Trendspotting

Target-Date Funds Continue Growth
But target-risk funds are losing assets

Art by Tara JacobyThe growth rate of target-date funds (TDFs) remains positive but continues to slow as plan sponsors move to collective trusts and custom solutions, according to Morningstar’s quarterly target-date report.

In the second quarter, target-date funds experienced $19.3 billion in positive inflows. Total assets under management (AUM) surpassed $760 billion at the end of the quarter.

Target-risk funds saw aggregate outflows of $2.9 billion during the quarter. Total AUM at the end of the second quarter was nearly $752 billion, according to Morningstar’s quarterly target-risk report.

This quarter marks only the second in the past three years that target-risk funds have seen total AUM fall, Morningstar says. Still, as of the end of Q2, total assets in target-risk funds were up 1% from a year ago.

After two consecutive quarters of positive returns, average TDF performance reversed course in the second quarter with an average loss of 0.3%. Over the last 12 months, the average target-date fund gained 2.1%. Target-risk funds lost 0.5% on average for the second quarter but gained 1.8% over the past 12 months.

Individual asset class performance was mixed during both the second quarter and the last 12 months. In the U.S., growth equities continued to outperform value equities, with small growth stocks among the best-performing asset classes for the last 12 months. While diversification into non-U.S. equities hurt the performance of target-dates over the last 12 months, larger exposures to developed foreign equities helped fund performance in the second quarter. Among alternatives, commodities were the worst-performing over the year, and real estate investment trusts (REITs) were the worst-performing in the second quarter. —Rebecca Moore

The Retirement Paycheck
Providers need to start shifting participants’ focus to income

Art by Katherine Streeter

The legions of Baby Boomers approaching retirement are turning up the heat on the issue of ongoing income, especially to pay health care expenses in retirement, according to Cerulli Research.

The July 2015 Cerulli Edge–Retirement Edition takes a look at how recordkeepers and plan sponsors can change plan participants’ perspectives, helping to de-emphasize investment return and think about potential income.

Most plan participants lack the translation of current balance to future retirement income, contends Cerulli in its report, which recommends that this information be included on statements from plan recordkeepers.

What do plan participants believe is the most important information on their retirement plan statements? Not income—according to Cerulli’s data, a majority of participants (80%) say it is their accumulated balance or investment performance.

Those in the 60 to 69 age range may seem likely to pay the most attention to income projections on a statement, but this is not the case, as only 19% of that group appear to do so, Cerulli says. Nearly half (46%) of people in their 60s say they are most interested in the investment performance shown on their statement. Participants consistently consider a defined contribution (DC) plan through the lens of accumulation and forget that their savings are meant to play a key role in a drawdown schedule in their retirement years.

Cerulli says that getting participants to see the balance as a stream of monthly payments—an actual retirement pension—will help them grasp what the savings actually mean and not just view them the way they would a typical brokerage account. When that mind-shift takes place, participant attitudes toward these funds will also change.

Citing the Department of Labor (DOL)’s consideration of a rule to make income projections mandatory, Cerulli recommends that all recordkeepers provide the information, as a best practice. Relatively conservative assumptions or the DOL’s recommendations should be the yardstick, Cerulli says. It is also possible that the inclusion of income projections could spark conversations with those participants who want to delve more deeply into the meaning of that calculation and how any outside assets might come into play.

A number of factors must be considered, such as the metrics that indicate success in the minds of many plan participants. Investment performance remains the top indication of success, Cerulli says, which potentially creates unrealistic expectations for market performance and can lead participants to allocate in a too-risky manner.

Here, recordkeepers can be of assistance, by helping to monitor investment choices and proactively contacting retirement plan participants who have misallocated accounts. —Jill Cornfield

Retirees Under-Annuitized
Logic would dictate that retirees buy annuities

Art by Jeffrey Alan Love

The importance of annuity-like income as a share of income for aged families—those who have reached 62 years and older—is the focus of a paper from the Center for Retirement Research at Boston College.

Contrary to a widespread fear caused by the shift from defined benefit (DB) to defined contribution (DC) retirement plans, there is little evidence that the annuity-like income share of total income has fallen, over the past three decades, for aged families, especially those of low income, the paper finds.

However, “Do Retired Americans Annuitize Too Little? Trends in the Share of Annuitized Income” contends that many middle- and high-income older families would experience a jump in monthly income if they annuitized their wealth.

Pension annuities offer retirees a simple vehicle for insuring themselves against the risk of outliving their retirement savings, the paper says. As the U.S. workplace retirement system shifts to defined contribution plans with lump-sum payouts, it seems logical to think retirees will shift their retirement savings portfolios toward annuity products in order to replace the guaranteed life income payouts once provided by old-fashioned, defined benefit pensions. Such a shift has yet to occur, however.

Only a very small percentage (8%) of older workers and recent retirees with DC-type lump-sum payouts have purchased or intend to purchase an annuity with their retirement savings. Still, economists and experts on insurance agree that annuities can play a key role in providing stable retirement income that lasts for the lifetime of retired workers and their spouses.

For the average family headed by a person 62 or older, two-thirds of total income consists of some form of annuitized income—Social Security, public or private employee pensions, or annuities. Aged families in the bottom two-fifths of income distribution report a higher percentage of annuity income compared with families in the top three-fifths of the distribution. In the higher ranks of the income distribution, annuitized income flows account for a progressively smaller percentage of total family income.

Many explanations have been offered for the very small share of retirees who buy annuities. One reason is that most retirees already receive a substantial fraction of retirement income in annuity-like payments. Another is that many Americans nearing retirement have too few financial assets to make purchasing an annuity worthwhile.

The researchers considered the 62 and older population as a whole, as well as different segments of the aged families’ income distribution, from the early 1980s through 2009, drawing on survey data from the Survey of Consumer Finances. —Jill Cornfield

Long-Term Potential of HSAs
These accounts can be a significant tool in mitigating health care costs

Most employees who have access to health savings accounts (HSAs) mistakenly think these work like flexible spending accounts (FSAs)—if they fail to use their balance in a given year, they will lose it. Thus, the majority of HSA holders use the accounts only for current health care expenses, according to a new report from UMB Healthcare Services, “HSAs Build Long-Term Wealth With Tax-Favored Savings.”

That misconception is not surprising, given the fact that HSAs are still fairly new and are rarely included in benefits education and communications, writes Dennis Triplett, chairman of UMB Healthcare Services, in the report.

UMB analyzed the balances of 440,000 HSA investors in 2014 and found they had an average balance of $1,874—far lower than the annual maximum contribution the Internal Revenue Service (IRS) allows. For 2015, the limit is $3,350 for individuals and $6,650 for family coverage, plus a $1,000 catch-up for people over 55 years old.

Given the fact that the Employee Benefit Research Institute (EBRI) calculates that a couple retiring at age 65 today will need nearly $300,000 to cover their subsequent health care costs, retirement plan advisers should emphasize the benefits of long-term investing and maximizing HSAs, UMB Healthcare Services suggests.

For instance, UMB projects that a 40-year-old employee earning $80,000 who starts to maximize his HSA contributions and earns a 5% return will have more than $306,000 by age 65. UMB also notes that whereas 401(k) investments and withdrawals are tax-deferred, they are never taxed in an HSA.

UMB suggests that advisers can help their sponsor clients look for HSAs that offer robust investment options and proactive education.

In conjunction with the white paper, UMB is launching a tool for HSA investors called UMB HSA Saver—a dashboard that will show account holders their current investments and enable them to research other investment options.

UMB’s report comes on the heels of one from Avida Bank that predicts a wave of investing in HSAs that will boost assets from $3 billion invested today to $12 billion in 2017 and $40 billion in 2020. —Lee Barney

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Alternatives Gain Favor
Sixty-three percent plan to allocate more than 11% of assets to alternatives

Sixty-three percent of advisers surveyed by Morningstar and Barron’s financial magazine say they will allocate more than 11% of assets to alternative funds in the next five years, up from 39% who expressed that level of commitment in 2013.

Institutional investors, on the other hand, are growing slightly wary of alternative investments, citing high fees and poor transparency. Just 22% of institutional investors plan to allocate more than 25% of their portfolios to alternative funds, down from 31% in 2013.

Additionally, 45% of institutions said that alternatives were “somewhat less important” or “much less important” than traditional investments, up from 28% in 2013. Nearly one-third of advisers (31%) said that alternative investments are “much more important” or “somewhat more important” than traditional investments, up from 27% in 2013.

The most popular alternative choice for institutions and advisers alike is multi-strategy funds, cited by 22% of institutional investors as their fastest-growing alternative strategy and by 14% of advisers.

“Financial advisers are increasingly enthusiastic about alternatives just as institutions are becoming more cautious,” says Josh Charlson, director of manager research for alternative strategies at Morningstar. “Advisers have a far wider range of liquid products to choose from than in the past, while institutions have become less enamored because of the high fees and poor transparency of traditional hedge funds.”

Growth rates in alternatives exceeded all other asset classes, despite slowing to 12.3% in 2014 from 42.2% in 2013. By comparison, U.S. open-end funds grew 2.1% in 2014 and 3.0% in 2013. In 2014, 118 alternative mutual funds were launched, up from 89 in 2013. The multi-alternative category led the way with 40 fund launches, followed by 32 launches in the nontraditional bond category and 21 in the long-short equity category. —Lee Barney