By: Eric J. Freedman
Eric J. Freedman is Chief Investment Officer and head of the Consulting Research Group at CAPTRUST.
The global economic environment presents new challenges for investors across the board. Public and private pension plans, consultants, Wall Street strategists, and money managers have all ratcheted down their forward-looking views on asset returns, meaning that defined contribution plan participants will be hurting if the financial community’s morose predictions bear fruit.
Historical Context
U.S. investors have enjoyed an almost 35-year bull market in bonds. In the fall of 1981, 10-year U.S. Treasury notes yielded over 15.8%, and because prices move in the opposite direction of yields, bond prices have ratcheted higher since 1984, almost in a straight line. The Barclays U.S. Aggregate Bond Index, a bond proxy that includes investment grade corporate, Treasury, agency, and mortgage bonds (and is a benchmark for many actively managed bond strategies found in defined contribution plans), has produced annualized returns of over 8.4% since Treasury notes registered their early 1980s peak yields, three times more than the Consumer Price Index’s inflation measure.
Over the same time period, U.S. large-cap stocks (measured by the S&P 500) delivered nearly 11.5% returns per year. To be sure, events like Black Friday, the dot.com crash, and the financial crisis provided bouts of volatility, but stocks nonetheless provided high nominal returns to investors willing to “stay in the trade.” International stocks also delivered a premium over inflation and bonds, with the MSCI/EAFE Index annualizing at over 9.2%.
The Current Reality
But lately these tailwinds are dissipating and even disappearing. Government 10-year bond yields, which serve as building blocks for many asset price forecasts, remain at historic lows around the world. For instance, nominal U.S. yields languish below 2.5%, Germany’s paying a meagre 0.54%, Japan’s returning a mere 0.24%, and Switzerland’s paying negative nominal yields. Years of stubborn economic growth, low inflation, and central bank intervention have contributed to these historically low interest rates, and futures/forward markets suggest that they will remain low for some time.
The financial community has responded by marking down investment return expectations. On the pension front, CalPERS’ late 2015 decision to reduce its assumed investment return followed on the heels of its earlier 2012 decision to cut expectations. Over half of U.S. public pensions surveyed by the National Association of State Retirement Administrators (NASRA) cut their return expectations since 2008. Vanguard expects a 60% stock /40% bond portfolio to deliver between 3 and 6% annually, for the next half-decade. Investment banks and consultants like us have also moved to markedly lower return projections than what had been the norm previously.
Hope Emerges
Nevertheless, defined contribution plan participants can look to some forces working in their favor. For instance, a 2015 study by the Employee Benefit Research Institute and the Investment Company Institute quantified how retirement plan participants fared before, during, and after the financial crisis. The report noted that average 401(k) account balances grew at an annual 10.9% compound growth rate between 2007 and 2013, thus outperforming both the annualized S&P 500 (6.13%) and Barclays U.S. Aggregate Bond Index (4.91%) over the same period.
New 401(k) Plan Tools
This sort of “participant alpha” over traditional benchmark returns underscores the fact that retirement plan savers can use several plan design tools to their advantage. Scott Matheson, head of CAPTRUST’s defined contribution practice, points out that plan sponsors will need to help participants accumulate sufficient retirement assets by prioritizing systematic saving as never before. This is because regular plan contributions help participants dollar-cost-average through market ups and downs.
To this end, Matheson notes that many plan sponsors are adopting tools that help maximize employee savings. Company matches are a key contributor: nine of ten plans had employer contributions in the EBRI/ICI study. This is beneficial, since, when a plan sponsor matches participant contributions dollar-for-dollar for any portion of her contributions, that’s a 100% gain on her savings; if it’s a 50 cent match, that’s a 50% gain, and so on. Such “alpha” opportunities are important to give participants incentives to save. Other attractive tools include plan auto-enrollment and auto-escalation of contribution rates over time.
Moreover, participants seeking professional investment help increasingly have access to qualified default investment alternatives such as target date funds. Other asset management approaches including managed accounts can also simplify investment decisions.
Of course, participants must remain alert to how much they are saving and where they are invested. To combat lack of participant knowledge, some plan sponsors have added one-on-one and group participant advice within their plans. Further, the U.S. Department of Labor is moving to enhance fee transparency and fiduciary responsibility, with the stated goal of helping participants invest more cost-effectively.
The investment environment has been challenging for the past few years and it is likely to remain difficult. Yet despite low interest rates, subdued stock return prospects, and sluggish economic prospects, opportunities for “participant alpha” offer room for optimism.
This piece was originally posted on January 22, 2016, on the Pension Research Council’s curated Forbes blog. To view the original posting, click here.
Views of our Guest Bloggers are theirs alone, and not of the Pension Research Council, the Wharton School, or the University of Pennsylvania.
