Improving Participant Outcomes Through Investment Menu Design
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The document discusses the evolution of defined contribution plans and presents best practices for plan sponsors in designing investment menus to improve participant outcomes. It emphasizes the importance of understanding participant demographics, incorporating behavioral finance principles, and utilizing tiered investment structures to cater to diverse investor needs. Additionally, it highlights the shift from traditional paradigms to newer approaches that focus on participant success and the use of target maturity investment products.
Improving Participant Outcomes Through Investment Menu Design
- 1. Improving Participant Outcomes Through Investment Menu Design ©2003 – 2013 Multnomah Group, Inc. All Rights Reserved.
- 2. Scott Cameron, CFA Scott is the Chief Investment Officer for the Multnomah Group and a Founding Principal of the firm. In that role, Scott leads Multnomah Group’s Investment Committee, is responsible for the development of the firm’s investment research methodology, and conducts investment manager due diligence. Scott also consults with plan sponsors on investment menu design, investment manager selection, fiduciary governance, and vendor fees/services. Scott is a member of the CFA Institute, the CFA Society of Portland, the Investment Management Consultants Association, and the Portland Chapter of the Western Pension Benefit Conference. 2 Improving Participant Outcomes Through Investment Menu Design
- 3. Agenda • Evolution of Defined Contribution Plans • Plan Sponsor Best Practices • Target Maturity Investment Products • Options for Low Risk Investors 3 Improving Participant Outcomes Through Investment Menu Design
- 4. DC Investment Lineups: Old Paradigm • All participants are active investors • More choices lead to better portfolios • Fiduciary focus on 404(c) protection • Focus on investment products/manager analysis High Risk • Vendors compared on features Specialty Intl Equity Funds (i.e. U.S. REITs) Equity Core Bond Money Market / Stable Value Low Risk 4 Improving Participant Outcomes Through Investment Menu Design
- 5. Is the Old Paradigm Effective: the Evidence Participant Type How Participants Self-Identify Delegators 69% Do-It-Yourselfers 30% Self-Directed Sophisticates 1% Source: J.P. Morgan Retirement Plan Services 5 Improving Participant Outcomes Through Investment Menu Design
- 6. Is the Old Paradigm Effective: the Evidence Impact of Choice on P a r t i c ip a t i on Rates Source: Iyengar, Sheena S.; Jiang, Wei; Huberman, Gur “How Much Choice is Too Much?: Contributions to 401(k) Retirement Plans” 6 Improving Participant Outcomes Through Investment Menu Design
- 7. Investors Fail to Track the Market Annualized Returns for the 20 Years Ended 12/31/2010 10.00% 9.14% 9.00% 8.00% 6.89% 7.00% 6.00% 5.00% 3.83% 4.00% 3.00% 2.57% 2.00% 1.01% 1.00% 0.00% Avg. Equity Investor S&P 500 Index Avg. Fixed Income Investor Barclays Agg Bond Index Inflation Source: Dalbar, Inc. 2011 Quantitative Analysis of Investor Behavior 7 Improving Participant Outcomes Through Investment Menu Design
- 8. DC Investment Lineups: New Paradigm • Not all participants are the same • Incorporate behavioral finance knowledge into retirement programs • Fiduciary focus on participant outcomes Tier One • Focus on menu construction • Vendors compared on solutions Tier Two Tier Three 8 Improving Participant Outcomes Through Investment Menu Design
- 9. The Paradigm is Shifting • Pension Protection Act of 2006 • Automatic enrollment • Qualified Default Investment Alternatives (QDIA) • J.P. Morgan – “Focus your AIM: Innovating the Defined Contribution Core Menu to Help Increase the Odds of Participant Success” • Manning & Napier – Two-Tier Menu Design • Schwab Retirement Plan Services Inc. - Launches Schwab Index Advantage • Vanguard – “Converging Trends Drive Sponsors to Change Plan Lineups” 9 Improving Participant Outcomes Through Investment Menu Design
- 10. Plan Sponsor Best Practices Develop Fiduciary Governance Program Communicate to Analyze Employee Employees Demographics Determine Select Investment Objectives for the Managers/Products Plan(s) Select Asset Decide Investment Classes Menu Structure 10 Improving Participant Outcomes Through Investment Menu Design
- 11. Analyze Employee Demographics • Relevant Information • Methods • Age • Anecdotal/Experience • Income • Vendor Demographic Reports • Tenure • Payroll Data • Financial Literacy • Participant Surveys • Participant Opinions • Focus Groups 11 Improving Participant Outcomes Through Investment Menu Design
- 12. Determine Plan Objectives • Retirement Readiness • Income Replacement is Best Measure • General rule of thumb is 70%-80% of final year’s salary • Can vary based on lifestyle, income, etc. • Be Careful of Measurement Issues • No one is “average” • Shortfall risk is important 12 Improving Participant Outcomes Through Investment Menu Design
- 13. Decide Investment Menu Structure • Tiered Methodologies are Preferable • Simplifies Decision-Making • Employee communication is clearer • Decision-making is easier • Offers Meaningful Choices to Participants • Acknowledges participants are different • No one-size-fits-all choice is available • Participants want different options 13 Improving Participant Outcomes Through Investment Menu Design
- 14. Index Tier Option • Ability to Build Globally Diversified Index Portfolio • Low Cost • Broad Diversification Asset Allocation Funds (i.e. Target Maturity, Target Risk, etc.) • Style Specific Actively Managed Funds for Active Participants • Optional Self-Directed Brokerage Core Index Funds Account for Most Active Participants Active Style Funds (Optional) Self-Directed Brokerage Account / Mutual Fund Window 14 Improving Participant Outcomes Through Investment Menu Design
- 15. Sample Index Tier Tier 1: QDIA Tier 2: Core Index Array Stable Principal Fixed Income U.S. Equity International Equity Intermediate Money Market U.S. Stock International Stock Bond Tier 3: Core Active Array Stable Principal Fixed Income U.S. Equity International Equity Specialty Funds Active Intermediate Bond Large Cap Value Large Cap Growth Large Cap Value Large Cap Growth Fixed Annuity Inflation REIT Protected Bond Global Bond Small Cap Value Small Cap Growth International Small Cap Tier 4: Self-Directed Brokerage Account 15 Improving Participant Outcomes Through Investment Menu Design
- 16. Multi-Manager Core Tier Option • Core Array Consisting of Multi- Manager Portfolios • Money Market/Stable Value • Equity Asset Allocation Funds (i.e. Target • Fixed Income Maturity, Target Risk, etc.) • (Optional) Other Categories • Core Strategies Incorporate Multiple Sub-Asset Classes • Small Cap Core Multi-Manager Strategies • REITs • Emerging Markets • High Yield • Global Bond • Core Strategies Incorporate Open (Optional) Self-Directed Brokerage Account / Mutual Fund Window Architecture Managers 16 Improving Participant Outcomes Through Investment Menu Design
- 17. Tier 1 – Asset Allocation Strategies • Tier 1 is Typically the QDIA or QDIA-Type Option • Target maturity or target risk Growth of Target Maturity Products $400,000,000,000 • Fund or model portfolio • Target Maturity Funds are Most $350,000,000,000 Common $300,000,000,000 • Simplicity in design $250,000,000,000 5 Year Annualized Returns (Period Ending 12/31/2010) $200,000,000,000 Percentile Single Target- Managed All Other Date Fund Account Participants $150,000,000,000 Mean 3.93% 3.65% 3.76% 5th 3.62% 2.20% -0.02% $100,000,000,000 25th 3.62% 3.08% 2.66% 50th 3.90% 3.66% 3.80% $50,000,000,000 75th 3.90% 4.22% 4.64% $0 95th 4.65% 5.06% 8.09% Source: Vanguard 2011 “Participants During the Financial Crisis: Total Returns 2005- 2010” Source: Morningstar Direct 17 Improving Participant Outcomes Through Investment Menu Design
- 18. Target Maturity Selection Criteria Investment Management Firm Capabilities Equity Glide Path Costs Asset Class Selection Portfolio Management 18 Improving Participant Outcomes Through Investment Menu Design
- 19. Select Core Asset Classes • Objectives • Provide participants with the ability to create a diversified portfolio tailored to their specific risk tolerance and time horizon • 16 Allow participants to diversify their holdings among a number of 14 different asset classes with 12 different risk and return profiles • Utilize low correlated asset classes 10 to minimize the amount of risk at Return, % 8 any given return profile • Constraints 6 • 4 Minimize opportunity for participants to select undiversified 2 portfolios with unrealistic return 0 and risk expectations 0 2 4 6 8 10 12 Ris k (StDev Rtn), % 14 16 18 20 22 • Avoid narrowly defined “asset Frontier Cas h S&P 500 Index Small Cap Stoc ks Mid Cap Stoc ks REITs Intl Stoc ks Corporate Bonds classes” with risks that are difficult to identify 19 Improving Participant Outcomes Through Investment Menu Design
- 20. Global Market Capitalization $31.7 Trillion as of December 31, 2011 Source: Dimensional Fund Advisors; In US dollars. Market cap data is free-float adjusted from Bloomberg securities data. Many small nations not displayed. Totals may not equal 100% due to rounding. For educational purposes; should not be used as investment advice. 1. An example large cap stock provided for comparison. 20 Improving Participant Outcomes Through Investment Menu Design
- 21. Style Boxes ≠ Asset Classes Calendar Year Returns (2008) Large 0.00% -5.00% -10.00% -15.00% -20.00% -25.00% Mid -30.00% -35.00% -40.00% -45.00% -50.00% Small Large Value Large Blend Large Growth Mid Cap Value Mid Cap Blend Mid Cap Growth Small Value Small Blend Value Blend Growth Small Growth 21 Improving Participant Outcomes Through Investment Menu Design
- 22. Diversification is Tricky Correlation to the S&P 500 Index (Rolling 60 Month) 1.0 Correlation 0.0 -1.0 Dec -82 Dec -85 Dec -87 Dec -89 Dec -91 Dec -93 Dec -95 Dec -97 Dec -99 Dec -01 Dec -03 Dec -05 Dec -07 Dec -09 Mar-12 Small Cap Stoc ks Mid Cap Stoc ks REITs Intl Stoc ks Corporate Bonds Small Cap Stocks = Russell 2000 Index; Mid Cap Stocks = Russell MidCap Index; REITs = Dow Jones US Select REIT Index; Intl Stocks = MSCI EAFE; Corporate Bonds = BC Corporate Idx 22 Improving Participant Outcomes Through Investment Menu Design
- 23. Select Investment Managers/Products • Pre-Determine Investment Manager’s Role in the Menu • Understand the Investment Manager’s Investment Philosophy • Source of Value-Added • Types of Market Environments That Create Headwinds/Tailwinds • Evaluate Historical Performance in the Context of Investment Philosophy 23 Improving Participant Outcomes Through Investment Menu Design
- 24. Manager Performance Does Not Repeat 100% 90% 25% 25% 80% 35% 70% 25% 23% 60% 23% 50% 40% 23% 25% 13% 30% 20% 25% 29% 29% 10% 0% 1996-2000 2001-2005 2006-2010 Source: Morningstar; 190 funds with 15 year track records 24 Improving Participant Outcomes Through Investment Menu Design
- 25. Communicate to Employees • Benefits • Challenges • Demonstrates meaningful choices • Standard vendor communications to participants don’t always support tiered • Minimizes “choice overload” investment menus • Simplifies participant decision- • Vendor websites are not structured making to support tiered investment menus • Tiered menu communications are usually tailored for proprietary investment products 25 Improving Participant Outcomes Through Investment Menu Design
- 26. Low Risk Investment Options Option 1 Option 2 Option 3 Option 4 Money Money Money Stable Value Market Market Market Fund Short Term Ultra Short Short Term Government Term Bond Bond Bond Intermediate Bond Intermediate Intermediate Intermediate Bond Bond Bond 26 Improving Participant Outcomes Through Investment Menu Design
- 27. Stable Value Funds Face Market Pressure • Consolidation of stable value • Back to the future providers • Use of more traditional • Higher costs/lower capacity will GICs/separate account GICs with continue to squeeze providers synthetic GICs portfolios • More expensive wrap insurance will bring new entrants into the market • Bundling of wrap insurance with investment management • Low interest rate environment • Increased usage of traditional GICs • Improved MV/BV ratios and separate account GICs by plan • Stable value funds have only existed sponsors during a period of steady, declining interest rates • Increasing rate environment will put pressure on MV/BV ratios • May also cause higher levels of participant transactions as participants try to arbitrage return differentials • Money market funds react more quickly to yield changes (may outperform stable value for a period of time) 27 Improving Participant Outcomes Through Investment Menu Design
- 28. Questions? Scott.Cameron@MultnomahGroup.com (888) 559-0159 28 Improving Participant Outcomes Through Investment Menu Design
- 29. Disclosures Multnomah Group, Inc. is an Oregon corporation and SEC registered investment adviser. Investment performance and returns are based on historical information and are not a guarantee of future performance. Investing contains risk. Some asset classes involve significantly higher risk because of the nature of the investments and the low liquidity/high volatility of the securities. Any information and materials contained herein or on our website are provided for general informational purposes only and are not intended to be comprehensive for any particular subject. Multnomah Group utilizes information from third party sources believed to be reliable but not guaranteed, and as a result, information is provided to you "as is." We do not represent, guarantee, or provide any warranties (either express or implied) regarding the completeness, accuracy, or currency of information or its suitability for any particular purpose. Multnomah Group shall not be liable to you or any third party resulting from any use or misuse of information provided. Receipt of information or materials provided herein or on our website does not create an adviser-client relationship between Multnomah Group and you. Multnomah Group does not provide tax or legal advice or opinions. You should consult with your own tax or legal adviser for advice about your specific situation. 29 Improving Participant Outcomes Through Investment Menu Design