The Markets January 23, 2014

Funded Status Raises Allocation Questions

Advisers to defined benefit (DB) retirement plans may face challenging allocation questions as the funded status of corporate pension funds improves.
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Russell Investment’s analysis in a recent paper shows an improvement of nearly 15% for a representative open plan, and 8% for a representative frozen plan. This is indeed good news, the investment manager says, and also a big change, which will likely spark some substantial changes to the asset-allocation policies of a number of plans.

Have a clearly articulated answer to the question of what the target is, advises Martin Jaugietis, managing director of liability-driven investing (LDI) solutions at Russell Investments.

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A good strategy means considering several factors. First, a firm should decide what funded level it would like the plan to achieve. “Some clients want to reduce the size of the liability,” Jaugietis tells PLANADVISER. This can be done by selling a portion of the liability to an insurance company. But this in turn results in the need to pay a premium. A firm might want the plan to be fully funded at 100%, or even above. Having 110% or 115% of assets relative to the liability is a possible endgame target, Jaugietis notes.

Having a fully funded pension plan could be the target, in which case plan sponsors should recognize that they do not need to take any risk relative to their liability, Jaugietis says. When a plan has a more stable funded status, the risk of large drawdowns and required contributions is minimized, and the financial risk of the pension plan itself on the company is minimized.

Plan sponsors should know an improved funded status suggests less risk is required in the portfolio, Jaugietis says. The portfolio should move in the same direction as the liability. Equity market performance or the direction of interest rates are no longer such key concerns, he adds. “If you’re fully funded you should care less about tactical views. This is a discussion to take up with the investment committee.”

Risk Reduction

The asset allocation will automatically need to change on the heels of an improvement in funded status because of liability-responsive asset allocation. This trend in pension plans, which has been in use for the past few years, involves the systematic reduction of investment risk as funded status improves. Assets are moved away from return-seeking assets and placed into liability-hedging assets, Jaugietis explains. The industry calls this a liability-driven investing (LDI) portfolio. “The rationale is essentially that the cost-benefit tradeoff changes when plans are fully funded,” he says. “Further upside is less rewarding for a fully funded plan than for an underfunded one.”

An asset-allocation glide path should be set in order to hit the target, Jaugietis says. “You can have investment returns, or you can contribute to the plan.”

Jaugietis points out that premiums set by the Pension Benefit Guaranty Corporation (PBGC) areset to increase substantially, which in turn increases the incentive to fund the plan earlier or more quickly. The discussion should focus on the best investment strategy and what funding policy will help the firm get to the endgame.

Current trends, according to Jaugietis, include firms asking if they have the right partners or resources to carry through the strategy, and outsourcing to a specialist asset manager for the investment component to provide these services. There is more dynamism in the use of asset classes as well, he says, and plan sponsors are turning to multi-asset investing.

The last component to consider is benefit design, adds Jaugietis. Firms must look at the overall pension benefit. He notes that a number of companies have closed and frozen their pension plans, and provided an additional 401(k) benefit. Comparing it to the three legs of a stool, he emphasizes, “A clear strategy of investment policy, investment strategy and benefit design are necessary.”

More about asset allocation in higher funded pension plans is on Russell’s site.

Data & Research January 23, 2014

Hispanic Americans Face Saving Challenges

A new study finds that for Hispanic Americans, the need to support elders and children is competing with the need to save for retirement.
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“The Hispanic American Financial Experience,” from Prudential Financial, finds that the Hispanic American community is moderately confident in its future outlook for household finances. The group is also moderately confident on the state of the local and national economies, as well as on the amount of attention given to its needs by the financial industry and government. 

In addition, the study finds Hispanic Americans have placed a priority on funding near-term goals, such as supporting multigenerational families. These factors, according to the study, make it difficult for the group to prepare for long-term financial goals.

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The study also indicates that the complexity of programs such as Social Security, a lack of access to work-based retirement plans, and limited contact from financial advisers all act as barriers for members of this community to achieve long-term financial goals.

Current Focus on Near-Term Goals

With regard to retirement planning, the study shows that Hispanic Americans face distinct challenges. More than twice as many Hispanic Americans as the general population (15% compared with 6%), say that supporting elderly family members is a financial priority. In addition, 31% of Hispanic Americans place importance on funding the education of their children or grandchildren, compared with just 18% of the general population.

“The study shows that many Hispanic Americans have clear financial goals, but they may be unsure about how to achieve them,” says George Castineiras, senior vice president of total retirement solutions at Prudential Retirement. “We see an underestimation of how much money may be required to retire, a fact evidenced in part by lower participation in workplace-based retirement plans, lower rates of investing and longer expected time in the workforce, with three out of every four expecting to continue working during retirement.”

The focus on shorter-term financial objectives may hinder Hispanic Americans’ ability to set goals for savings and retirement. The study also reveals that the group has less access to workplace-based retirement plans and, even when given access, members of the group are still less likely to contribute to retirement plans.

Slightly more than half (53%) of Hispanic Americans say that saving for retirement is an important financial priority, compared with 62% of the general population.

Better Understanding of Retirement Issues Needed

Fewer than half of those surveyed for the study say they have a good understanding of Social Security, workplace-based retirement plans or financial products. In addition, 29% believe they will need only one source to fund retirement savings, compared with 19% of the general population. When it comes to considering financial products or services, Hispanic Americans cite trust of providers as the major barrier, while 14% say they have difficulty understanding the products and 13% don’t know where or who to go to for information.

“One major question raised by the study is whether Hispanic Americans would plan for their retirement differently if they had access to information that could help them generate the knowledge they need to make investments decisions to secure their own and their family’s futures,” says Castineiras.

Saving and Investing Habits

The study indicates that Hispanic Americans take a careful and conservative approach to financial planning. The Hispanic American community also revealed a cultural aversion to accumulating debt. Sixty-two percent say there is no such thing as “good debt,” yet seven in 10 indicate that it is nearly impossible to live debt-free, especially when it comes to big-ticket items such as a home, car, paying for college or starting a business.

Heading into 2014, the top financial resolution among Hispanic Americans is to pay down debt, yet only 38% feel confident they can achieve this. While more than 37% cite saving money as a goal, only 26% feel confident they can attain it. Just 13% say they will contribute more to a 401(k) or other retirement plan, and in that group only 31% feel very confident that they will be able to do so.

Supporting family lies at the heart of many financial priorities for this community, very often making family finances multigenerational and global. According to the study, nearly one out every six Hispanic Americans supports their parents, and 42% of non-U.S. born Hispanics send money to relatives in their home country. Additionally, one-third of the study’s respondents intend to spend their retirement years partially or fully outside the United States.

“The study suggests the significant economic impact that Hispanics have on their families and communities both within and beyond our border,” says Alexandra Galindez, Prudential’s vice president of multicultural marketing. “As the Hispanic American population continues to grow in the U.S., it becomes increasingly important to provide the community with financial information that can help build wealth, as it could have a tremendous impact on the U.S. economy and abroad.”

Contact with Financial Advisers

The study also revealed that Hispanic Americans, regardless of their income level, receive less contact from financial advisers or professionals that could help them gain the knowledge they need to plan for their financial future. The study’s authors suggest that having more access to information and advisers who can help individuals make financial decisions could lead to higher confidence rates, as well as more solid planning for reaching retirement goals among Hispanic Americans.

While the study shows that the biggest gap in financial confidence among Hispanic Americans is between those with and without a financial adviser, establishing a relationship with an adviser proves challenging. Compared to the general population, Hispanic Americans are half as likely to have a professional financial adviser or to have been contacted by an adviser. However, when contacted, this community is equally as likely to work with a financial professional as the general population.

Prudential’s study was conducted among Hispanic Americans with a household income of $25,000 or more and found that even among Hispanic Americans with a household income of $75,000 or higher, and regardless of country of birth, there is a gap in understanding financial products and services when compared to the general population.

The study consisted of an online survey administered by GfK Custom Research, Inc., in both English and Spanish, from October 28 to November 18, 2013. This survey polled 1,023 Americans who identify themselves as Hispanic and questions covered a broad range of financial topics.

Prudential Financial, Inc. is a financial services provider that offers retirement-related services, as well as life insurance, annuities, mutual funds and investment management.

The study results can be downloaded here.

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