Trendspotting
TDFs Are Going Global
The funds welcome international stocks and bonds
Art by Meg HuntTarget-date funds (TDFs) have quickly become a favorite default option within retirement plans. Deciding the overall split between stocks and bonds within a TDF series, the glide path is a primary driver of results—and, therefore, participant outcomes; what the asset classes are composed of can also impact results and is worthy of consideration, according to a white paper by Portfolio Evaluations Inc.
As a number of TDF providers have announced changes to their funds’ international stock and bond exposures, it is important for plan sponsors to understand the implications of those changes and how their plan’s TDFs may be affected, says Kathryn Spica, senior investment analyst at Portfolio Evaluations in Warren, New Jersey. TDF providers may also use different tools when implementing these changes, from strategic shifts to tactical overlays to currency hedging.
Since 2007, the average international stock exposure across
TDFs has moderately increased, from roughly 18% to 22% of assets. On the bond
side, the average international exposure has grown, from less than 1% to 4% of
assets.Those numbers are likely to grow further by year-end.
For example,
Vanguard, the largest mutual fund target-date provider by assets, said earlier
this year it would increase its international stock stake to 40% of total stock
assets throughout 2015, up from 30%. In addition, after introducing
international bonds to the portfolio for the first time in mid-2013, the firm
is also boosting the international sleeve of its TDF bond assets, from 20% to
30%. American Century, PIMCO, Prudential and Schwab are among other providers
adding international bonds or increasing their international stock exposure.
Providers are continuing to rethink the global exposures of their TDFs for several reasons. One is to reduce the home country bias in their portfolios. While no provider has gone so far as to match the global market’s roughly 50% U.S./50% international stock split and 40% U.S./60% international bond split, over time the average allocation in TDFs has inched closer to that of the global market portfolio. For some providers, the strength of the U.S. stock and bond markets over the past several years is reason to believe international markets may provide better opportunities going forward.
However, there is still wide variation in the range of international exposures across the funds. No provider eschews international stocks completely, although a few still have yet to utilize international bonds, or at least to include a dedicated international bond strategy. In addition, variation also exists along individual glide paths. While most of the increases in target-date funds’ international stock and bond exposures are strategic in nature, reflecting providers’ desire to have more global exposure, some providers also have the ability to tactically allocate to international securities.
‘Auto’ Helping Millennials
Many are on the path to retirement readiness
Art by Kyle SteckerMillennials saving for retirement are bucking reports of
savings insufficiency and equity aversion, according to a white paper published
by Vanguard researchers.
“The Auto Savings Generation: Steering Millennials to better retirement outcomes” finds that participation rates, saving rates and equity allocations for Millennial participants—i.e., those ages 18 through 34—have been on the upswing over the last decade in defined contribution (DC) plans. Vanguard credits the advent of automatic plan design features and the increasing adoption of target-date funds (TDFs) for putting Millennials on the right path to retirement readiness.
Millennials’ participation in 401(k) plans in 2013 was higher than that of the equivalent age cohort in 2003, in large part driven by automatic-enrollment plan design. In Vanguard plans with an auto-enrollment feature, 87% of Millennials participated in their workplace retirement plan—an increase of more than 70% compared with 10 years prior. Vanguard notes that Millennial investors are the first generation with access to automatic plan features from the beginning of their working years.
The company reported an improvement in total saving rates across all generational cohorts in 2013, with Millennial investors demonstrating the strongest gains. The average 401(k) deferral rate for that group was 3.6% in voluntary enrollment plans and 4.2% in auto-enrollment plans—a jump from the 3.1% average contribution rate in 2003 for individuals ages 18 through 34. In plans that offer a company match, average total contribution rates for Millennials climbed to 5.1% in voluntary enrollment plans and 6.6% in auto-enrollment plans in 2013—up from a 4.2% average contribution rate for individuals ages 18 through 34 in 2003.
Vanguard says auto-escalation savings features are likely causing the improvement in Millennials’ savings rates. Many Vanguard plan sponsors have introduced this option as a complement to auto-enrollment, with 70% of plans offering both features as a default. In auto-enrollment plans, nearly two-thirds of Millennials were also enrolled in an automatic increase feature. However, even in voluntary enrollment plans, these participants were more likely to sign up for automatic annual deferral increases.
Despite the fact Millennials have experienced two significant bear markets during their lifetime, their equity allocations also increased over the 10-year period Vanguard analyzed.
The group’s median equity allocations rose to 89% in 2013, up from 82% in 2003, primarily due to climbing adoption of TDFs. Vanguard data shows usage of the funds has increased dramatically over the last decade. In 2013, 64% of Millennials in auto plans invested in a single TDF, as did 23% enrolled in voluntary plans. —Rebecca Moore
Alternatives, ESG Gain Traction
… in spite of a lack of clarity from the DOL
Alternative investments come under Cerulli’s scrutiny in a recent issue of “The Cerulli Edge—U.S. Monthly Product Trends Edition,” which takes a look at alternative investing in the form of environmental, social and governance (ESG) considerations.
As institutions pursue alternative strategies for both diversification and potential return, ESG investments appear in more and more lineups—even while retirement plans grapple with advisory opinions from the Department of Labor (DOL) that can make it difficult to adopt them.
The United Nations Principles for Responsible Investment (UN PRI) remains a catalyst for the ESG/responsible investing movement, according to Cerulli’s report. Asset managers, consultants and asset owners alike use these principles as a starting point when beginning to consider factors from an ESG/socially responsible viewpoint. As of April, signatory assets under management (AUM) totaled more than $59 trillion, with more than 1,380 signatories.
Although the marketplace can credit the PRI for setting standards, these are not without some shortcomings. In one research discussion with a consultant who specializes in ESG-oriented investing, Cerulli learned that the reporting requirements for asset managers under the PRI are largely process-oriented. This can potentially lead to signatories looking to only “check the boxes” and claim they are following the U.N.’s guidelines in order to boost their ESG credentials.
As ESG investing gains an increasing share of media attention, new firms have entered the market looking to distinguish themselves based on their ability to identify possible ESG investing opportunities and truly abide by ESG-oriented practices, Cerulli says. The report cites a firm that follows a systematic, intentional approach when choosing investments; as well as having investment management capabilities, the firm produces thought leadership through weekly/quarterly insights.
Cerulli notes the importance of managers detailing how they integrate ESG factors into their investment process. —Jill Cornfield
Boomers Not on Track
But they can take steps to improve retirement outlook, IRI
says
Baby Boomers are ill-prepared for retirement, the Insured Retirement Institute (IRI) says in its new report “Baby Boomers and Retirement Planning Strategy.” Forty percent have no retirement savings at all, and 69% have no defined benefit (DB) plan. Of those who do have savings, 59% have saved less than $250,000 and 37% have saved less than $100,000.
Annual expenditures for today’s 65-year-old retiree exceed $50,000, yet Social Security generates only $16,000 a year on average.
However, the good news, the IRI says, is that Boomers can take steps to rectify the situation. Retiring at age 70 instead of 65 can reduce needed retirement savings to approximately $720,000, and moving to a part of the country with a lower cost of living can further decrease that amount.
A 50-year-old saver who takes advantage of retirement plan catch-up contributions of $6,000 per year until age 70 at a 5.5% annual rate of return will add another $239,000 to his savings. Boomers can also seek help from family, increase their savings, reduce expenses in retirement and attempt to maintain the best health possible.
The report concludes, “Statistically, the retirement
realities facing many Boomers are grim. Put simply, they face a dangerous
combination of being under-saved and long-lived. Those at the point of
retirement with no savings and who are unable or unwilling to delay retirement
are in the worst position and will need to take the most drastic steps to
reduce expenditures.
Those with time left to build savings can take steps to
increase their savings as much as possible, delay retirement to maximize Social
Security and reduce the cost of lifetime income, and work on reducing
anticipated expenditures by carefully planning both the timing and location of
their retirement.” —Lee Barney
Taking on Health Care Expense
Advisers bit the bullet on these high costs
Art by Kyle SteckerAs many participants fall short on saving for retirement, it
stands to reason that advisers might refrain from addressing the high cost of
health care in retirement. Yet advisers say they do, indeed, address this harsh
reality with their clients.
“We talk about all aspects of what they will need in retirement,” says Michael Woomer, senior vice president of institutional and retirement plan services at Fort Pitt Capital Group in Pittsburgh. While a recent report from the National Association of Government Defined Contribution [DC] Administrators estimates that a 65-year-old couple retiring today should expect to spend $220,000 on health care over the course of a 20-year retirement, Woomer says the costs could range from $150,000 to $400,000.
“People basically understand that they will be facing health care costs, but they don’t understand how big the impact will be, so we tell participants how important it is to save as much as they can,” Woomer says.
It is far more important for retirement plan advisers to discuss health care costs in retirement than it is to talk about lifestyle goals, agrees Mary McDougall, a Merrill Lynch financial adviser in St. Paul, Minnesota. The premiums and out-of-pocket expenses that retirees face range from $10,000 to $20,000 a year, she says. “The expenses are a lot more than they expected.”
Whether advisers want to address these costs or not, the trend toward high-deductible health care plans paired with health savings accounts (HSAs) is bringing the subject of health care costs—pre- and post-retirement—to the fore, says Shelby George, senior vice president, advisor services, at Manning & Napier in Rochester, New York. Just as they moved from pensions to defined contribution plans, employers are migrating toward high-deductible health care plans that put more of the onus on participants, and employers “are encouraging advisers to talk about it more in their education materials,” she says.
Advisers are also increasingly encouraging participants to invest in HSAs. “This is one area that participants can use to save above and beyond the retirement plan,” Woomer says.
Even for investors with more than $5 million in liquid assets, says Frank Migliazzo, managing director, private wealth advisors at Merrill Lynch in Troy, Michigan, health care costs are a concern. Merrill Lynch research has found that, over the last 30 years, health care costs have risen an average of 6 percentage points above inflation annually, he says.
Merrill Lynch has also found that many people will end up in a nursing home, Migliazzo says. For a 65-year-old, there is a 15% chance he will need to be placed in a nursing home. At age 85, that rises to 55%, and at age 90, it increases to 70%. Dementia is another worry. —Lee Barney
Embracing Financial Wellness
40% of employers now offer such a program
Financial wellness programs are gaining traction among employers and are sorely needed, Alliant Credit Union says in a new white paper titled “Financial Wellness in the Workplace 2015.” The paper is based on a survey, conducted in January, of 408 human resources (HR) executives at companies with more than 1,000 employees, as well as a survey of 1,007 workers between the ages of 18 and 64, performed a year ago September. In addition, it spells out best practices for establishing a financial wellness program.
Forty percent of companies now offer financial wellness programs, Alliant found. The reason they embrace these programs, the firm says, is “businesses realize that helping their employees achieve and maintain financial well-being is a win-win for their people and their organizations. Financial stress has a significant impact on both the physical well-being of employees and their workplace productivity. This realization has led many HR executives to regard a financial wellness program as not only compassionate for employees, but as a sound investment for the company.”
The most common component of a financial wellness program is retirement planning, cited by 65% of HR executives. This is followed by medical and health-care cost-planning programs, cited by 52%; confidential employee self-assessment of their finances, by 44%; tracking tools for goal attainment, by 41%; investment planning programs, by 38%; customized financial education, by 35%; incentives or rewards for participation, by 34%; fraud-protection advice, by 27%; saving for college programs, by 26%; managing debt programs, by 23%; and education on day-to-day budgeting, by 22%.
These programs can address a recognized worker need, Alliant says. While 20% of Americans today smoke and 30% are obese, 70% are seriously concerned about their finances, and 78% are deeply worried about the direction of the economy.
Pointing to a survey by the National Foundation for Credit Counseling, Alliant notes that only 28% of Americans say they are financially fit. More than three-quarters, 76%, live paycheck to paycheck. Forty-four percent do not even have $2,000 set aside in an emergency fund; 33% save nothing each month; 30% save less than $100 a month; 36% do not contribute to a retirement savings plan; 46% spend two to three hours of company time each week dealing with their personal finances; and 79% say their financial worries keep them up at night.
“With workers reporting financial problems as their chief cause of stress, the need for financial wellness programs is both a physical and a fiscal imperative,” Alliant says.
Employers can definitely reap the benefits of such a program, the credit union says. The Consumer Financial Protection Bureau found in 2014 that companies enjoy a return of up to $3 for every $1 they spend on financial wellness programs. This return on investment occurs due to increased productivity, less sick leave taken, and reduced disability and workers compensation claims. —Lee Barney
A Place for Active Management
Investors want to protect assets in a down market
Sixty-three percent of professional U.S. investors foresee an increase in market volatility in the next 12 months, according to the MFS Active Management Sentiment study “There’s No Substitute for Skill: The value of active management through market cycles.”
Seventy percent say protecting capital in down markets is one of the most important considerations when selecting an active manager, and 63% say actively managed strategies work best in a falling market. Evidence bears this out, MFS Investment Management says: Over the past 25 years, the top quartile of active managers has achieved an average of 7.6% in excess returns in bear markets.
Despite significant flows to passive strategies since the financial crisis of 2008, only 38% of professional investors are highly confident in passive management.
When selecting an active manager, 83% of professional investors say risk management is the most important trait, followed by active security selection (67%). Asked about their concerns regarding active managers, 68% of respondents cited the tendency to focus on short-term investment returns over the past 12 months. In the U.S., 82% of investors said they are willing to pay more for outperformance over five years, and 68% are willing to pay more for managers who can outperform over 10 years.
Sixty percent of U.S. professional investors said that actively managed strategies will continue to play a significant role in their portfolios in the future, and U.S. investors have allocated 77% of their portfolio assets to active investment strategies.
“At some point, we will see additional volatility, and that creates opportunity for active managers to identify risks and generate alpha,” says Joe Flaherty, chief investment risk officer for MFS in Boston. “Downside risk management is part of the value proposition that active managers can deliver through research and security selection. Many active global managers have significantly outperformed in falling markets. A passive strategy, by definition, takes full market risk. In recent years, strategies that straddle the line between active and passive have become increasingly popular with investors.”
CoreData conducted the study for MFS Investment Management, based on a survey of 1,038 financial advisers and institutional investors across the globe, including the 575 in the U.S., whose responses are cited above. —Lee Barney
