Over 70% of existing Defined Contribution (DC) plan assets still reside in the core menu.1 Many of the participants invested in the core are age 50 and older, and therefore may be constructing portfolios to more suitably address their specific, and increasingly complex, financial needs. Here, we will explore three asset classes that merit inclusion in DC investment menus, each of which can serve a specific purpose to meet the demands of pre-retirees:
Emerging Markets Enhanced
Alpha Through Consistency
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 any participant’s diversified portfolio given the potential for materially higher long-term returns relative to developed markets. Structural inefficiencies in emerging markets also present significant alpha opportunities, but alpha only meaningfully impacts participant outcomes if it is delivered consistently — an objective that the majority of pure active approaches have historically failed to deliver upon.
At State Street, our emerging markets enhanced strategy targets the ‘sweet spot’ of returns by seeking to maximize excess return per unit of risk in a fee efficient manner. The strategy has delivered 98 basis points of excess annual return (in line with its 0.75%-1.00% target) over the market-cap weighted benchmark with 0.91% historical tracking error. In addition, the five-year information ratio ranks No. 1 in the eVestment Emerging Markets Large Cap universe.4
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 newly retired have not been adversely impacted by high or unexpected inflation. Market history suggests that this may not be the case going forward, and as such, exposure to real assets is crucial. Actively managed real assets strategies, however, tend to come with high fees — around 80 basis points, on average6 — and an inconsistent track record in reliably tracking inflation. 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. At State Street, our real assets strategy, ranked No. 1 in the eVestment Liquid Real Assets universe for net inflows in 2018, uses a disciplined asset allocation approach that combines REITs, commodities, natural resource stocks, global infrastructure and US TIPS to provide opportunities for higher risk-adjusted returns, lower volatility, additional income and positive returns over inflation.
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
savings runway, those nearing retirement more acutely feel the consequences behind each investment decision and the impact of returns — particularly in this lumbering ‘lower for longer’ environment. Because the core is most heavily invested in by older savers, plan sponsors should be mindful of how to reinvent their menu with a broader range of asset class exposures and more thoughtfully consider active management. Doing so will increase investment management precision and help to bridge the retirement funding gap.
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1 Employee Benefit Research Institute, 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2016, September 2018
2 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%, alpha return of 1%. 73% represents the savings from investment returns divided by total savings at 65. For illustrative purposes only.
3 Source: eVestment as of 12/31/2018.Volatility reduction is calculated by comparing annualized standard deviations of the strategy with the benchmark, which is MSCI World Index in this illustration.
4 As of December 31, 2018. Information ratio is calculated as excess return over the MSCI Emerging Markets benchmark per unit of tracking error. Strategy information ratio is 1.52.
5 Reflects gross of fee returns for the strategy. Reflecting the highest tier of fee for the strategy (45 basis points), the strategy has outperformed in 86 of 100 rolling three-year periods since inception.
6 eVestment. Median fee for a $10 million mandate among managers in the Real Assets universe that publish fee schedules.
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The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
All the performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.
Diversification does not ensure a profit or guarantee against loss. The use of leverage, as part of the investment process, can multiply market movements into greater changes in an investment’s value, thus resulting in increased volatility of returns.
Investing involves risk including the risk of loss of principal.
There are risks associated with investing in Real Assets and the Real Assets sector, including real estate, precious metals and natural resources. Investments can be significantly affected by events relating to these industries.
Foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations, all of which may be magnified in emerging markets.
The views expressed in this material are the views of the State Street Defined Contribution Team through the period ended February 28, 2019 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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Exp: July 31, 2020