Conference coverage: Watch and learn

A cross-section of industry stakeholders at Benefits Canada’s 2014 DC Investment Forum explored emerging trends and established practices against the backdrop of challenges that continue to shape Canada’s DC landscape.

Saving for Retirement: Insights From Behavioural Finance
The worldwide trend away from DB plans and toward DC plans has increased not only employees’ autonomy but also the magnitude of their decisions. Saving for retirement is now a more complex problem, explained Alessandro Previtero, finance assistant professor at the Richard Ivey Business School, Western University.

“There are three main choices employees have to make about saving for retirement: joining a savings plan, how much to contribute and how to invest,” he said. “Another hurdle to saving for retirement is choice avoidance. The greater the number of choices, the more reluctant people are to make a decision. When you don’t know what to choose, you tend to do nothing.”

Previtero suggested auto-enrollment and auto-increase—escalating the employee’s contribution rate annually— as the solution to overcome these behavioural obstacles. “Changing the default from non-participation to participation is the most powerful instrument for people to save,” he said. “Once people are automatically enrolled, they tend not to opt out. This way, plan members have the power of compounding working for them.”

Auto-increase brings people closer to their retirement goals in a relatively shorter time frame, he added.

The other big challenge is the tendency among investors to chase short-term trends. “One way to prevent this is to offer balanced or lifecycle funds that automatically rebalance,” Previtero explained. “This puts investors on autopilot so they don’t feel the need to meddle with their asset allocation.”

Why Determining Retirement Readiness Doesn’t Have to Be Complicated
There are three key elements to successful retirement: adequate saving, efficient asset allocation and a smooth transition to retirement, according to Stephen Bozeman, director, senior product strategist, DC group, with BlackRock Inc.

The first two can be effectively addressed by allowing plan sponsors to auto-enrol and auto-escalate participants into plans, he said. However, the transition from pre-retirement to retirement remains uncertain for many who aren’t sure of the cost of retirement. Bozeman acknowledges that getting a certain income is still a challenge but assures it’s possible to navigate decumulation with greater clarity and understanding.

“One way participants can measure their success is by looking at a benchmark such as global equities to see if they’re accumulating assets efficiently and how their portfolio performed relative to that,” he said.

Bozeman conceded that, for younger participants, it gets much trickier with age when their objectives begin to change closer to retirement. “You’re less interested in accumulating assets efficiently than in having more certainty around what’s going to happen to you in a few years.”

He said one way to get a clearer picture is to measure asset growth against one’s spending liability. “Your assets might be going up in value, but if the cost of retirement income is growing faster, you are losing ground relative to a retirement income goal in spite of having more assets,” he explained. “If you see your retirement savings as an income number, then you can either manage to that number by saving more and investing differently, or change your spending behaviour or your expectations.”

One of the biggest challenges to retirement is managing certain spending over an uncertain period of time. The solution, said Bozeman, lies in being very granular about the areas you can control. “You have non-discretionary expenses for which you would want to get guaranteed income, and you want to prepare yourself for that,” he noted. “To get certainty, we generally have to give up flexibility.”

Members’ Perceptions and Potential Implications for DC Investment Plan Design
Misconceptions among plan members affect their investment decisions to the detriment of their overall success in asset accumulation. Shawn Cohen, director, relationship management, with MFS Investment Management Canada, said there is a misalignment between asset allocation considerations and the importance of a long-term horizon.

Sharing the findings of the 2014 MFS DC Pulse, a survey that studied the outcomes of plan member perceptions, Cohen expressed concerns over the role of short-term events in long-term investment decisions.

“The survey participants considered a major drop in the stock market as more important than investing too conservatively when considering factors that could negatively impact a member’s capital accumulation plan [CAP] balance,” he said. “It’s concerning because they’re basing their decision on a very short period. In fact, it should be the opposite—especially for gen Y, who are too conservative in their asset allocation due to their experience through the financial crisis.”

There are key attributes for plan sponsors to consider when putting an investment platform together. “They include having investment options that offer a consistent risk/return profile and downside protection—characteristics suited for the CAP context,” said Cohen. “Plan sponsors should also ensure that investment managers utilize a long-term horizon in investment decisions.”

Other design attributes encouraging greater participation, such as employermatching contributions and autoescalation, are also quite influential in a successful retirement, he added.

Cohen remains concerned about the trend of performance chasing. Making investment decisions based on past performance “is like saying it will rain tomorrow because it rained yesterday, even though there are no clouds in the sky,” he said. To address such behavioural issues, the industry has moved toward target-date funds (TDFs), Cohen added.

As low-maintenance solutions, TDFs are designed in accordance with investors’ changing goals and risk profile over various life stages. They do so by focusing on growth-seeking investments in the beginning and becoming more conservative closer to their maturity date.

Is There a Default Default?
Default strategies are an important component of retirement savings, since the experience of plan sponsors globally shows people tend to go into these strategies in great numbers. And once they opt in, they tend to stay there.

A default fund is for life, so it’s very important to get the default strategy right, said Scott Lothian, senior strategist, global strategic solutions, with Schroders.

“Given that most employees tend to fall back on default options, auto-enrollment is one of the most straightforward strategies to achieve success,” he said. “Auto-enrol employees with a good level of minimum contribution and incentivize it as much as possible.”

The main requirement for a successful DC investment strategy, he added, is to deliver stable real growth. In Canada, there’s a need for greater attention to asset allocation, he said, adding that “set-andforget” approaches may be hampered by their fixed asset allocation anchors.

Lothian proposed dynamic asset allocation that targets real-world investment outcomes by adapting to the market environment. “Plan members should target an investment return outcome above inflation, not a peer group or a fixed asset allocation,” he said. “This will better align members’ investments with their real-world retirement needs.”

Lothian also drew attention to the concentration risk some Canadian plans may be exposed to. “Canadian equities represent about 3.7% of the global market, yet they often represent up to 50% of the equity portion of balanced and target-date funds. Canada needs to diversify to have more stable growth through global equities,” he argued.

The Benefits of Sector-neutral Investing for DC Plan Members
Volatility among the major equity market sectors can be substantial. However, sector-controlled portfolios are not necessarily excessively risk-controlled, said Andrew Marchese, chief investment officer and a portfolio manager with Pyramis Global Advisors.

Marchese warned that betting on sectors exposes investors and portfolio managers to excessive risk with little predictability. A sector-neutral approach can limit the negative impact of sector volatility on performance, he said.

“One of the things you want to consider when you evaluate an equity portfolio is the largest source of risk,” he said. “When examining a broad market, one of the largest sources of risk is the variance of returns between sectors.”

This, he added, makes particular sense in Canada, which comprises oversized sectors that work at different parts of the cycles and are therefore very large sources of risk—and potentially, of returns. “If you get the sector tilts right, you’ll have the opportunity to achieve outsized gains,” Marchese said. “Get them wrong, however, and the reverse is likely true.”

To effectively gain sector neutrality, take the equity portion of a portfolio and split its contents in a way that’s exactly equal to that represented in the benchmark, Marchese said. “That way, you can reallocate risk to something that is a little more tangible,” he continued. “When you transfer the risk from a sector tilt, you have a variety of independent investment positions that you can add to generate excess returns.” Effectively, this helps structure a portfolio that has the risk profile of a passive benchmark while producing active equity returns.

The sector-neutral approach isn’t limited to Canada but is applied equally to broader markets, he added. “The same holds true for the U.S., which is the deepest, broadest and most diverse market in the world,” he said. “The greatest sources of risk in constructing a diverse equity portfolio actually exist at the sector level irrespective of geography.”

Stocks within the same sector do tend to be more correlated than stocks within different sectors, but some industries within the same sector may have different drivers, Marchese contended. “So you have industry exposure in addition to single-security exposure.”

A Closer Look at Today’s TDF Landscape
Plan members need to bear in mind that, in a rising rate environment, bonds will actually lose value—along with their ability to protect a portfolio.

Chhad Aul, a portfolio manager with Sun Life Global Investments, warns that rising rates, a low-return environment and high volatility are likely to remain some of the top concerns of DC consultants over the next few years. As a result, the majority of investors today favour low- or no-risk investment.

“Against the current backdrop, TDFs make a lot of sense,” Aul said. “They are professionally managed [and] have a glide path that mirrors the risk profile of plan members as they move from early working years to retirement.”

TDFs, he added, simplify decisionmaking for plan members and do away with many irrational behavioural aspects. “In Canada, TDFs are an extremely popular choice as a default option. Plan members invested in TDFs express greater confidence that they’d reach retirement goals, which leads to higher contribution levels.”

Since their introduction in Canada in 2004, TDFs have evolved to offer many features and options to plan sponsors. One of the greatest evolutionary changes is the addition of the tactical element to the glide path.

“Here, managers look at a host of economic and market information to make small adjustments, in a riskcontrolled fashion, to deviate from the static glide path,” said Aul. “The goal is to protect capital on the downside while looking for opportunities to add value when valuations may warrant it.”

As well, there are TDFs offering a guaranteed value if held to maturity, which makes them “particularly suited to extremely risk-averse plan members,” Aul added. He argued “plan members invested in TDFs tend to have significantly better returns than those who constructed their own portfolios.”

Expert Panel: Rethinking Investment Decisions
Research shows members don’t plan well for retirement and often make poor investment decisions that result in underperformance. An expert panel closing out the forum offered investment solutions such as TDFs, better default options and allocations to non-traditional assets to improve outcomes for DC plan members.

Shane Ayres, vice-president, institutional distribution, with Pyramis Global Advisors, said default options are critical but plan sponsors should do more. “In seeking better outcomes for their employees, plan sponsors should look beyond just the default investment options and review their overall plan design and other plan options available to them. For example, in addition to selecting an appropriate default investment option, it’s important to consider employee and employer deferral rates as well as other plan design characteristics, such as auto features and limiting employee withdrawals.” Ayres recommended TDFs as an optimal default investment option.

Pat Leo, director, institutional business development, with Sun Life Global Investments, shared a similar view, saying TDFs tend to drive higher contribution levels among investors. “TDF investing really takes the responsibility of making investment choices off plan members and sponsors,” he said. “This allows them to focus on how much money to contribute to their plan to get them to retirement.”

TDFs, he added, continue to evolve from an asset class perspective, with an increasing amount now being allocated to non-traditional asset classes such as real estate, infrastructure and emerging markets. “We see that trend continuing,” said Leo.

There’s also mounting aversion to risk among younger investors, which has implications for plan sponsors. This makes risk management a key part of the equation, explained Bradley Hicks, managing director with MFS Investment Management Canada.

“We’re likely going to be in a slower growth world for some time and can expect episodes of volatility to continue,” he said. “Plan sponsors need to look at the way they evaluate potential targetdate options and consider offering solutions that provide a framework for managing downside risk in the event of a market pullback.”

Are plan providers in Canada doing enough to encourage innovation in the DC investment space? Kin Chin, director, DC investment strategy, with BlackRock Inc., expressed disappointment at the lack of innovation—particularly on the decumulation side of the equation.

“Canada is a smaller market, which is why we’re sometimes slower to innovate relative to some bigger markets like the U.S., given the scale and investment required to bring some of the new decumulation ideas to fruition,” he said. “Even if plan sponsors make the funds available, there’s no guarantee there will be enough take-up. Unless the members are defaulted into some of the new strategies, you really need to spend some time on the education front to make sure they’re using these new ideas properly. We know from experience, this is a difficult task.”

Vikram Barhat is a Toronto-based business and financial journalist.

Get a PDF of this article.