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Reinventing the Defined Contribution Core Investment Menu

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

Investment Strategist

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.

  1. Emerging markets, for growth opportunity
  2. Real assets, for inflation dampening
  3. Retirement income, for longevity protection

Emerging Markets Equity Select: Alpha Through Conviction

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.

State Street’s Approach

  • We believe that by looking beyond the horizon of the average investor and identifying emerging market companies around the globe that can deliver sustainable, compounding “growth at a reasonable price” (GARP), we will outperform the market.
  • The strategy is highly concentrated (57 holdings) with low turnover (20%) — a testament to the conviction that we have in portfolio holdings.
  • Bottom-up security selection is grounded in three key criteria: quality, sustainable growth and reasonable valuation.
  • We seek to achieve EM exposure through a risk-controlled framework, a critical approach for pre-retirees. To do this, State Street uses a proprietary Confidence Quotient(CQ) indicator in addition to its GARP focus in an effort to deliver sustainable valuations.
  • By offering a similar standard deviation to the index, State Street strives to capture more market upside:
  • Over three years: 120% of the upside with 94% of the downsideiii
  • Over five years: 114% of the upside with 95% of the downsideiv
  • Our long-tenured portfolio management team, led by George Bicher, has delivered a strong track record, outperforming the MSCI Emerging Markets benchmark by 371 basis points net of fees since inception in 2015.

Where it Fits in a DC Plan

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

Real Assets: Stability Through Inflation Management

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

State Street’s Approach

  • Our real assets strategy uses a disciplined asset allocation approach that combines REITs, commodities, natural resource stocks, global infrastructure and US TIPS to provide potential opportunities for higher risk-adjusted returns, lower volatility, additional income and positive returns over inflation.
  • Index implementation seeks to deliver accurate tracking and low turnover, at a substantially lower cost to investors than the active counterpart.
  • The strategy ranked No. 1 in the eVestment Liquid Real Assets universe for net inflows in 2018.

Figure 7: State Street Global Advisors Real Assets: Strategic Asset Allocation

Where it Fits in a DC Plan

A stand-alone core investment option for participants who may be nearing retirement or newly retired investors who will be most affected by inflation.

Retirement Income: Confidence Through Longevity Protection

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.

State Street’s Approach

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:

  • To combat complexity, participants are given the opportunity to use their target date assets to purchase an annuity at age 65.
  • Costs are controlled through index-based implementation and institutional annuity pricing.
  • Plan sponsors mitigate some fiduciary risk as the fiduciary role of insurer selection is provided by the investment manager.ix
  • To enable financial flexibility and reduce illiquidity, State Street uses only a portion of retirement savings assets are used to purchase the annuity, which will activate later in the retiree’s life, say at age 85.x

Where it Fits in a DC Plan

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

Investment Strategy Finesse Over Fever Pitch

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.

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