AUTOMATED INVESTMENT SERVICES:

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1 AUTOMATED INVESTMENT SERVICES: Transamerica s Automated Investment Service Outperforms Do-It-Yourself Investors A White Paper Prepared by Transamerica Retirement Solutions

2 Introduction In recent decades, the retirement industry has experienced a paradigm shift in how individuals fund their retirement. Defined benefit pension plans used to be the primary complement to Social Security for most individuals. By and large, defined contribution retirement plans have now supplanted pension plans in prevalence and importance. As a result, individuals have become increasingly responsible for the investment decisions required to achieve positive retirement outcomes. There is widespread belief that the majority of defined contribution plan participants are ill-equipped to make the types of complex investment decisions necessary to bring them retirement income sufficiency. To address this issue, the marketplace has developed various solutions to help simplify and automate the investment process for participants according to generally accepted investment principles. One such solution is a target date structure, which invests participants retirement savings based on a planned retirement year. The investments shift based on a predetermined schedule, called a glide path, into increasingly more conservative stances over time, containing less equity exposure. Transamerica Retirement Solutions innovative solution is PortfolioXpress, a flexible, open-architecture, customized target date service that streamlines the complex investment decision-making process for participants and automatically implements a well-diversified and regularly rebalanced and reallocated mix of their retirement plan s available investment options. When combined with sufficient savings levels, PortfolioXpress is designed to help plan participants by providing an appropriately diversified investment mix, which may serve them better than do-it-yourself (DIY) investing. Since the service s introduction in 2006, PortfolioXpress has seen dramatic growth. It is offered by more than 2,300 retirement plans and utilized by more than 350,000 participants. Evaluating Target Date Solutions Since the Pension Protection Act of 2006 specifically identified target date solutions as an appropriate category for a plan s Qualified Default Investment Alternative (QDIA), plan sponsors and advisors have relied on these types of products to guide the investments for participants who do not make investment elections, as well as those who actively choose to use such a strategy. However, evaluating the efficacy of target date solutions and thereby demonstrating their value is a common gap for most sponsors who choose to include these options in their retirement plans. In part, this is true because the analysis required is complex each target date solution has its own specific approach to portfolio construction and different underlying holdings and the data necessary for the research is difficult to obtain. To address this need, Transamerica launched an initiative to provide a framework and the supporting analysis to assist plan sponsors and advisors, leveraging the substantial amount of data on Transamerica s retirement plan recordkeeping system. By nature, target date solutions are designed to invest a participant in a well-diversified portfolio that manages risk by becoming more conservative over time up to and sometimes after a participant s intended retirement year. Therefore, achieving the absolute highest level of performance is not an appropriate measure for whether a target date solution is effective. Instead, one should evaluate if it provides comparable or higher returns with a more narrow distribution of outcomes (i.e., lower risk) for target date investors versus DIY investors. Ultimately, we believe this is the measure plan sponsors and advisors should consider in order to evaluate if plan participants are better off in a target date solution such as PortfolioXpress. The purpose of this study is to determine if the PortfolioXpress service has achieved these goals generating comparable or higher returns with lower risk versus DIY strategies, and to quantify the results. Asset allocation and diversification do not assure or guarantee better performance, cannot eliminate the risk of investment losses, and do not protect against an overall declining market. 2

3 Developing a Data Set Transamerica compiled a participant data set of approximately one million plan participants across defined contribution plans that offer the PortfolioXpress service to ensure a robust sample and to lend confidence to the distribution of returns. To obtain a pure comparison of PortfolioXpress participants versus DIY participants, Transamerica excluded participants who moved into or out of the service during the time period examined. Additionally, Transamerica excluded participants with de minimis balances (less than $100), which often represent non-meaningful data points. The resulting sample represented a cross section of plan participants across different age ranges and demographics. The sample plans included a wide array of investment fund menus without any standardized fund lineup, and also included plans with different PortfolioXpress glide paths. The returns metric Transamerica used was each participant s Personalized Rate of Return (PRR) during the calendar year of The PRR is calculated using a dollar-weighted approach. It reflects investment earnings on initial balances as well as ongoing contributions and other transactions, and it removes the impact of the cash flows of any contributions or withdrawals so that those cash flows themselves do not skew the results. The returns are net of underlying fund fees and any plan service fees. Then, Transamerica split the sample into two groups, those who used the PortfolioXpress service during the entirety of 2012 without interruption, and those who were DIY investors for the entire year. In plotting the data, Transamerica normalized the occurrence of each returns level to facilitate a comparison of the two groups despite the difference in the number of participants in each group. In addition, Transamerica grouped all participant returns under 0% and over 25% to demonstrate the fatness of the tails of the distribution. 3

4 Analysis and Conclusion Figure 1 plots the results for participants at a given returns level in each sample. The blue line represents DIY participants, while the red line represents participants using PortfolioXpress. The distribution of the PRR for DIY investors is bimodal with returns concentrated around approximately 2% and 14%. The presence of a relatively large proportion of results between 0% and 2% can be explained by the common investor pitfall of keeping most or all of one s account balance in a money market or stable value option. The distribution of the majority of the returns for DIY investors falls between 2% and 16%, with a fat lower tail of returns at or below 0%. In contrast, the distribution of returns for participants using PortfolioXpress is more similar to a normal distribution with a concentration around 16%. The majority of returns lie between 10% and 18%, with essentially no lower tail fatness of 0% or negative returns. Both PortfolioXpress and DIY investors had similar occurrences of returns above 20% in the upper tail. Analysis of the data demonstrates that the average participant in the PortfolioXpress service experienced comparable or higher returns with a more narrow distribution of outcomes when compared with participants who invested on their own. Figure 1 25% PortfolioXpress DIY Percentage of Participants 20% 15% 10% 5% 0% 0% 5% 10% 15% 20% 25% Personalized Rates of Return Past performance is not a guarantee of future results. In applying a particular asset allocation model to an individual situation, one should consider other assets, income, and investments (e.g., IRA investments, savings accounts, and interests in other qualified and nonqualified plans) in addition to investments in the plan/ira and how this impacts retirement income sufficiency. 4

5 Figure 2 summarizes the key return and risk metrics for both groups. Median returns for PortfolioXpress participants were approximately 14.8% compared to 10.1% for DIY articipants. In addition, approximately 3.5% of PortfolioXpress participants earned a rate of return of 5% or less while approximately 27.6% of DIY participants earned a rate of return of 5% or less. The data indicates that participants experienced less risk with more consistent performance in the PortfolioXpress service during 2012, supporting the premise that participants may be better off using an automated investment service such as PortfolioXpress than Investing on their own. Figure 2 Return metrics: PortfolioXpress Participants DIY Participants 2012 PRR Median 14.8% 10.1% 2012 PRR Average 14.2% 11.1% Risk metrics: % of sample 0% PRR 0.1% 2.5% % of sample 5% PRR 3.5% 27.6% % of sample 10% PRR 14.5% 46.4% % of sample 15% PRR 60.5% 83.2% % of sample 20% PRR 98.8% 98.4% Sample Size 216, ,423 The Personalized Rate of Return (PRR) reflects investment earnings on initial balances as well as ongoing contributions and other transactions, and it removes the impact of the cash flows of any contributions or withdrawals so that those cash flows themselves do not skew the results. It is net of underlying fund fees and any plan service fees. 5

6 About Transamerica Retirement Solutions Transamerica Retirement Solutions is a leading provider of customized retirement plan solutions for organizations of every size. Transamerica partners with financial advisors, third party administrators, and consultants to cover the entire spectrum of defined benefit and defined contribution plans, including: 401(k) and 403(b) (Traditional and Roth), 457, profit sharing, money purchase, cash balance, Taft-Hartley, multiple employer plans, nonqualified deferred compensation, and rollover and Roth IRAs. Transamerica helps more than three million retirement plan participants save and invest wisely to secure their retirement dreams.* For more information about Transamerica Retirement Solutions Corporation, please visit trsretire.com. * As of December 31, Transamerica or Transamerica Retirement Solutions refers to Transamerica Retirement Solutions Corporation. This paper is intended to show the potential benefits to participants of using an automated investment service providing a diversified investment mix versus DIY participant investing. Nothing presented herein is intended to constitute tax, legal or investment advice, and no investment or plan design decision should be made solely based on any information provided herein. Nothing presented herein should be construed as a recommendation to use the PortfolioXpress service, to purchase or sell a particular investment or follow any investment technique or strategy. Because each employer is unique, an employer should consider its indiviual circumstances when evaluating a plan administrative solution and should consult their retirement plan and/or legal advisor. While Transamerica has used reasonable efforts to obtain information from reliable sources, we make no representation or warranties as to the accuracy, reliability, or completeness of third-party information presented herein. PortfolioXpress is a registered service mark of Transamerica Retirement Solutions Corporation (Transamerica). PortfolioXpress presents a series of asset allocation models up to and through a designated retirement year. You are solely responsible for choosing the retirement year. In implementing the service, you agree to each of the asset allocation mixes and automated rebalancing transactions that will take place over time within your account as you approach the selected retirement year. If you sign up, you should carefully review the service agreement for additional information regarding fees and other terms and conditions that may apply to this service. Retirement date portfolios are subject to the same risks as the underlying asset classes in which they invest. The higher the portfolio s allocation is to stocks, the greater the risk. The principal value of the portfolio is not guaranteed at any time, including at and after the target date. Past performance is no guarantee of future results. The performance results shown reflect aggregated data and any individual participant may experience poorer performance using the PortfolioXpress service versus using a DIY strategy. There can be no assurance that any particular asset class will outperform another asset class. There is a risk of loss from an investment in securities. Securities offered by Transamerica Investors Securities Corporation (TISC), 440 Mamaroneck Avenue, Harrison, NY Transamerica Retirement Solutions is an affiliate of TISC. 440 Mamaroneck Avenue, Harrison, NY trsretire.com PS (08/13) 2013 Transamerica Retirement Solutions Corporation 56