Portfolio Shifts Continue After Banner Year

A strong recovery in asset values and pension funding levels hasn’t slowed the pace of change in institutional investment portfolio strategies, according to an analysis from Greenwich Associates.

Results from the “Greenwich Associates 2013 U.S. Institutional Investor Study” show the value of U.S. institutional investment portfolios increased about 11% last year, led by a combination of strong investment returns and rising interest rates that reduced the dollar amount corporations and governments must commit today to cover future pension liabilities. Despite that appreciation, institutional investors continue to implement significant changes to their portfolio management strategies and asset-allocation profiles in an effort to achieve a series of increasingly diverging objectives, says Andrew McCollum, a Greenwich Associates consultant.

McCollum explains U.S. public and corporate pension plans are reacting in very different ways to their improved funding circumstances. Corporate funds, which are subject to “mark-to-market” accounting rules that tie pension liabilities directly to the overall balance sheet and expose sponsor companies’ earnings performance to pension valuation volatility, are looking for opportunities to add risk-reducing assets.

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“As companies’ funding ratios inch up, they tend to increase allocations to fixed income as part of risk-reducing asset-liability matching and liability-driven investment strategies,” McCollum says.

Other steps observed by McCollum include the closing or freezing of defined benefit (DB) plans for new and existing employees in favor of defined contribution (DB) arrangements, which define a sponsor’s commitment in dollar terms rather than benefit terms, thereby reducing long-term liability. A growing number of corporate plans are also engaging in pension buy-outs, a strategy embraced by about 10% of large U.S. corporate plan sponsors over the past three years, according to Greenwich Associates.

Some experts and observers predict 2014 will be an especially favorable time for corporations to enact buy-out strategies, in part because of increasing Pension Benefit Guaranty Corporation (PBGC) premiums. Researchers at the benefits consulting firm Mercer tell PLANADVISER that the increase in PBGC premiums caused the relative economic cost of running a pension plan (as compared with projected benefit liabilities) to jump about 40 basis points in recent months for a theoretical plan, up to 108.7% of liabilities as of the end of February (see “PBGC Premium Hikes Shake Up Buyout Landscape”).

The cost of retaining liabilities hovers above real liability values due to such things as administrative costs, management fees and insurance premiums. Such factors can make it more economical for a corporation to offload pension liabilities to an insurer, even with premiums running at 7% to 8% or more of total liabilities.

Public pension funds, which operate under less stringent accounting rules but have little hope of seeing large infusions of new taxpayer cash in the current economic and political environment, are taking a much different approach, McCollum says.

One common behavior among public plans is an increased allocation to alternative asset classes, with the goal of either boosting returns or reducing market correlations. Greenwich’s research finds public funds have taken action in this area by making large investments in private equity, pushing this asset class to 10% of total public pension portfolio assets—up from about 7% three years ago.

U.S. endowments and foundations continue to pursue the so-called “Yale model,” but in 2012 and 2013 they reduced allocations to alternatives for the third consecutive year. That trend appears poised for change however, as not-for-profits plan to reduce allocations to both active U.S. equities and fixed income while increasing allocations to alternatives in the coming three years.

Over the next three years, institutional investors in general say they expect to increase target allocations to alternative asset classes such as private equity, real estate, hedge funds and commodities, while reducing allocations to U.S. and regionally-focused equities.

More information is available at http://www.greenwich.com/.

Recordkeepers Strongly Influence Outcomes

Retirement plan participants’ savings rate is the most important factor for ensuring successful retirement savings outcomes.

A new study focused on determining the influences, other than demographics, on participant deferral rates. Importantly, the study found the greatest independent impact on deferral rate is the employer match. This factor alone has two times the independent effect on deferral rates than age or household income, each taken separately, according to the survey. In addition, the data shows the participants’ level of financial literacy and level of confidence in being able to amass sufficient financial resources to comfortably retire are key drivers of deferral rates.

However, the survey also found the actions and effectiveness of a plan’s recordkeeper can have a positive or negative composite effect on deferral rates almost as powerful as the effect of the match.

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“One of reasons we were interested in doing this study is that when plan sponsors do a recordkeeper search, there’s not really an effective way to measure how well a recordkeeper engages plan participants,” Laurie Rowley, co-founder and president of The National Association of Retirement Plan Participants (NARPP), tells PLANADVISER. With the study, NARPP develop the FELT (Financial Empowerment, Literacy and Trust) score index comprised of factors, controlled by recordkeepers, that have a positive effect on deferral rates, she says. When evaluating which recordkeeper to use, the index shows which providers are helping participants save more, based on a combination of participant trust in the recordkeeper, education provided by the recordkeeper, and other areas of support.

According to the study, currently, only one in four (26%) participants feel they can “always trust” their (respective) recordkeeper to do what is right. This varies widely by recordkeeper from a low of 15% to a high of 38%.

“Intuitively, trust affects every relationship we have,” Rowley says. “We found trust impacts how often participants contact their recordkeeper, and also impacts the likelihood participants calculate what they need for retirement—one of the most important things participants can do prepare for a secure retirement.”

Among the 23 recordkeepers profiled, an average of 14% of participants indicated they contact their recordkeepers more than once every month, an average of 23% of participants do so once every month, and 30% reported they contact their recordkeepers several times a year. Ten percent said they never contact their recordkeepers. The study included responses from 5,000 participants among the 23 recordkeepers.

An average of 46% of participants has calculated how much they need for retirement.

One bothersome finding of the study, according to Rowley, is participants’ understanding of basic investment terminology was low. For example, only 38% of participants, on average, said they understand very well what diversification means—the percentage among women was even lower at 27%. “These are terms participants will need to know throughout their lifetime savings journey,” Rowley says. “If plan sponsors and recordkeepers do not educate them, they are setting participants up for failure.”

When asked about education provided from their recordkeepers, an average of 37% of participants in the study said the information presented to them is always in their best interests. Only one-third (34%) indicated the information helps them understand the basics of investing, and only 30% reported that fee information is presented in a way that is easy to understand. One-quarter of participants said sometimes the financial education feels more like product advertising or sales.

Rowley suggests plan sponsors consult with recordkeepers about how to educate participants. “Just because there is auto enrollment or automatic investing help via managed accounts or other vehicles, doesn’t mean [participants] don’t need to know the jargon,” she contends. “What if they change to an employer that doesn’t auto-enroll? Plus, this may be why there is such low level of engagement among participants who are auto-enrolled versus those who make the choice on their own.”

Information about the study, or about the FELT score index may be obtained for free by emailing Rowley at laurie.rowley@narpp.org.

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