Look to the past to predict the future when it comes to pension investing, defined benefit (DB) retirement plan sponsors are urged by global advisory and broking firm Willis Towers Watson (WTW) in a new paper on investment actions recommended for 2019.
A decade after the last major recession of the U.S. economy, many DB plan sponsors have become convinced that the current environment is the “new normal,” according to the paper dated November 27. Soaring equity prices and low interest rates have influenced investments; rising Pension Benefit Guaranty Corporation (PBGC) premiums, artificially smoothed discount rates, and increasing settlement activity also have affected pensions. But they may be more cyclical than some plans realize, WTW said.
The consulting firm outlined 10 recommendations for pension investing in the year ahead, based on lessons learned in the last worldwide financial collapse:
- Avoid surprises. During the global financial crisis, the average plan’s funded ratio fell by 25 percent. Businesses with large pension obligations were forced to source extra cash for their plan. The good news now is there are tools that can be used to simulate different economic environments for DB plan sponsors to better understand the potential impacts of financial risks and develop strategies to manage them.
- Reduce uncompensated risks. Not all asset classes, managers, and strategies struggled during the financial crisis. Some investment strategies—like reinsurance, merger arbitrage, and momentum—came out of the period ahead. Going forward, it’s unlikely that everything will implode at once, the consulting firm said, so diversity is key. Explore reducing your plan’s reliance on the highflying equity portfolio, it advised.
- Make every dollar work harder. In the 1990s, before liability-driven investing (LDI) became dominant, most sponsors intended to keep plans open forever, and targeting an 8-percent expected return seemed perfectly reasonable, WTW said in the paper. Now, with the shift toward closed, frozen, and terminated plans and the option to transfer risk to insurers, many portfolios have loaded up on long credit bonds, reducing their return potential. There is a delicate balance between building a powerful return generator and managing your liabilities, but it need not be one or the other, WTW said.
- Concentrate your equity bets. Before the 1970s, active management dominated equity strategies. Then, in 1975, Vanguard introduced passive management. Today, there is a well-documented flow of assets from active to passive strategies. But according to academic research, plan sponsors may be missing an opportunity to add value. WTW said it has joined with a number of equity managers to implement this research for clients.
- Be a bond market trendsetter. At the end of 1989, the global bond universe represented $12 trillion; 61 percent of debt was issued in the United States. Today, the bond market represents nearly $110 trillion, with just 36 percent issued in the United States. If your plan governance structure allows, WTW said it believes there are large opportunities in securitized credit, bank loans, and private debt.
- Revisit financial management strategies. Plan sponsors may now be seeing their highest funded status since the global financial crisis. If you saw your plan’s funded status nosedive a decade ago, you have a second chance at locking in your improved position. Revisit your company’s funding and accounting policies, the plan’s strategic asset allocation, and your progress along your “derisking” glidepath and on long-term plan financial forecasts to confirm the path you’re on is the right one.
- Stay informed about the changing annuity marketplace. Before 2012, the annuity purchase marketplace averaged $1.5 billion in transactions per year. In 2017, this figure was $23 billion, according to WTW. Increasing funding levels have further shifted the DB plan focus to derisking. The majority of the obligations that have been settled to date have been focused on retiree-only transactions, but insurance markets are continually evolving to meet plan sponsor demand, adding flexibility for sponsors’ transactions.
- Focus on value for fees rather than the fees themselves. In the year 2000, the average mutual fund or exchange-traded fund (ETF) cost 100 basis points (bps) for active and 25 bps for passive; today, those numbers are 72 bps and 15 bps. Sponsors are increasingly focused on reducing investment fees, but WTW in the paper emphasized the value from fees, not the fees themselves.
- Consider your governance structure. Sponsors have constantly faced too many decisions with insufficient time to vet them, WTW said. Today, delegation—or the outsourced chief investment officer (OCIO)—is everywhere. Sponsors are continuing to find that delegation can potentially lead to better financial outcomes, better execution, and better value, along with helping provide an additional layer to fiduciary documentation and oversight.
- Maintain your DB plan if it’s the right fit for your company. When the modern pension plan took shape after the Great Depression, its main objectives were to help older employees retire and to prevent poverty for the aged. Today, as more and more sponsors close or freeze their DB plans and switch to defined contribution(DC)-only arrangements, their ability to accomplish these goals may be challenged, WTW stated. But despite this trend, the firm said it retains many clients still committed to open DB plans.
Jane Meacham is the editor of BLR’s retirement plan compliance publications. She has nearly 30 years’ experience as a writer/editor of financial services news.