PLANADVISER - March/April 2020 - 29

on average, two sell-offs of 10% or more in a calendar year.
And, since the 1970s, the declines lasted an average of 42
months-i.e., measuring from the month end that the index
crested to when it resumed that peak level. For retirees, the
pain of the declines is compounded by the need to withdraw
depreciated dollars to fund the cost of living.
Target-date fund managers and managed account
providers control the looming risk of equity markets through
portfolio construction. For younger participants in targetdate
funds, who might have a 40-year investment horizon,
equity market drops matter less, says Jason Shapiro, director
of investments with consultants Willis Towers Watson, in
New York City. " If people are defaulted in, they stay invested
for the most part, so the question of equity markets becomes
more germane to those near retirement. "
Late 2018 provides an instructive laboratory experiment
on the success of TDF portfolio design. For the fourth calendar
quarter, the price level of the S&P 500 fell about 15%.
The late-2018 damage to TDF portfolios was limited by
portfolio construction, but there were distinct differences
in performance, Shapiro says. " At the 25th percentile, nearretirement
funds were down 5.5%, and at the 95th percentile,
about 8%. Two-and-a-half percent of someone's wealth just
before retirement is significant. "
But, Shapiro adds, those TDFs that fared better in late
2018, owing to greater diversification, also had underperformed
in the long equity rally since 2009. " There's no free
lunch here, " he observes.
Few funds take a tactical approach to risk hedging. One,
PIMCO's RealPath Institutional series, included put options
as a hedge against equity tail risk, alongside other heavy
armor against inflation. But in a bull market, " the series
received no joy for its relatively conservative stance [or]
... its policy of protecting against stock market 'tail risk,'
[which never arrived], " wrote John Rekenthaler of Morningstar
in late 2018, on the announcement that the series
would close this February.
" But even for the TDFs with less aggressive portfolios, "
says Shapiro, " advisers and sponsors need to ask themselves,
'Is that good enough? If we position ourselves conservatively,
are our participants going to be set up for success against
equity risk?' Sponsors can do more, with customized asset
allocations, so those who don't need the risk can take more
off the table than a TDF would. "
Resources Investment Advisors, in Overland Park, Kansas,
provides participants with custom portfolios built from three
assets, in the form of collective investment trusts (CITs).
" Since the dawn of investing, there have been only three
things to invest in-equity, fixed income and an uncorrelated
asset, " says James Battmer, chief investment officer (CIO)
at the firm. " We can create thousands of allocations based
on data points for participant age, outside assets, a raise or
another child, and deliver it in a way people can understand. "
Besides engaging outside asset managers for the equity and
fixed-income components, the firm partners with the investment
arm of the Chicago Boards Option Exchange (CBOE)
for a low-cost uncorrelated asset, quantitatively managed
Erosion of
principal by
inflation
Rising rates
hurting bond
prices
ParticipantExperienced
Risks
Drawdowns
approaching
retirement
Source:
J.P. Morgan Asset Management, " Off Balance "
and combining elements of equity, fixed income and cash.
Battmer explains: " Over the long run, it has returned about
7% annually and has a standard deviation similar to fixed
income. " Higher equity allocations and mitigation against
equity risk are essential, " he adds, " because historical returns
suggest that people will not reach their goals by investing in
the fixed-income markets of the future. "
Battmer also emphasizes attention to noninvestment
aspects of DC plans-the participant-controlled risks. " We
get people to optimize their health benefits through an HSA
[health savings account] and to use Roth accounts the right
way, to avoid creating tax consequences out of thin air. "
" The softer issues [of] individual circumstances are an
essential part of the 401(k) process, " says Randy Long, head
of Sageview Advisory Group in Irvine, California.
" The biggest issue is that participants have to save more, "
Long adds. " Following different risk strategies, and deciding
when to rebalance, and diversifying alternative investments
are all part of a sound retirement strategy, but there is so
much to be said for saving a lot. " -John Keefe
The Universe of DC Plan Risks
Failure
to save
enough
Misusing
investment
options
ParticipantControlled
Risks
Withdrawals
prior
to
retirement
planadviser.com March-April 2020 | 29
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PLANADVISER - March/April 2020

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