8/13/2014. Test Drive Defining and Understanding DC Investment Vehicles

Transcription

1 Continuing Education Credits Be sure to sign the Sign-In/Sign-Out sheet outside of the room when applying for Continuing Education Credits for the following certifications. (Check the appropriate certification) CFP CPE You do not have to sign in and out for InFRE credits InFRE tracking forms were included in conference registration materials. Test Drive Defining and Understanding DC Investment Vehicles Lori Lucas, CFA DC Practice Leader Callan Associates Martha Spano Principal Buck Consultants John Turk Vice President Prudential Retirement Moderated by Chris Whatley, CFP Oklahoma Municipal Retirement Fund Agenda Non-annuity Investment Vehicles-Types and Characteristics Prevalence of Various Investment Vehicles Pros and Cons Fee implications Fund Structure issues Special Investments White Label Funds Managed Accounts Self-Directed Brokerage Windows All about Annuities as Investments 2 1

2 What is a.. Mutual Fund An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, and the investors own units of the pool, not individual securities. Commingled Fund A collective investment trust is a trust fund sponsored by a bank or trust company that pools the contributions of participants of qualified retirement plans. It is exempt from SEC registration Separate Account A portfolio of securities dedicated to a specific client and managed by a SEC registered Investment Advisor. A separate account can be either discretionary or non discretionary 3 Mutual funds Easy to use and administer Fall short of plan and participant needs Expense ratios can be high High utilization of proprietary funds of record keepers Revenue sharing pays admin fees Options focused on star funds, not asset allocation and risk Traditional assets only Commingled funds Improved cost structure over mutual funds More control and flexibility of investment options Access to higher quality products Improved fee transparency paid to investment managers and record keepers Higher governance time and costs Introduction of different assets Separate accounts Lowest cost structure More control and flexibility of investment options Access to higher quality products Improved fee transparency paid to investment managers and record keepers Highest governance time and costs Alternative asset classes Investment management fees decreasing Governance budget increasing Legislation and fee disclosure increasing 4 Investment Vehicles Mutual funds CIT s Separate Accounts Annuities 401(k) Plans 401(a) Plans 403(b) Plans* NA NA 457 Plans IRAs NA NA *Exception for Church plans 5 2

3 Prevalence of Investment Types Offered Most plans (71.6%) have at least one institutionally structured fund, such as a separate account, collective trust, or unitized/private label fund in their lineup. *Multiple responses were allowed. Source: 2014 Callan DC Survey Does your plan offer the following investment types within the fund lineup?* % Mutual funds 92.0% 95.0% 51.9% Collective trusts 48.3% 43.8% 50.6% Separate accounts 42.5% 40.0% 13.6% Unitized or private label funds 12.5% 6.9% 7.4% Pooled insurance company separate account 9.2% na 3.7% Exchange-traded funds 2.3% 2.5% 1.2% Fixed annuities 2.3% 5.0% 1.2% Variable annutities 1.1% 8.8% 1.2% Other 3.4% 1.3% 0% 20% 40% 60% 80% 100% 6 Pros and Cons of Mutual Funds in DC Plans Pros SEC registered Mutual fund Board of Directors Recognized and understood by the public Fits easily into recordkeeping platforms Ticker symbol Revenue sharing often available Low minimums Cons Fee schedules generally do not fully leverage assets for institutional investors Often not managed in an institutional manner Reduces opportunity set of investment managers Many actively managed funds do not have norevenue-sharing classes available 7 Pros and Cons of Collective Trusts in DC Plans Pros Typically less expensive and offer tiered fee schedules Standardized and customized revenue sharing Fewer mutual fund issues Transaction penalties Registration and other costs Investment limitations Morningstar and Lipper coverage has increased Fact sheets and disclosure statements are available Cons Must be maintained by a bank No ticker symbol Less reporting and data availability More set-up time/steps than mutual funds No board of directors, product not registered with SEC Revenue sharing not always available 8 3

4 Pros and Cons of Separate Accounts/Unitized Funds Pros May provide lowest fees for large plans Customizable investment policy guidelines Allow for customized, equitable administrative fees Access to greater set of institutional managers May allow plan sponsor to leverage DB plan managers Cons Require trustee/custodian to be hired for unitization Require customized fact sheets and, if desired, other strategy details Communication challenges (fund descriptions, manager strategy, etc.) Possible implementation challenges: many moving parts Not traded on NSCC Not a regulated/registered fund No revenue sharing High minimums 9 Plan Asset Size Institutional MF $500 MM Proprietary funds Retail expense ratio Style bias & drift Too many options Chase the hot dot Low governance Generic education Institutional MF Commingled Funds $700 MM Open architecture Institutional pricing Lower price but inflexible fees Increased governance Generic education Institutional MF Commingled Funds Separate Accounts $1 Billion Next generation of vendors Flexible structure Lowest pricing Style consistency and control Customized lifecycle with possible alternative assets High governance Custom education TIME 10 Fee Advantage of Various Fund Structures by Plan Size Retail Mutual Funds Institutional Mutual Funds Fees Commingled Funds Separate Accounts Plan Size 11 4

5 Fee Differentials Among Various Investment Structures Plan sponsor sought to determine if any savings could be expected if the plan were to use alternative investment options. Fee Types Option 1: Current (Retail and Institutional Mutual Funds) Option 3: Fund-of-Funds with Option 2: Institutional Mutual primarily CITs and Separate Funds and Some CITs Accounts Investment Management Fees 0.31% 0.28% 0.19% Administrative Fees Included in Investment Included in Investment 0.08% Management Fee Management Fee (Unbundled fee quote) (approximately 11 bps) (approximately 8 bps) Trust & Custody Fees & Fund Fact Sheets Included Included 0.01% Total Plan Fees 0.31% 0.28% 0.28% Source: Callan Associates. 11 Structures: Impact of Reduced Fees on Retirement Income Adequacy Using the asset allocation of the typical participant, the weighted average expenses of DC plans are given below, assuming various investment structures. Weighted Average Expense of Each Plan Size by Fee Structure Plan Size Structure Large Medium Small Retail Mutual Fund 1.01% 1.01% 1.01% Institutional Mutual Fund 0.85% 0.87% 0.90% Non-40 Act Fund 0.54% 0.60% 0.71% Source: Benefit Quarterly. Note: For purposes of this analysis, the most cost-efficient structure (collective trust or separate account) for each mandate size and asset class is used in evaluating Non-40 Act fund fees. Large plans have assets greater than $1 billion, medium have assets of $500 million; small have assets of less than $100 million. 12 Structures: Impact of Reduced Fees on Retirement Income Adequacy Large Plan Fee Impact: Fund Structure Target Income CIT/Separate Institutional Retail Mutual Replacement Ratio No Fees Account Mutual Funds Funds Income Replaced in Retirement 65.0% 70.0% 61.9% 57.8% 55.8% Years of Retirement Sustainability Source: The Long-Term Impact of Fees on DC Participant Balances. Benefits Quarterly. Third Quarter

6 Fund Line-up/Fund Structure Investing is a challenge for most participants Decision Paralysis Complacency Too many decisions Too many choices Do nothing No attention after making initial decision Spend one hour per year on investing No rebalancing Emotional influence Buy high, sell low Chase performance Let emotions dictate Research from Rutgers University, Boston College, Universities of Texas and Pittsburgh 16 Participant Percentage of participants questions confused have by changed plan featureslittle over time Where to invest funds 75% Limitations on contributions 25% How much to save 44% Enrollment 20% Withdrawals 32% Website 19% Loans 31% Fees 18% Fund transfer/reallocation 31% Conversion/blackout period 12% Financial planning tools 29% Statements 10% Company contributions 27% Employee contributions 8% Rollovers 26% Voice response system 6% Source: Deloitte Annual 401(k) Survey Retirement Readiness 17 6

7 Percentage of participants confused by plan features Option Offered Used Option Offered Used Money market 19% International 70% equity 97% 27% Stable value 58% 26% Emerging markets 25% 9% Bond funds 98% 26% REITs 27% 9% TIPS 31% 6% Health care 12% 8% High yield 19% 6% Energy 9% 8% Traditional balanced 77% 25% Precious metals 5% 3% Target risk 25% 31% Self directed brokerage 12% 1% Target date 84% 58% Managed accounts 16% 6% Domestic equity 99% 45% Company stock 10% 57% The average number of options available to participants has remained at 18 for the past 3 years, for 403(b) plans majority have over 25 options, and as high as 200. Source: Vanguard 2013 How America Saves, 18 %of participants using Number of options offered and used Options offered have stabilized over the past several years at around 18 1 Only 7% of participants rebalance over time 2 Participants rarely utilize new options Note: Number of options treats lifecycle funds as a single fund Sources: 1 Vanguard How America Saves 2011, 2 JP Morgan Retirement Services 19 NAGDCA Members on Investments NAGDCA Public Sector DC plan Survey Report, March

8 Designing optimal investment line-up Higher sophistication Many plans use a tiered structure: Present the line up that identifies who may best served by which state funds Primarily communication tool Some plans are moving to three tiers, dropping the Active core Offers something for everyone: Asset allocation funds provide a one-stop option to meet needs of most participants Passive funds offer low fees and market returns; avoid issue of underperformance Core funds provide diversification, opportunity to outperform, fill gaps Sophisticated investors can access additional choices via SDBA * Self-Directed Brokerage Account SDBA* Active core Passive core Asset allocation Lower sophistication 21 There is a best practice structure of investment options ABC has 36 fund options Reward Best practices plan structure Brokerage window Current plan structure Risk 22 Lower expected Range of investments risk / Lower expected return Higher expected risk / Higher expected return Green text = assume new addition Grey text = assumes in transition 23 8

9 Special Investments Unitization and Investment Flexibility Plan sponsor sought to simplify lineup and increase flexibility through manager of manager approach. Participant View: U.S. Equity Large Cap U.S. Smid Cap Equity Non U.S. Equity Real Assets 24 Plan Sponsor View: U.S. Equity Large Cap - 17% Large Growth SA - 17% Large Value SA - 17% Large MF - 50% Russell 1000 CIT Real Assets - 28% Global Property SA - 28% Global Listed Infrastructure SA - 20% Real Asset MF - 20% Real Asset CIT - 30% TIPS CIT Non-U.S. Equity - 19% EAFE SA - 19% Global MF - 19% Non-U.S. Growth SA - 19% Non-U.S. SA - 19% Emerging Markets MF - 3% ACWI ex USA CIT U.S. Smid Cap Equity - 32% Smid Core - 22% Small Core SA - 22% Small Growth SA - 22% Small Value SA - 3% Russell 2000 CIT 26 9

10 What the Custodian Sees Admin Pools A B C D U.S. Large Cap Equity Pool U.S. Smid Cap Equity Pool Non-U.S. Equity Pool Target Date Underlying Real Assets Pool % SA % Smid Core 19.4% SA % SA % SA % SA % Global 28.5% SA % Mgr Fund 21.6% SA % SA % Mgr % CIT Russell % SA % SA % Mgr-CTF 3.0% CIT Russell % Em Mkts 3.0% Barclays US TIPS 3.0% Barclays ACWI Separate Accounts SA 1 SA2 SA 4 SA 5 SA SA 8 SA 10 SA 11 SA 12 3 SA 6 SA 7 SA 9 Mgr Mgr Mgr Mgr Mgr Mgr Mgr Mgr Global Mgr Mgr Mgr Large Cap Large Cap Small Cap Small Cap Small Cap EAFE Non-U.S. Non-U.S. Property Global Listed Bond Fund Core Bond Value Equity Core Equity Growth Equity Value Equity Growth Equity Securities Infrastructure Plus Unitized Pools Non-U.S. Equity Index TDIT U.S. Bond Index TDIV U.S. Equity Index TDIU 100% Barclays ACWI 100% Barclays U.S. Debt 100% Barclays Russell Participants Units Large Cap Growth Fund Unitized Fund Liquidity Buffer Manager ABC Separate Account Underlying Fund(s) 28 Pros and Cons of Manager of Manager or White Label Funds Pros Reduce plan complexity/streamline for participants Reduce opportunities for momentum market timing Eliminate mapping issues for those funds Potential ability to introduce alternatives and illiquid assets Cons Not all record-keepers support Challenges in setting up Rebalancing challenges Other challenges similar to separate accounts 29 10

11 Take-Away from Unitization: Lessons Learned Vehicle Type is important: Mutual Funds Typically more expensive revenue sharing Inflexible for investment guidelines More difficult in custom structures, lagged holdings reporting, fees Lack of institutional client service Commingled Funds: need to be on recordkeeper platform Daily liquidity is essential Separate Accounts Fee advantage? Investment flexibility Experienced and engaged client required Brand name not a big issue 30 Managed Accounts An investment advisor manages and monitors the retirement account. Typically: Offered by the same independent third party that provides online advice. Use the same investment methodology, features, etc., as for online investment advice. Advise on drawing down income through retirement. Geared for do-it-for-me investors, as the provider implements the advice by taking discretionary control of the participant s account. Paid via an asset-based fee deducted from participant accounts. Solutions may be opt-in or opt-out. 36.2% of large plan sponsors offer managed accounts. <5% offer as default. Source: 2014 Callan DC Survey 31 Pros and Cons of Managed Accounts Pros Professional management Tailored solution Leverages funds within the plan Advice can extend to contribution levels and drawdowns Cons Fees Limited utilization of tailoring Materially better than target date fund? 32 11

12 Self-Directed Brokerage Accounts What They Are: Full window, including mutual funds, ETFs, individual securities Limited window, typically with only mutual funds Administered through brokerage not part of recordkeeping system Brokerage firm typically opens accounts, monitors accounts, accepts orders, maintains records, responds to account questions. May have separate entities executing trades, preparing statements, custodian accounts. 33 Pros and Cons of Self-Directed Brokerage Accounts Pros Provides wide array of investments for vocal minority of do-it-yourselfers Can facilitate efforts to streamline core lineup Cons Low utilization Cost Loss of revenue sharing Poor utilization Loss of economies of scale 34 Self-Directed Brokerage Accounts Prevalence 35% 30% 25% 20% 15% 10% 5% Prevalence Assets 0% Source: 2014 Callan DC Index

13 Annuities Accumulation phase Fixed annuities Variable annuities Contracts Group Individual Annuities in distribution 37 What is a.. Fixed annuity A fixed annuity is a contract with an insurance company. You give them your money to manage, and in exchange they pay you a guaranteed return, About.com Money over 55. Variable Annuity A contract with an insurance company. With a variable annuity, you place your funds with an insurance company and you choose how the money will be invested. You choose investments from a pre selected list of funds (these funds are called sub accounts inside of a variable annuity) which can range from aggressive stock funds to conservative bond funds. Because you choose the investments, the returns will vary depending on the underlying performance of the investments you choose. About.com Money over

14 Fixed annuities Insurance company general account Spread based Crediting rate Guaranteed minimum crediting rate Guaranteed not to lose principal/interest Backed by full/faith credit of insurance company Liquidity In-contract transfers In-plan transfers Benefits Termination by plan/participant May be restrictions that are time and/or fee based Comparisons Bond funds Money market funds Stable value funds 39 Variable annuity unit value net asset value Participant Purchases units from insurance company separate account. Insurance company Selects sub advisors to manage separate account(s). Using participant contributions and/or transfers, purchases shares from mutual fund company Mutual fund Manages assets in separate account for insurance company, and by proxy, participants 40 Variable annuity Separate account Sub accounts Insurer is the manager, selects the sub-adviser Individual sub-account has own CUSIP Both insurance and security Many choices Dividends/capital appreciation Performance of sub-account different than actual mutual fund due to timing and/or expenses of annuity 41 14

15 Features of a variable annuity Death benefit Expenses Fund management expense Mortality & expense Other Free look Liquidity In-contract transfers In-plan transfers May require replacement documentation Benefits Termination by plan/participant 42 Transfers with a variable annuity In contract Fund A to Fund B Typically no restriction From one provider to another May be restricted due to contract, fees, and time. Also state replacement documentation may be required. 43 Contract types Plan/employer level Participant/employee level 44 15

16 Plan/employer level contracts Ability to terminate/stop new contributions to legacy providers Ability to mandate that existing assets be transferred/mapped to new provider/fund(s) 45 Participant/employee level contracts Plan sponsor/employer had ability to terminate/stop new contributions to legacy providers Decision to transfer existing assets to new provider/fund(s) sits with individual participants Common in public sector education-higher Ed/k Annuities in distribution Participant may use some or all of account balance to purchase income stream from insurance company Income stream may be guaranteed for period of time, amount, and/or event(s) Only method by which a participant may guarantee an income stream for their life May be fixed or variable in amount May be precluded by plan document 47 16

17 Questions 48 Contacts Chris Whatley, CFP Plan Advisor and Portfolio Strategist Oklahoma Municipal Retirement Fund 525 Central Park Dr Ste. 320 Oklahoma City, OK x Fax Lori Lucas, CFA Executive Vice President Fund Sponsor Consulting Callan Associates Inc. P: Martha Spano, Principal Buck Global Investment Advisors 1801 Century Park East Suite 500 Los Angeles, CA Ph: Fx: John Turk, III Vice President, Consultant Relations, Prudential,