Transcript Results-Driven Retirement Plans Scott Knapp February 17, 2010

2010 ACUL Conference & Annual Meeting
Scott D. Knapp, CFA
Director – Investment Strategy
April 30, 2010
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Agenda
Brief Macroeconomic Review
Post-Crisis Trends in Retirement
Future Trends with Retirement Plans
Investing Retirement Assets
Questions
Scott Knapp, CFA
Director of Investment Strategy
800.356.2644, ext. 8486
[email protected]
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Brief Macroeconomic Review
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Opinions about the economy are like noses…
…everyone has one, but some get more attention than others.
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“We have two kinds of
economic forecasters:
Those who don’t know,
and those who don’t
know they don’t know.”
- John Kenneth Galbraith
CUNA Mutual Group Proprietary
Reproduction, Adaptation or Distribution Prohibited
© CUNA Mutual Group
Cyclical Influences
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A Slow Recovery, But it is a Recovery
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Easy Comparisons in First Half of 2010
Source: Mastercard
Many indicators are relatively good and still very weak.
Comparisons get harder later in the year.
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Inventory Build-Out Provides Lift
But it’s mostly over. Final demand must continue to
increase to keep the engine running.
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Weak Employment Continues
U-6 unemployment peaked at 17.3% in December ’09 - the highest ever recorded.
The marginal cost of adding employees has gone up considerably.
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U.S. Government Incentives Driving Existing Home Sales
Source: National Association of Realtors
The housing market is still not standing on its own
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Secular Influences
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Massive U.S. budget deficits…
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…create massive long-term debt.
U.S. public debt = 63% of GDP in 2010
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Entitlements Explain It All
Alan Greenspan:
“I fear that we may have
already committed more
physical resources to the
baby-boom generation in
its retirement years than
our economy has the
capacity to deliver.”
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Growth in Spending Before Obamacare
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The press is starting to catch on…
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…because it’s a huge story!
• $1.4 trillion equaling 10% of GDP in budget deficits in 2009 – the highest since WWII.
• $775 billion in new taxes would have to be raised to stabilize the budget deficit at 2% of
GDP (47% of Americans currently pay no income taxes, VAT?).
• $10 trillion will be added to the national debt in the next decade.
• $5.6 trillion will be spent on interest costs alone in the next decade.
• 63% debt-to-GDP ratio expected in 2010, up from 37% in 2007.
• $20 trillion of debt equaling 90% debt-to-GDP expected within the decade (crisis!).
Remedies: 1) far-above-trend economic growth, 2) huge spending cuts,
3) massive tax increases, 3) debt monetization
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Cyclical versus Secular
Cyclical:
– Employment and housing are still soft
– Most indicators are pointing to near-term recovery:
• Inventory build-out and government stimulus has helped (but it’s mostly over)
• Blue Chip estimate: 2.7% GDP growth (5 – 6% is normal at this stage of a recovery)
• Corporate profit margins, cash flow, and balance sheets have improved dramatically
– YOY comparisons easy in first half of 2010 and will provide good news
Secular:
– Major restructuring of U.S. economy – What are the rules?
– U.S. government expanding influence and/or control – What is the Fed’s exit strategy?
– Massive budget deficits lead to massive long-term debt – A crisis appears inevitable!
– Setting the stage for a secular bear market in bonds?
Rising interest rates and commodity prices will be a Rorschach test for analysts
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Post-Crisis Trends in Retirement
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How the Financial Crisis Impacted Retirement Planning
According to the 2008 EBRI Retirement Confidence Survey:
– Only 13% of workers feel very confident they will have enough money for
retirement – a 50% decline from 2007
– Over 28% of workers said they have adjusted their retirement age
– The number of current workers expecting to work during “retirement” has grown
to 72% (only 34% of current retirees work for pay)
– Only 44% of workers have calculated retirement savings needs
– Only 20% of current retirees feel very confident about their retirement security
One in four workers age 56 to 65 held 90% or more of their 401(k)
investments in common stocks. Two in five held 70% or more.
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Annual U.S. Stock Market Index Returns Since 1825
A retirement saver’s nightmare!
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Financial Crisis!
Congress Debates Pension
Reform
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The Current State
of Retirement
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July 29, 2002!
The Current State
of Retirement?
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Evolution of Retirement Plans
Social Security Act
creates a program to
pay workers age 65
and older a continuing
income after retirement
President George W.
Bush proposes plan for
Social Security reform
ERISA sets framework for
benefit plan and protects
employees enrolled in
benefit programs. It also
permits tax-deductible
IRAs
1935
1960
1974
1981
401(k)!
President Eisenhower
signs a law permitting
disability payments to
workers of any age and to
their dependents
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Verizon and IBM
plan for pension
freezes
2005
2006
2018
PPA
First year in which the
Social Security Board
of Trustee projects tax
revenue will fall below
the program’s costs
Evolution of Retirement Plans
1980s
• Mostly DB plans
• Vast majority of cost/risk
borne by employer
• 401(k) just starting
• Minimal investment
choices
• Theme: “We must take
care or our people”
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1990-2008
• Transition from DB to DC
plans
• 401(k) plans become
primary retirement plan
• Investment choices
proliferate
• Theme: “We must allow
our people to ride the
stock market”
2008+
• Mostly DC plans
• Vast majority of cost/risk
borne by employee
• Many DB plans freezing or
going away
• Theme: “We must make it
easy for our employees to
achieve a financially secure
retirement”
Retirement Plans Prior to 2008
Decisions were primarily driven by process mandates:
1. Choose a service provider
2. Adopt an Investment Policy Statement
3. Select investments and evaluate fees
4. Offer the plan to employees
5. Switch providers based on fees and fund performance
Process-Based Goals: Excellent fund performance and low fees
Plan sponsors followed processes that didn’t
necessarily lead to positive outcomes.
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Outcome-Based Retirement Plans
Achieving retirement security is contingent on:
• Employer’s decision to offer a quality retirement plan
• Employee’s decision to save
• Employee’s decision to save enough
• Employee’s decision to invest properly
Outcome-Based Goal: Retirement Security
A successful retirement plan gets these four things right.
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Measure, Measure, Measure!
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Investing Retirement Assets
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Retirement Plans Prior to 2008
Decisions were primarily driven by process mandates:
1. Choose a service provider
2. Adopt an Investment Policy Statement
3. Select investments and evaluate fees
4. Offer the plan to employees
5. Switch providers based on fees and fund performance
Process-Based Goals: Excellent fund performance and low fees
Plan sponsors followed processes that didn’t
necessarily lead to positive outcomes.
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Trying to choose best-of-breed funds…
Peer-Average Return
Salesman: “I can offer funds that are MUCH better than yours.”
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…has never worked…
Peer-Average Return
Peer-Average Return
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…so the best way to win the “hot fund” game is to not play.
Peer-Average Return
Good plans will always have some funds that outperform,
some that underperform, and some that are about average.
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Asymmetric Value Framing
40%
30%
Fund A
Relative-Return
Value Framing
Fund B
20%
10%
0%
-10%
-20%
-30%
-40%
1997
2008
Absolute-Return
Value Framing
Fund B
Fund A
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Asymmetric Value Framing
40%
30%
“Winner!”
Fund A
Relative-Return
Value Framing
Fund B
20%
“Losers!”
10%
0%
-10%
-20%
-30%
-40%
1997
2008
Absolute-Return
Value Framing
Fund B
Fund A
37
Post-Crisis Retirement Investment Strategy
Adopt a broad definition of risk:
•
•
•
•
In MPT, risk is volatility (standard deviation)
To most participants, risk is the chance of losing money (Value at Risk)
Standard deviation and Value at Risk are not the same thing
Investment strategy should be mindful of participants’ definition of risk
Investment strategy should emphasize active risk management:
•
Tactical overlay shifts money based on a macro forecasts, relative value among
asset classes, or changes in risk budget
Accommodate investors’ asymmetric value framing:
•
•
Absolute returns matter
Participate and protect!
38
The Industry Responds: Target-Date Funds
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Data Indicates Target-Date Fund Leadership in DC Plans
40
What’s right with Target-Date Funds?
• They make participating in a 401(k) plan easy
– A single fund with an optimal mix of asset classes
– Help participants maintain a long-term perspective
– Professional management
– Approved as QDIAs
• Increase the probability of participants’ success
– Success is adequate income replacement during retirement
– Success is NOT outperformance versus peers or the market
• Expected to lead in the 401(k) space
– Cerulli and ICI expect TDFs to grow faster than any other fund category
– Plans with QDIAs choose TDFs far more than their alternatives
41
What’s wrong with Target-Date Funds?
• No standard glide path
• Most assume nothing changes at retirement
• Participants don’t understand them:
– Many think they mature like a CD
– Many think they guarantee an income like a DB plan
• Most don’t accommodate of investor behavior
• Performance versus peers driven entirely by glide path decision:
– Standard performance measures don’t work
• Unmet expectations:
– Random and self-directed portfolios have outperformed
– Do not address sequence-of-returns risk. Near-term retirees got killed in 2008!
42
Target-Date Funds did not perform as expected…
2008 Returns
Random or self-directed portfolios outperformed
during the financial crisis
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…and here’s why.
2020 Fund Asset Allocation
Asset Class
Max
Min
Range
Average
Stocks
83%
0%
83%
56%
Bonds
158%
0%
158%
40%
Cash
44%
-79%
123%
2%
Other
90%
-2%
92%
2%
n=246
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What does a good Target-Date Fund look like?
• Designed with an outcome-based strategy in mind:
– They increase the chance of achieving retirement security
• Employ sophisticated institutional management:
– Combine the best of actuarial science and investment management
– Managed like DB plans that have significantly outperformed 401(k) participants
• Make it very easy for participants to make good decisions:
– A single source of investment value
– Discourages random fund selection
– Built with “real people” in mind
• Allows the plan sponsor to confidently adopt auto features:
– Approved by the DoL as QDIAs
– Support fiduciary oversight
45
Future Trends in Retirement Plans
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Future Trends
1
Continued trends to outcome based plans - the DBization of 401(k)s
2
Fewer investment options (but more broad-based)
3
Delivery of more guidance
4
Increased attention to Target Date Funds
5
Proliferation of DC/DB hybrids
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Questions?
Scott D. Knapp, CFA
Investment Strategist
CUNA Mutual Group
[email protected]
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Thank you! Questions?
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