Who Is Responsible for Retirement Security?

National Retirement Security Week, from October 21 through 27, highlights the complementary roles of governments, employers and individuals in creating better retirement security for everyone in the U.S.

National Retirement Security Week highlights the major influence of defined contribution (DC) retirement plans when it comes to helping U.S. employees generate assets to live on in retirement.

To mark the occasion, experts and analysts have published copious amounts of new reports, white papers and blog posts harkening both the successes and the shortcomings of the DC plan system. Many agree that plan advisers and plan sponsors—along with government regulators and product providers—have done a lot to boost retirement security since the passage of the Pension Protection Act (PPA) in 2006. But there is also near universal agreement that all retirement industry stakeholders can do more to help prepare people for their post-employment future.

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According to Jim Poolman, executive director of the Indexed Annuity Leadership Council (IALC), one shortfall in the industry is the fact that participant education has focused far more on the accumulation of assets—rather than on full retirement planning, which also includes guidance on how to spend down those assets effectively. Poolman says plan sponsors, broadly speaking, are only just starting to look beyond maximizing participation rates and asking whether plan participants are taking full advantage of the employer benefit offering.

“Beyond accumulation, it is important to talk about lifetime income, about the risk of outliving your income or your retirement savings,” Poolman says. “We need to talk about expenses and educate individuals about unforeseen costs and hardships in retirement. This is educating them not only about saving for retirement, but about what circumstances surround a successful retirement.”

Poolman suggests “unforeseen circumstances,” such as the sudden diagnosis of a chronic medical condition, can totally derail a participant’s savings strategy—assuming there is even one in place. Even those who proactively take care of their health and put plans in place for paying for future health care face an incredible challenge, given the rising cost of care over time. He says employers can step up here and implement education and potentially even ancillary savings opportunities around medical security for workers’ retirement years.

Employees Want Help—That Much Is Clear

According to Robert Scheinerman, president of group retirement business at American International Group (AIG), a survey conducted by VALIC, an insurance company within AIG, shows one in four employees “do not even know what to ask first about retirement planning.”

There were various qualitative responses which demonstrate a large portion of the U.S. population does not really feel comfortable doing retirement planning on their own,” Scheinerman says.

He recommends plan sponsors utilize a three-pronged approach when designing their benefits. One prong will address those rare individuals who understand their retirement needs and how to craft their own savings strategy. The second prong or tier will be tailored for those who believe they have some idea about how to make a plan, but continue to need support. The third and most important tier will be designed to benefit the majority of people, who are unfamiliar with retirement planning.

“While there are a certain amount of people who think everyone should just do it themselves, we know today that this is not realistic,” Scheinerman says.  

Communications via email may be sufficient for supporting those participants who take charge of their own planning needs, he says, but purely digital communications are not sufficient for those requiring additional support. Offering in-person or at least on-the-phone retirement counselors makes a world of a difference.

“Should plan sponsors or participants express concern with investment portfolios, for example, a retirement plan counselor can analyze investment profiles and pinpoint which participants are investing too aggressively, or too conservatively,” Scheinerman says. These are the types of questions most people just don’t feel comfortable answering on their own—even those with some level of expertise on finance as a general topic.

Scheinerman and Poolman agree that plan sponsors should consider developing formal education schedules that include regular follow ups and benchmarking. Plan sponsors must also remember how investment risk tolerance changes as employees age, and ensure their participants know that retirement planning is a marathon—not a one-time event.

“Quality participant education occurs throughout the life cycle of the plan participant. Getting somebody to contribute 10% to their 401(k) is not the end of the game,” Poolman says. “We should be promoting continuous education about how important it is to be financially literate throughout your entire life, so that you make necessary changes along the way.”

Institutional Investors Seek ESG Opportunities via Fixed-Income Vehicles

BlueBay Asset Management's My-Linh Ngo offers a crash course in ESG fixed income.

RBC Global Asset Management recently published its third annual Responsible Investing Survey, and My-Linh Ngo, ESG investment specialist for the firm’s London-based BlueBay Asset Management division, offered PLANADVISER her take on the results.

At a high level, the survey results suggest institutional investors in the U.S. are rapidly warming to the utilization of environmental, social and governance (ESG) factors when building out their portfolios—and many are already implementing their own takes on ESG investing. Notably, the percentage of U.S. institutional investors that reject ESG considerations outright shrank dramatically year over year, from 51% to 34%.

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As Ngo pointed out, equities have long been the primary focus of ESG analysis and investing, but these days ESG analysis is quickly moving beyond equities. Thirty-percent of respondents in the U.S. said it is important to incorporate ESG into fixed-income considerations, Ngo said. Asked directly whether they incorporate ESG into fixed-income management, 52% of U.S. investors that already use ESG said yes.

“Our company has a core belief that ESG considerations are investment additives, not a hindrance to performance,” Ngo said. “Thinking about ESG helps us to generate a more holistic and informed view of how companies are performing, or are likely to perform in the future. So, we are applying an ESG risk overlay across all of the fixed-income assets we manage. It is not something that we limit to niche funds.”

Of course, the specific approaches BlueBay applies will vary across different products and geographies—but ESG risk overlays “come standard with every fund and investment product,” Ngo said. “We do it this way because we see ESG as something that can be quite beneficial in terms of measuring and addressing downside risk, especially on the fixed-income side.”

More Sophisticated Than Simple Screens  

According to Ngo, providers these days are taking a much more sophisticated approach to ESG than just running simplistic negative portfolio screens to avoid bad apples.

“Today we are conducting sophisticated analysis on the investment materiality of key ESG factors, and we are doing this in a rational way that looks across the entire institutional portfolio,” Ngo said. “I must stress, this work is not about running a bunch of negative screens, but instead it is about being scientific about how you build portfolios and truly acknowledging the risks you take.” It’s an unbiased, pragmatic approach that is grounded in focusing on the impact on investment performance.

Like other ESG advocates, Ngo said she was somewhat frustrated to see the most recent regulatory guidance issued in the U.S. on this topic—the Trump administration’s DOL Field Assistance Bulletin 2018-01. Ngo said this guidance is largely unhelpful and even potentially misleading, as it seems to discourage consideration of ESG factors by retirement plan sponsors while at the same time doing nothing to actually supersede the previous regulatory action, the Obama administration’s Interpretive Bulletin 2015-01, which encouraged more use of ESG. In the end, Ngo said, the demand for ESG is coming from investors themselves and is ultimately unlikely to be derailed by a lack of regulatory clarity.

Fixed-Income ESG Is Similar and Different 

Before taking a deep dive into the mechanics of ESG fixed income, Ngo first highlighted some of the ways that the analysis mirrors what is seen on the equity side of the portfolio.

“In absolute terms, both ESG equities and ESG fixed income are not quite mainstream yet,” Ngo said. “They are getting there, and in relative term, ESG thinking in equities is more mainstream. Another similarity is that both sides allow investors to come at ESG from both the business/economic perspective and from the values/beliefs perspective. We feel that, in both cases, ESG can benefit long-term risk-adjusted returns. Finally, both ESG equities and ESG fixed income still face similar issues in terms of inherent challenges of visibility and understanding in terms of the breadth and quality of the actionable data that is available.”

This point is echoed by recent Natixis research, showing 45% of institutional investors feel it is difficult to measure and understand financial versus non-financial performance considerations when establishing ESG programs. Some of their concern may be based on the criticism received by CalPERS and the New York City pension funds following fairly enthusiastic ESG implementation and fossil fuel divestment efforts. However, the Department of Labor (DOL) and other regulators and resources have offered extensive guidance on the topic as it pertains to retirement plans, it should be noted.

Moving on to the areas where ESG fixed income is different from equities, Ngo first pointed to the fact that on the equity side, generally speaking, investors can choose from a large universe of unique issuers, but at the same time the instruments they can invest in to get exposure to these companies are quite limited. Usually it is one share class or possibly two, Ngo said.

“What this means in practice is that you can take a very fundamental view on the equity side of whether you want to have investment exposure to a given company or not—because they only have that one vehicle and thus only one singular investment risk profile from the ESG perspective,” Ngo said. “This allows you to more easily build in your fundamental view directly into your decision of whether or not to invest in this company.”

On the fixed-income side, essentially the inverse is true.

“You have a smaller pool of unique issuers, but each of these has a larger pool of instruments you can invest in,” Ngo said. “What this means in practice is that each issuer will have a variety of different bonds that have different yields and different maturities. The different bonds will afford different levels of protection, as well, depending on the structure of the capital pool and how the bond is built. Thus, in practice, there are multiple credit risk profiles to consider for each issuer, depending on the bond that you choose to invest in. For this reason, the ESG analysis for fixed income is made that much more technical and quantitative.”

Another major difference to consider, Ngo said, is tied to the fact that equity markets “are so much more sentiment-driven relative to bonds, and they move at least in some degree according to what people are anticipating, with or without evidence, about the future.”

“In practice, this means a mere rumor can impact the share price of a company,” Ngo said. “Even if it is unsubstantiated, if there is a perception of risk this will be reflected in the stock price immediately, and potentially in quite a pronounced way. But when you look at fixed income, the credit rating is a more stabilizing force, in a way, because it is looking at the narrower but more extreme risk of the potential for default of that issuer. There are other risks in between, in terms of credit downgrades or upgrades, but it’s all much more tied to the real balance sheet of the company and how this relates to the maturity of your debt holdings.”

Based on these facts, Ngo said the determination of the materiality of ESG risks is more subtle on the fixed-income side, but also more ripe with possibilities.

“As an example, let’s say you have an energy company and it is very exposed to climate risks in the long-term, and let’s also say you have one short-term bond from the company and one long-term bond in your portfolio,” Ngo said. “Well, you can pretty easily argue that the ESG risk is less significant, potentially much less significant, for the short-dated bond, while the same risk is very material to the long-term bond.”

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