Looking back on developments regarding 401(k) and other defined contribution retirement plans during the past year, we have highlighted eight trends that plan sponsors, committee members and participants can expect in 2013 and beyond.
1. Focus on behavioral finance and participant plan usage.
Retirement committees have traditionally focused attention on fulfilling fiduciary responsibilities, such as selecting and monitoring prudent investment options for their plans, or ensuring reasonableness of fees. Current behavioral finance research and data has slightly expanded this approach; it adds emphasis on monitoring participant use of the plan, and on developing effective participant education, communication and messaging.
2. Consolidation of investment menus.
Studies conducted by behavioral finance economists such as UCLA’s Dr. Shlomo Bernartzi and the University of Chicago’s Dr. Richard Thaler reinforce a key finding: a reduction in the number of plan investment options makes employees more likely to participate in the plan. In an effort to maximize plan use and successful participant outcomes, consolidation of plan investment line ups should accelerate. This consists of a formal process to review and evaluate the funds available in the lineup, and the selection of one or two funds in each of a core set of asset classes, plus a target-date suite of funds.
3. Additional asset classes for greater diversification.
Having reduced the number of funds within each traditional asset class, plan sponsors are considering adding a select number of nontraditional assets as a hedge against rising inflation and a path to greater diversification. Such assets include Treasury Inflation Protected Securities (TIPS) and Real Estate Investment Trusts (REITs), as well as shorter duration fixed income products (e.g., short-term bond funds) suited to a low interest rate environment.
4. Continued fee scrutiny.
With respect to the core investment menu, most plans use mutual funds and in some cases variable annuities. Plan sponsors (excluding those that sponsor 403(b) plans) are considering alternative investment vehicle structures, such as collective trusts, separately managed accounts and exchange-traded funds, which tend to carry lower expense ratios. A focus on fee disclosure in 2012 led retirement committees to review and evaluate alternative structures in an effort to reduce costs. This helped direct them toward low-fee, "passive" index funds such as those reflecting the S&P 500 (large U.S. companies), the Russell 2000 (small U.S. companies) and MSCI All-World indexes.
5. Challenges to the fixed annuity and stable value fund marketplace.
Fixed annuity and stable value funds are available for participants who seek preservation of principal, with a modest investment return. In these funds, however, sponsors will continue to face the effect of shrinking “insurance wrap capacity,” which is a critical component for participants seeking a safe investment return. Since the economic downturn in 2008, many banks, insurers and investment management companies have departed from the stable value business, resulting in limited space to provide the wrap or guaranteed return of some percentage equal to or greater than 0 percent.
Moreover, the shrinking wrap capacity has driven up the expense associated with stable value funds, and limited the investment strategy available to the managers of those funds (usually related to the duration and quality of the fixed-income securities). Meanwhile participant crediting rates and minimum guarantees continue to fall. Indeed, the low interest rate environment presents a challenge to plan sponsors. They must perform manager due diligence with vigilance, ensuring that any selected fund remains a prudent investment, backed by a financially secure guarantor.
6. Continued growth of qualified default investment alternative (QDIA) appropriate funds.
Based on recent trends, it appears that QDIA-appropriate funds, typically a diversified target-date, lifestyle or balanced fund, will continue to grow. Surveys and asset flows suggest that participants like the "set-it-and-forget-it" approach. Similarly, interest is growing in products that seek to provide automatic diversification, such as managed accounts (a fee-based third-party service) and custom portfolio funds.
7. Participant desire for guaranteed income.
Surveys indicate that participants desire a guaranteed stream of income at retirement, similar to that of a defined benefit pension plan. The next challenge for investment managers, insurance companies and third-party providers will be to develop products and services to meet this demand, and for regulators to provide some type of fiduciary protection to encourage adoption. This represents an area for significant potential growth, especially as baby boomers continue to retire. Plan sponsors will need to look under the hood of such products, though, to determine whether they are appropriate investment options for their plan.
8. Sustained regulatory scrutiny and legislation.
Much of the discussion during the "fiscal cliff" negotiations focused on ways to increase revenue. Consideration was given to reducing, or even eliminating, the tax-deferred status of retirement programs. Such a move would likely hurt already low U.S. savings rates. In addition, there will be more discussion, and possibly further regulations, around the definition of fiduciary—whom that includes (e.g., service providers such as investment advisers) and what their responsibilities are.
The U.S. retirement system remains strong, but the wheels will keep turning in an effort to meet the needs of participants in all types of retirement programs.
Jeffrey H. Snyder is vice president, senior consultant, retirement, at Cammack LaRhette Consulting.
© 2013, Cammack LaRhette Consulting. All rights reserved. Republished with permission.
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