Products June 22, 2016

Investors Hungry for Ways to Address Uncompensated Risk

Institutional investors are getting serious about reducing uncompensated portfolio risk, according to one investment manager, driving demand for “low volatility” and “managed volatility” strategies. 
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As a senior vice president and client portfolio manager at INTECH, Richard Yasenchak spends a lot of his time fielding highly technical investing questions from all manner of institutional investors.

Yasenchak recently sat down with PLANADVISER to discuss the issues he is hearing about most from institutional investor clients heading into the second half of 2016. He says there is clearly a strong focus developing around “low volatility” and “managed volatility” products, even as investors are still coming to a better understanding of what these terms actually mean when it comes to building high-quality portfolios.

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“There’s no question that we are seeing our most significant growth in mandates aimed at reducing uncompensated risk for long-term equity investors,” Yasenchak says. “The growth in the space has been pretty remarkable, but it’s not at all surprising given the way the markets have behaved in the last year or longer. We are clearly moving into a higher-risk regime where reliable returns are harder to come by.”

The wider economic reality of dampened returns and increased volatility is having a direct impact on the way large institutional investors think about protecting their assets and portfolios. Given that INTECH is a provider of quantitatively driven low volatility and managed volatility products, it’s no surprise Yasenchak is fielding a lot of questions in this area.

“The clear interest in managed volatility and low volatility really cuts across our global client base,” he adds. “We are getting questions all the time about volatility management from large public and corporate pension plans, for example, and we are even seeing some building interest from large private defined contribution (DC) programs.”

When talking about “low volatility products,” Yasenchak is referring to portfolios that “specifically seek benchmark-like returns, over the full market cycle, with a total volatility, measured as the standard deviation, falling considerably below that of the index.” At INTECH, such products are generally built around the philosophy that purely capitalization-weighted indexes are not efficient and can be improved upon by varying portfolio weights based on the volatilities and correlations of stocks within the portfolio.

“These products are also built on the belief that positive excess returns can be achieved over the long term using estimates of volatilities and correlations, through systematic rebalancing that shifts the portfolio exposures over time to take into account the overall level of risk currently in the market,” Tasenchak says. “It all comes down to mitigating uncompensated risk.”

NEXT:  When managed volatility makes the most sense 

According to Yasenchak, “managed volatility” and “low volatility” portfolios are ultimately trying to take into account the fact that, when risk surges in the market, “the old adage that you must have risk to have reward breaks down.”

“Of course it’s true that you cannot generate returns over the long-term without taking on some measure of investment risk,” he notes, “but this does not mean that all the risk you are taking over time is being compensated equally. Right now there is a building consensus that there is less potential return out there in the markets, while at the same time the risk is increasing substantially. While we are not making forward-looking performance predictions, this fact should still inform our portfolio allocation decisions.”

“Managed volatility” products are built essentially around the same ideas, but such funds generally seek to outperform their index over the full market cycle, while still pursuing total volatility below that of the index. “Again, this investing philosophy is built around the idea that capitalization-weighted indexes are not wholly efficient and can be improved upon by varying portfolio weights based on the volatilities and correlations of stocks,” Yasenchak says. “At INTECH, we rely on algorithms and automation to generate portfolio recommendations that we believe can outperform while offering additional protection on the downside.”

Breaking these ideas down further, he observes that managed volatility and low volatility products, at the heart, are aimed at helping investors achieve a greater sense of security while still holding on to their equity exposures.

“Compared with other approaches, I think low and managed volatility strategies make a lot of sense right now,” Yasenchak concludes. “Fixed-income yields remain at historic lows, so any reduction in the commitment to equities will almost certainly have a corresponding reduction a client’s expected portfolio returns. This is unacceptable given everything we know about the retirement shortfall. Low volatility and managed volatility equity can offer up an answer.”

Data & Research June 22, 2016

Clients’ Knowledge Base Influences Investing Opinions

New research from Prudential Retirement finds clear evidence that those who are more familiar with key financial topics are far likelier to describe them as important to the retirement planning effort.
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More plan participants—nearly eight in 10—intend to rely on their workplace defined contribution (DC) plan as a source of retirement income than any other source, including Social Security, research from Prudential Retirement finds.

The number who cite their plan as a primary source of retirement income exceeds by 33% the number who cite Social Security. Yet, only 4% of DC plans offer their participants a guaranteed lifetime income solution. Only 45% of DC plan participants surveyed say they are highly satisfied with their plan’s help with securing an adequate income source once they retire.

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Sri Reddy, head of Full Service Investments at Prudential Retirement in Hartford, Connecticut, tells PLANSPONSOR, there is more plan sponsors can do. “They can offer guaranteed lifetime income solutions. For years this has been an acceptable qualified default investment alternative,” he notes. Fifty-four percent of participants surveyed say they believe guaranteed lifetime options offered as a default investment option would provide better-than-average retirement outcomes.

“Plan sponsors say don’t see a lot of participants asking for lifetime income, but the awareness is not there for participants,” Reddy continues. “The survey is telling plan sponsors if participants knew guaranteed lifetime income is an alternative for plan design, they would have asked for it.”

Only about one-third of participants surveyed are familiar with lifetime income solutions, and only 5% can confirm they use them. However, among Millennials, 55% are familiar with these solutions and 17% say they have had experience with them.

Thirty-two percent of all participants consider guaranteed lifetime income solutions very important, but the figure jumps to 78% when participants are familiar with them. Asked why they value these solutions, participants most commonly say they provide financial security, certainty or predictability; are easy to understand and manage; and help people save and prepare for retirement.

“Other studies we’ve done show that people with guaranteed lifetime income solutions save more. It ensures them that they are managing risk over time,” Reddy says.

NEXT: Rethinking auto solutions

When defined benefit (DB) retirement plans were the primary retirement savings vehicle, all employees were automatically placed into them, and the plan sponsor invested their accounts for them. However, DC plan sponsors often fear participant backlash due to loss of control if they use automatic plan features.

In its research report, “The Ease of Automation and Guaranteed Lifetime Income,” Prudential Retirement suggests plan sponsors reframe the default debate to counter the common perception that auto features equate to a loss of control for participants. Plan sponsors should adopt simplified enrollment processes and use strategic communications to drive home the message that these features are aimed not at usurping control but rather at helping participants improve their retirement outcomes.

The survey found great interest in automatic plan features from participants. Nearly half of participants worry they won’t meet their retirement goals. They say they are doubtful they are saving enough for retirement or that they will have enough retirement income to meet their monthly expenses for life.

Nearly three-quarters of plan participants familiar with automatic enrollment consider it a very important plan design feature. With increasing numbers of DC plans adopting auto enrollment, more than six in 10 participants say they are familiar with the feature and nearly half have experience with it. While 44% of all participants consider auto enrollment very important, the figure jumps to 71% among those familiar with it. Participant views on re-enrollment track a similar curve; 39% of all participants surveyed consider it very important, but the percentage jumps to 63% with familiarity.

“The number [of plan sponsors] re-enrolling all employees is still small. They need to do so to help all participants, not just new participants,” Reddy says.

Plan participants aren’t as familiar with automatic escalation of contributions to their DC plans as they are with automatic enrollment. Forty-nine percent of those surveyed say they are somewhat or very familiar with auto escalation, but only a fraction—12%—have experience with it, primarily due to a lack of access.

Nonetheless, nearly one-third of participants consider auto escalation very important to plan design, and, as with auto enrollment, that figure nearly doubles with familiarity and experience. Sixty-three percent of participants familiar with the feature say it’s very important, as do 65% of those with experience.

NEXT: Investing help and understanding progress are needs cited by participants

Less than half of DC plan participants are highly satisfied with them in many key areas. Their plans most often fall short, participants say, in protecting them from financial market volatility, in helping them choose the right investments, and in maximizing their investments’ growth potential. Many participants also give their plans less-than-stellar marks for their ability to help them secure an adequate income source once they retire, understand how much they need to save for a secure retirement, or monitor and understand their progress toward their retirement savings goals. Plans do best, participants say, at helping them get started with saving for retirement.

Account growth and investment options are key to participant satisfaction with their plans. Asked what works well with their retirement plans and what doesn’t, participants who are most satisfied cite their investment options (mentioned by 32% of highly satisfied participants), the growth of their accounts (mentioned by 27%), and the matching contributions made by their employers (15%).

However, those who are least satisfied with their plans call out those same issues as areas that could be improved. Eighteen percent of those participants cite dissatisfaction with account growth, 14% with the employer match, and 11% with investments—highlighting the critical role these play in plan satisfaction.

Asked on what plan sponsors should focus, 66% said maximizing account growth potential is important, 64% cited securing an adequate income source, 63% said helping them choose the right investments, and 61% cited helping them monitor and understand their progress.

Fifty-six percent each said helping them understand how much to save and protecting them from market volatility were important focuses.

“A good outcome is making sure participants get to retirement with enough money to generate an income stream that helps them get through retirement with dignity and without outliving their money,” Reddy says. “The best way to do this is to get them saving and saving enough, rebalancing investments and offering guaranteed lifetime income solutions.”

He notes that most of what plan sponsors can do can be done with little or no cost to them or participants, with the exception of lifetime income solutions.

The research report may be downloaded from here.

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