Despite the surge of new flows into the default investment, more than 70% of the $2 trillion in existing defined contribution (DC) plan assets still resides in the core menu.i
Many of the participants invested in the core are older, as reflected by the stratification of assets featured in Figure 1. While this trend may be attributable to older workers’ inertia — and new hires’ gravitation to the default — some participants over age 50 may also be constructing portfolios from the core menu to more suitably address their specific, and increasingly complex, financial needs as they near retirement.
Figure 1: Examining the Core Through a Demographic Lens
Because those closest to retirement are those with the greatest concentration of assets in the core, the investment approach to menu management must be deft. Instead of feverishly chasing alpha — which could introduce more risk than a near-retiree could absorb — managers must take a more measured approach, seeking returns strategically.
We will also make the case that active management can play an important role in providing participants with meaningful levels of real income replacement in retirement. But not all asset classes merit an active approach, and not all active approaches are similar. Sponsors must be prudent in choosing where to implement active management, and carefully evaluate the types of alpha-seeking behavior that their managers employ.
Figure 2: Hypothetical Growth of DC Savings for Median 55-Year-Old Participantᶦᶦ
Here, we will focus on three asset classes that merit inclusion in DC investment menus, each of which can serve a specific purpose to meet the demands of mature savers within the core menu.
Managing risk is crucially important for retirees, but greater measures must be taken to close the funding gap that today’s participants face. We believe that emerging markets are a key allocation in a diversified portfolio given the potential for materially higher long-term returns relative to developed markets, where return expectations have compressed considerably in recent years. Emerging markets made up roughly 12% of the total equity market cap as of December 31, 2019. For certain plans and participants, holding emerging markets via broad, market cap weighted index funds may not provide the desired level of exposure, and a stand-alone allocation may be appropriate for participants seeking higher growth. Structural inefficiencies in emerging markets also present significant alpha opportunities, suggesting that an active approach may be additive, but alpha only meaningfully impacts participant outcomes if it is delivered consistently.
Emerging markets span countries and cultures that are, by definition, in transition. That very change can lead to enormous potential for growth. To capitalize on these growth opportunities, State Street’s Emerging Markets Equity Select strategy features deep fundamental research — from both the bottom up and the top down. In addition to company specifics, we’re always mindful of the macro environment — studying economies, currencies and geopolitics — because it can be very important for EM companies. In an era of rapid trading and quantitative algorithms, we take a different approach. We invest like owners, not traders. We get to know our companies well, and we hold them for the long term within a risk-managed framework. Ultimately, our goal is to deliver long-term outperformance for our clients.
A stand-alone core investment option for the purpose of seeking consistent alpha in higher-growth emerging markets.
Figure 3: State Street Beats the Median: Rolling 3-Year Excess Return Over Benchmark
Figure 4: Strategy Performance
The ability to spend in retirement will be impacted by more than just participants’ balances on their retirement date. With inflation largely contained in recent years, people who are newly retired have not been adversely impacted by high or unexpected inflation.
Market history suggests that this may not be the case going forward. In fact, inflation uncertainty as measured by the New York Fed consumer survey between 2013 and 2021 has spiked.v As COVID-19 vaccine distribution continues, people will begin shopping and dining en masse again, exercising what has been nearly a year of pent up demand. But low inventory due to manufacturing shut-downs, agricultural interruptions and frozen supply chains, could upset the supply-and-demand function and set the stage for inflation.
Figure 5: Inflation Uncertainty
Exposure to real assets can be an important tool to hedge inflation. Actively managed real assets strategies, however, tend to come with high fees — around 75 basis pointsvi, on average — and an inconsistent track record in reliably tracking inflation.vii The objective for this allocation should be effective inflation management — capturing the asset class efficiently and at a low cost to investors, rather than seeking excess return at the expense of higher volatility, fees and style drift.
Figure 6: Inflation Beta and Correlation to Inflation
Figure 7: State Street Global Advisors Real Assets: Strategic Asset Allocation
A stand-alone core investment option for participants who may be nearing retirement or newly retired investors who will be most affected by inflation.
As pensions wane and longer lives demand retirement savings stretch farther, longevity risk looms. For years, retirement industry players and policymakers have been seeking to stem retirement savings shortfall with decumulation solutions. Thanks to intrepid plan sponsors and committed policy advocates there are now more options for plans and participants seeking a guaranteed income stream in retirement:viii in- and out-of-plan structures, annuity and non-annuity vehicles, default and core menu investments.
However, adoption of retirement income products continues to lag due to perceived product complexity and costs as well as concerns around fiduciary risk and limited access to or illiquidity of accrued savings. These barriers must be addressed as decumulation is a vital issue for pre-retirees and one that should be a key considered of the retirement transition. Unlike leveraging EM to boost growth or inflation management vehicles to preserve wealth, retirement income is about creating confidence: the confidence to retire on time and to structure a financial plan that can absorb some of the unknowns of later life.
We believe that decumulation will drive the next generation of retirement solutions. To that end, we have developed a target date strategy that builds on our history of accumulation success while introducing a retirement income strategy that delivers income flexibility and security while addressing the concerns voiced by the market:
Depending on the solution, retirement income strategies can be used as either a stand-alone core investment option, purchased at the point of retirement or embedded in a target date solution to enable a seamless transition from accumulation to decumulation phases. To learn more, visit ssga.com/retirementincome.
Age brings experience and insight. But it also introduces complexity and a degree of vulnerability, particularly in people’s financial lives. With a shorter retirement saving runway, those nearing retirement more acutely feel the impact of returns and the consequences of each investment decision. Because the core menu is most heavily invested in by older savers, plan sponsors should be mindful of how to reinvent their core with a broader range of asset class exposures and more thoughtfully consider active management to address with more precision the needs of those nearing retirement — and in doing so, help bridge the retirement funding gap.
i Source: Employee Benefit Research Institute, using data from Plan Asset Allocation, Account Balances & Loan Activity in 2016 report.
ii Assumes a starting salary of $69,460 at 55 years old with 2.5% annual growth (ending wage $88,915) and a beginning balance of $250,000, total annual contribution rate of 11%, beta return of 5% and alpha return of 1%. 73% represents the savings from investment returns divided by total savings at 65. For illustrative purposes only.
iii Source: eVestment as of December 31, 2020.
v Survey of Consumer Expectations, © 2013–21 Federal Reserve Bank of New York (FRBNY). Data for developed markets across the world follow a similar pattern.
vi Source: eVestment. Median fee for a $10 million separate account mandate in the eVestment Liquid Real Assets Universe as of December 31, 2020.
vii In the case of an annuity, the contract’s financial guarantees are solely the responsibility of and are subject to the claims-paying ability of the issuing insurance company.
vii Annuities are issued by third-party insurance companies, which are not affiliated with any State Street Bank and Trust Company entity, including SSGA.
vii Qualified longevity annuity contract (QLAC) payments are subject to the claims-paying ability of the issuing insurance company; it is possible that the issuing company may not be able to honor the annuity payments. The annuity is not provided by or guaranteed by State Street or any of its affiliates, including State Street Global Advisors. QLAC purchases are subject to regulatory limitations. Participants who redeem from the fund prior to the annuity purchase will not be eligible for the annuity income benefits described in this document. Participants who are not in a fund vintage that aligns with a retirement age of 65 may not obtain the annuity income benefits. Ages and expected dates of retirement are approximate and may not accurately reflect the age or retirement date of each participant at each stage of the product. Participants are responsible for selecting their own target retirement date. QLAC: a form of a deferred income annuity that allows participants to defer a portion of their guaranteed income payments to a later age, and reduce their DC plan balance subject to required minimum distribution (RMD) rules. Investment balances may fluctuate based on market factors. The annuity described in this brochure incorporates a return of premium benefit (i.e. if the participant — and spouse in the case of a joint & survivor annuitant — dies before they have recouped their initial premium, the difference between the initial premium and the payments received will be returned to the estate).
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Foreign investments involve greater risks than US investments, including political and economic risks and the risk of currency fluctuations, all of which may be magnified in emerging markets.
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