Examining the more conservative investments options in your plan

Transcription

1 Examining the more conservative investments options in your plan Moderator: Michael Kozemchak Managing Director, Institutional Investment Consulting Speakers: Pat Romano Fredrik Axsater Philip T. Maffei II Leo Zerilli Purdue Research Foundation Director, Investment Research Managing Director, Global Head of Defined Contribution State Street Global Advisors Senior Director, Stable Value Solutions TIAA-CREF Head of Investments, John Hancock Investments

2 With all the talk about alternatives, equities and the like, discussion of options designed to preserve capital or just produce a relatively smaller return with relatively less risk get shoved to the side. This session will look at these more conservative options. Interesting Factoid Fixed Income markets are going through unprecedented change. Traditional bond funds are struggling to deliver the outcomes they have in the past. 87.6% of traditional bond funds lost money in 2013*. What are the implications of this on your plans conservative options? Source: Morningstar. During 2013 (1/02/12 to 12/31/13), over 87.60% traditional bond funds (as defined by all share classes of funds in the Morningstar Intermediate Term Bond category) produced a negative return.

3 AGENDA What is traditional meaning of conservative Which investment options are generally considered in the conservative category by participants Historical conservative option plan weightings How are these more conservative options likely to preform in a rising rate environment and do participants understand the risks What should committees be thinking about as it relates to managing their conservative investment options and How Did Purdue address this challenge Is it appropriate for participants to re-think their conservative investment strategy and should committees be considering communication to educate or stimulate change Trends - What are the experts seeing and What are they recommending

4 What is traditional meaning of conservative

5 Conservative Investment Options Conventional: Money Market Funds Invests in highly liquid short-term financial instruments (commercial paper, Treasury Bills, etc.) Maturities less than 1 year Short-Term / Ultra-short-term Bond Funds Durations ~ 3 years or less Stable Value Funds / products Seeks capital preservation and predictable growth Multiple structure types exist. Common thread: insurance or bank contract Durations and provisions differ by product Emerging: Target date funds in or approaching terminal allocations (e.g. targets 2015 and less) Conservative Alternative Funds

6 Comparing Conservative Options Growth of $10,000 $45,000 Conservative Options - Growth of $10,000-12/31/1988 through 09/30/2013 $40,000 $35,000 $30,000 Value $25,000 $20,000 $15,000 $10,000 Dec-88 Dec-90 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Hypothetical Stable Value Account Barclays 1-3 Gov/Credit Bond Index imoneynet MFR Money Funds Index Past performance is not indicative of future performance. Sources: imoneynet, Barclays Capital, Stable Value Investment Association. Hypothetical Stable Value Account represents a "wrapped" stable value fund using Barclays Intermediate Gov/Credit Index as underlying fixed income investments, gross of investment management, wrap and recordkeeping fees.

7 Comparing Conservative Options Volatility of Returns 2.00% Conservative Options - Volatility of Returns - 12/31/1988 through 09/30/ % 1.00% Monthly Returns 0.50% 0.00% -0.50% -1.00% Dec-88 Dec-90 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Hypothetical Stable Value Account Barclays 1-3 Gov/Credit Bond Index imoneynet MFR Money Funds Index Past performance is not indicative of future performance. Sources: imoneynet, Barclays Capital, Stable Value Investment Association. Hypothetical Stable Value Account represents a "wrapped" stable value fund using Barclays Intermediate Gov/Credit Index as underlying fixed income investments, gross of investment management, wrap and recordkeeping fees.

8 Historical Conservative Asset Allocation Historical Conservative Asset Allocation Top 1,000 Pension/Employee Benefit Funds Asset Allocation Source: Pensions & Investments, Surveys of Top 1,000 Pension/Employee Benefit Funds

9 Plan Assets by Age Cohort ~60% of assets held in in 50s and 60s age cohort Source: ICI Research Perspective, December (k) Plan Asset Allocation, Account Balances, and Loan Activity in 2012

10 How are these more conservative options likely to perform in a rising rate environment and do participants understand the risks

11 Bond prices fall when interest rates rise Assume rates rise 25 basis points every six months Five Year U.S. Treasury yield is 1.50 % 25 basis point rise in rates means 1 percent drop in price Ten year U.S. Treasury yield is 2.75 % 25 basis point rise in rates means 2 percent drop in price

12 What should committees be thinking about as it relates to managing their conservative investment options and how did Purdue address this challenge

13 Tier One Purdue University DC Plan Target Date Funds, Index Based, off-the shelf Tier Two Index Funds Tier Three Active Funds Stable Value New - Index Based Legacy TIAA-CREF Traditional Annuity

14 Is it appropriate for participants to re-think their conservative investment strategy and should committees be considering communication to educate or stimulate change

15 Participant Behavior: Combining Literacy and Action Participants are seeking more conservative investments post-2008 but their reasons for doing so are not always aligned with the actual benefits Participants are investing more conservatively but don t always understand the benefits of investing in bonds 7% Invest Somewhat/ Much More Aggressively 44% No Impact 49% Investing somewhat/ more conservatively 51% Lower risk than stocks 40% Better portfolio diversification 36% Helps minimize the impact of inflation 30% Reduced volatility 17% Growth opportunities DC SSgA, The Participant Magazine (January 2014)

16 Conservative Option Trends What are the experts seeing and What are they recommending

17 Q & A

18 Appendices

19 What is Stable Value? Stable value offerings generally share similar goals, seeking safety of principal, stability and predictability of returns, and a level of liquidity Available through a variety of product structures Underlying all stable value products are one or more guaranteed contracts issued by an insurance company or a bank Unique and attractive risk/reward characteristics Over a full market cycle, have generally provided returns similar to those of short- to intermediate-term bond funds but with volatility of returns similar to that of money market funds. 1 Attractive participant liquidity features 1. For example, see Stable Value Funds Performance Analysis, David F. Babbel, Professor, Wharton School and CRA International, and Miguel A. Herce, Ph.D., CRA International, April 2008.

20 Stable Value Trends Aging demographics and near 0% money market rates contributing to continued demand Packaging stable value within custom target date / target risk funds Lack of consensus on how to treat transfers from independent modeldriven advice Banks continuing to reduce wrap contract business, some insurance companies expanding wrap contract business Fee disclosure / wrap fee stabilization Tactical lengthening or shortening of underlying durations Proliferation of guaranteed insurance products on non-proprietary platforms Inclusion of lifetime income as a stated goal within the plan s Investment Policy Statement

21 Comparing Stable Value Products Very difficult to perform an apples to apples comparison between SV products SV comparisons absolutely must take into account the following: Plan Sponsor and participant liquidity provisions, including competing fund rules Interest crediting rate structure, minimum floor rate and guarantee period Financial strength of underlying contract issuer(s) and directness of guarantees Underlying collateral portfolio investment credit quality, allocation, duration and guidelines