PLANADVISER - July/August 2018 - C2

Two Key Themes for DC Plans
For defined contribution (DC) plan participants, wealth accumulation
has depended on both equities and fixed income. Yet fixed
income will be ever more important in 2018 and beyond, in our view.
Of the $7 trillion in DC assets, roughly two-thirds is held by participants
over age 50, the period when fixed income exposure peaks in
portfolios. The performance of bonds will thus be critical to seeking
retirement security. We believe the prospective low-return environment
calls for a highly capital-efficient approach, including actively
managed bonds and passively managed or enhanced equities, in
target date, core and retirement income allocations.
< Richard Fulford, Executive Vice President, Head of U.S. Retirement at PIMCO
H
ere are some suggestions for
adapting DC menus to better serve
participants in the years ahead.
TDFs: Go Active Where It Matters,
Passive Where It Saves
Target-date funds (TDFs) offer participants
a diversified, all-in-one default solution for
potential wealth accumulation. But TDFs,
which entered the scene nearly 25 years ago,
need optimization along the active-passive
axis.
In our view,
sponsors may improve
participant outcomes and prudently manage
plan expenses by
employing
active
and
passive strategies selectively.
Today, 98% of DC plan sponsors that
use TDFs have underlying strategies that
are exclusively passive or exclusively active,
according to BrightScope. Only 2% of plan
sponsors use TDFs that blend active and
passive approaches.
In contrast, 62% of plan sponsors blend
active and passive approaches on the core
menu.
Why the inconsistency? We suspect this
is due, at least in part, to a dearth of active/
passive blend TDF strategies. Over time,
however, we expect TDF allocations will
migrate to blend strategies, improving alignment
with plan sponsor preferences.
A blend approach makes good sense: Go
active where it matters, particularly in fixed
income, where alpha has been historically
more consistent; go passive where it saves,
especially in equities, where the cost differential
between active and passive is significant,
59 basis points on average.i
Blend TDFs that actively manage bonds
and passively manage stocks may not only
2 | planadviser
reduce plan costs, but they also may deliver
results that are superior to exclusively active
or passive approaches.
We make the case for active fixed
income in " Bonds Are Different: Active
Versus Passive Management in 12 Points. "
Active management has historically been
successful in fixed income because, in part,
unlike the equity market, the bond market
has a variety of structural inefficiencies that
active managers can exploit to seek alpha.
Data support our view: About 80% of active
fixed income managersii
beat their median
passive peers over the five years ended 31
December 2017. In contrast, only 37% of
active equity managersiii
outperformed their
median passive peers during the five-year
period ended December 2017.
The potential benefits of active fixed
income are great. This is most true for individuals
who are near or in retirement, when
glide path allocations to fixed income peak.
For example, a participant invested in the
market-average TDF that employs actively
managed bonds and generates an additional
100 basis points (bps) of alpha annually on
the bond portion of the glide path realizes
a dramatic improvement in retirement
outcomes over a fully passive approach.
Asset longevity jumps by 19% (from 21 to 25
years) and retirement assets increase by 9%.
See Figure 1 on facing page.
In short, we believe that qualified default
(QDIA)
investment
alternative
Retirement Income: Don't Make Perfect
The Enemy of The Good
When it comes to retirement income, we
think it's time to heed the advice of the
French philosopher Voltaire, who famously
remarked, " Perfection is the enemy of good. "
In theory, a perfect retirement income
solution would provide a guaranteed level
of lifetime income and an absence of investment
risk. In practice, mythical solutions of
this sort do not exist, and most retirement
solutions that include some form of insurance
guarantee are far from perfect. They
suffer from complexity, high cost, incremental
sponsor risk, and a lack of transparency
and transferability. Not surprisingly,
adoption of guaranteed solutions by sponsors
and participants has been limited.
Surveys show, though, that participants
prefer good, if imperfect, solutions. They
value low volatility and full control over
drawdowns, and prefer to source income
from interest and dividend distributions
rather than principal. They're willing to
forgo insurance for the absence of the
complexity, high cost and other drawbacks
noted above.
In practice, of course, participant preferences
may vary widely. But momentum to
embrace practical solutions appears to be
building.
One sign is the surging interest among
strategies
that blend active bond investing with
passive equity exposure represent the most
capital-efficient approach-and can potentially
increase the odds that savers reach
their retirement objectives.
SPONSORED SECTION
plan sponsors to retain plan participants
after they retire. According to the 2018
Callan Defined Contribution (DC) Trends
Survey, 48% of plan sponsors with a written
policy for employee retention seek to retain
participants
in plan post
retirement, up
from 28% in 2016. Sponsors see benefit in
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PLANADVISER - July/August 2018

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