Before evaluating investments for inclusion on a defined
contribution (DC) plan fund lineup, plan sponsors need to decide what types of
investments they want to use.
An article from Willis Towers Watson, “Moving the Needle on
Defined Contribution Plans,” suggests that the purpose of the plan will help
sponsors define the pieces of an investment lineup.
Evaluating Participant Demographics
David O’Meara, director, investments, Willis Towers Watson,
says the first task in determining the purpose of a plan is framing who the end
user of plan is—understanding its participants and how to unlock more value for
them. He notes that there’s been an evolution in the DC plan industry over the past
20 or so years from offering an abundance of choices to offering more
simplification, because DC plan participants have a hard time processing all
those options and making good asset allocations with that amount of complexity.
“Plan sponsors need to know their plan demographics and the
investment sophistication of participants,” says Michael Welz, president and
chief investment officer (CIO) at USI Advisors. “If they have an
unsophisticated participant base, it may not be viable to offer some investment
options, such as sector or region funds, multi-sector or high yield.”
Welz says the age of participants matters as well. If the
population is mostly young and has time to grow assets, the investment lineup
can focus more on accumulation. But investments that help participants create
income for retirement are also a key consideration for DC plan investment
menus.
Plan sponsors can also track how many participants are using
investment education tools provided by recordkeepers or advisers. If many are
using these tools, it might give plan sponsors more flexibility in what
investment options to offer.
Accumulation
In its article, Willis Towers Watson says one thing that can
simplify investment lineups for participants is leveraging multimanager funds,
which can help reduce style bias by any one manager relative to a fund’s
benchmark.
“A lot of individuals will sell yesterday’s losers and buy
yesterday’s winners, and, over time, that will detract from investment
outcomes,” O’Meara says. “We find packaging multimanagers into single funds and
white labeling them to be a more efficient way to build better investment
choices for participants so they can maintain expected outperformance at lower
investment risk. It is also better to put managers with different investment
styles together to help participants avoid overtrading portfolios.”
Welz says if plan sponsors define the purpose of their
plans, it will provide direction for the plan investment lineup. He adds that
the plan’s purpose could be dynamic and change over time.
One purpose of DC plans is still to help participants grow
their assets. For this objective, Welz says, plan sponsors should look for
return-seeking investments.
Welz says target-date or target-risk funds are appropriate
for the majority of participants because participants typically don’t know how
to invest, and these accounts are tailored for them. “When combined with
auto-enrollment, a target-date or target-risk fund as the QDIA [qualified
default investment alternative] works very well,” he says.
However, he notes that every plan has a population of
“do-it-myself” participants who put a fairly aggressive asset allocation into
play. He adds that in addition to core equity and fixed-income options, plan
sponsors should consider offering a brokerage window, depending on participant
demographics.
Welz says there are so many different target-date fund (TDF)
products that the chances are high that an off-the-shelf one will work for the
vast majority of plans. However, he says, plan sponsors should go through a
prudent process for selecting TDFs.
“For example, an in-depth process will take the population
that uses TDFs—their income, contribution rates and account balances—and model
it out to age 65. Then consider how on-track for a successful retirement they
will be with the age-65 balance plus Social Security,” Welz says.
Regarding QDIAs and TDFs, specifically, investment experts
fall into different schools of thought about what plan sponsors need to provide
for participants. But O’Meara suggests that if a plan sponsor determines it
wants to provide the very best investment solution it possibly can, that might
involve not using an off-the-shelf QDIA.
“Sometimes it can only be done with a truly open
architecture investment program,” he says. “This can open up doors to investing
in asset classes not typically available in off-the-shelf solutions, namely
alternative assets used by other institutional asset owners, such as real
estate, private equity and hedge funds.”
With regard to custom TDFs, Welz says it takes a level of
sophistication for committee members to understand the various benefits and
drawbacks of them. He adds that some plan sponsors are reluctant to use custom
TDFs because of the lack of a public benchmark or because of higher fees and
the threat of excessive fee lawsuits. However, he says that when considering custom
TDFs, plan sponsors should use the same in-depth process he suggests for
off-the-shelf products.
Decumulation
Another aspect of reimagining investments is considering
what role DC plans have in being a true retirement vehicle, considering the
decline of defined benefit (DB) plans, O’Meara says.
“DC plans have been pretty good at helping participants save
and invest money, but not so good at helping them turn accumulated savings into
a sustainable income stream,” he says. “So many plan sponsors are now thinking
about the purpose of the plan and whether it is to provide a seamless
transition for participants to retirement so they can stay in the plan. Plan
sponsors are asking, ‘Can we deliver something better than participants can get
on their own, or is it our job to get them to and not through retirement?’”
Determining the purpose of the plan and the role the plan
sponsor wants to have post-employment can open the door for different solutions
to meet the needs of former employees, O’Meara says. He adds that solutions can
be any number of things from an annuity or some type of investment with a
guarantee to educational resources with a suite of services and funds that help
participants better understand their needs in retirement and options for using DC
account balances to meet those needs.
“We’re seeing more plan sponsors thinking about what to do
to deliver something, whether DB-like or other tools to leverage the plan’s
scale and economics to meet participants’ needs better than what they can get on
their own,” O’Meara says.
“Over the last 10 years, if we asked clients ‘What is the
purpose of your plan?’ in 99% of cases, it would be ‘to help participants grow
assets,’” Welz says. “It’s only been in last few years that
decumulation—providing income in retirement—has become a purpose.” He says this
is historically how most DC plan investment lineups have been based—and why
they have been dominated by equity funds.
“In general, most plans are underdiversified in fixed
income,” Welz says. “I think the industry is looking to bridge the gap between
accumulation and decumulation, so depending on which provider a plan sponsor is
using, it might provide an annuity-based product or another type of investment
product allowing quarterly or annual distributions.”
Thinking of the DC plan investment lineup in this way would
mean including investment options to help pre-retirees de-risk their
portfolios.
“DC plans tend to be growth-heavy, and not a lot of
participants are in fixed-income funds,” O’Meara says. “If there will be people
of advanced ages in the plan, the plan will need additional lower risk
investment options or other diversifying investments that may help to build a
more efficient, more robust, sustainable portfolio for retirees.”
ESG and D&I
Plan sponsors have also been thinking more about
incorporating diversity and inclusion (D&I) efforts into their benefits
programs. O’Meara says a plan sponsor wanting to make diversity and inclusion
part of its DC plan’s purpose should think about who the investment lineup is
developed for.
“In general, investment lineups benefit those who have the
ability to save and those more comfortable with investment decisions,” he says.
“So, plan sponsors should be thinking about those not able to save as easily to
help them with that, and, for those less highly educated and less comfortable
making investment decisions, plan sponsors should create ways to engage those
participants and simplify the investment selection process. This could lead to
better investor behaviors across the participant population.”
Welz says participants are requesting environmental, social
and governance (ESG) investment options more frequently than in the past, and
plan sponsors are asking consultants about them. “The demand is there, but I
think there will be more willingness to add ESG investment options when the
regulations are more clear,” he says.
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original article.