New Directions in Retirement Investing

Managing risk with outcome-based lineups

Five yearsafter the financial crisis began, investors still have much to worry about—namely, market volatility, economic uncertainty and the impact of inflation. Modern portfolio theory and style-box diversification just didn’t work so well during the market crash.

In an interview with PLANADVISER Managing Editor Lee Barney, Julia Lawler, senior vice president of investment services at the Principal Financial Group®, discusses how financial professionals can use an outcome-based approach to help create a more informed, more intelligently-constructed investment lineup. This approach develops investment lineups intended to help mitigate the risks that undermined participant allocations following the market crash and seek to address future risks such as inflation.

PA: What has changed for investors since the financial crisis? What risks do they still face?

Lawler: During the financial crisis, most investors saw the biggest loss to their investments they’ve probably ever witnessed. They truly faced volatility and downside risk, which made many investors more risk-averse than ever before.

At the same time, individuals are increasingly being asked to take on more of the responsibility for retirement, with fewer defined benefit (DB) plans available.

In light of these factors, we think investment lineups need to change—particularly to include strategies intended to generate income, protect investors’ purchasing power from inflation and better manage downside risk.

We think this presents a significant opportunity for financial professionals to demonstrate value by helping plan sponsors structure retirement plan lineups to better address these needs.

PA: As financial professionals work with plan sponsors, what are the enduring lessons of the financial crisis?

Lawler: Most notably, we learned modern portfolio theory is not the full answer, because all of those typical investment styles became highly correlated.

The second thing we learned is that the law of averages over long periods of time, while it still holds, doesn’t help an investor in a steep bear market. For example, in 2008 and 2009, many equity portfolios lost 30% to 40% of their value. It takes a very long time to recover a loss like that.

As a global investment management leader, we believe a different approach is needed, one where asset allocation and portfolio construction—with exposure to alternative asset classes and outcome-based investment strategies that seek to address certain risks—would play a much greater role.