariff dispute in early 2025 and ongoing bond sell-off during 2026.¹¹,¹²

This leaves pension investors with a difficult trade-off between reducing equity drawdown risk without simply swapping it for duration risk. This may be particularly relevant for pension investors approaching or entering retirement, where large drawdowns can have a disproportionate impact given less time for capital to recover and the risk that losses get crystallised through withdrawals.

A Third Path Between Equity Risk and Duration Risk

Rather than a binary choice between staying fully invested in equities or rotating into a bond market that no longer diversifies as reliably as it once did, a growing area of portfolio construction sits between the two.

Options-based equity strategies such as Defined Outcome strategies, otherwise also known as buffers, retain exposure to an equity index while using an options overlay to provide a pre-set level of downside protection, a “Buffer” in exchange for capping upside participation.

For pension portfolios, this can function as an intermediate allocation between unhedged equities and long-duration fixed income, reshaping equity risk rather than swapping it for an equally unpredictable duration risk.

The trade-off is explicit. These strategies are not designed to outperform equities in strong rallies, since upside is capped by construction. The premise instead rests on a more efficient balance between return taken and risk carried, which matters more as an investor's priority shifts from maximising growth to preserving what has already been accumulated.

Risk-Adjusted Outcomes Matter More Than Headline Returns

Headline return comparisons miss what actually matters for a retirement portfolio, the path an investor takes to get there, and how survivable that path is if it goes wrong at the wrong time.

Two measures capture this better than raw return:

Risk-adjusted return, measured by the Sharpe ratio, is return earned per unit of volatility taken. Across market cycles, the historical evidence for defined-outcome exposure to large-cap equity indices generally shows a comparable or modestly improved risk-adjusted return relative to holding the unhedged index outright, despite materially lower volatility and downside capture.¹³ The efficiency shows up on a per-unit-of-risk basis, where the outcome tends to be at least as good as holding the index outright. Based on monthly return data through July 2026, both the Quarterly 5% Buffer and Annual 15% Buffer strategies recorded a Sharpe ratio of 0.83, versus 0.81 for the S&P 500, with materially lower beta, volatility and downside capture.¹⁴

Drawdown severity, measured by the Calmar ratio, is annualised return relative to maximum drawdown. This is the more pension-specific of the two, because a severe drawdown immediately before or during retirement can do far more lasting damage to portfolio sustainability than day-to-day volatility ever does. The Quarterly 5% Buffer Index produced a Calmar ratio of 0.59 versus 0.58 for the S&P 500, while the Annual 15% Buffer Index produced a ratio of 0.72.¹⁵ The latter's maximum drawdown was approximately -19.4% versus -33.8% for the S&P 500 over the measured period (COVID selloff).¹⁶

For pension construction, reducing the depth of losses can matter more than reducing volatility itself, given the asymmetric impact of a bad sequencing outcome on a portfolio that is decumulating rather than accumulating.

Conclusion

Pension de-risking has long rested on a simple trade. Reduce equity exposure, increase bonds. That trade no longer appears to operate as cleanly as the models assume. The correlation that made it work has broken down, and bonds are facing pressures of their own. Defined outcome strategies offer a third path, reshaping equity risk rather than removing it, trading some upside for a contractual level of protection against the losses that matter most heading into retirement.

The evidence bears this out. Risk-adjusted return holds up alongside a meaningfully shallower maximum drawdown. Pension reforms across Europe may result in millions of new savers entering into the equity markets over the coming years, which only raises the stakes on getting this right. The combination earns a place in the pension toolkit, alongside rather than instead of traditional fixed income.

This document is not intended to be, or does not constitute, investment research as defined by the Financial Conduct Authority.