Vanguard Finds Re-Enrollment Effective for Portfolio Diversification

Six months after a re-enrollment, 94% of participants and 74% of plan assets were in TDFs, while one year later, 92% of participants and 81% of plan assets were in TDFs, a case study by Vanguard showed.

One year after a re-enrollment event, most participants remain invested in the default fund, Vanguard found in a case study.

Early in 2016, Vanguard examined the impact of a re-enrollment event within a large defined contribution (DC) plan, analyzing participant behavior immediately after the event and then six months later. It extended its analysis to study the behavior of the same participant cohort one year after the event.

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The original re-enrollment event occurred in two phases, beginning in December 2014 during the transfer of a large DC plan’s recordkeeping services to Vanguard. Because of the presence of a stable value investment fund, which required advance notification to the insurer, the full re-enrollment was not completed until June 2015.  After one year, the plan menu remained consistent in terms of the styles and number of funds offered; however, the bond funds and one stable value offering were changed.

Immediately after phase 1, at the end of December 2014, 10% of participants partially or fully opted out of the default fund and elected their own portfolios. After phase 2, this percentage increased slightly. One year later, 20% of participants were no longer solely invested in the default fund. However, Vanguard finds most of the increase is observed among participants who moved part of their portfolio out of the target-date default, and the percentage of participants who fully opt out remains low over the entire one-year period.

Vanguard notes that after the two-phase re-enrollment event, the trajectory of the median equity allocation aligned more closely to the target-date series. The distribution or variation around the glide path, representing individuals who chose to deviate from the single target-date default fund, grew wider as participant age increased. This widening of the distribution reflected later-than-normal retirement ages anticipated by some older investors, Vanguard found.

Six months after the re-enrollment, 94% of participants and 74% of plan assets were in target-date funds (TDF)s. One year later, 92% of participants and 81% of plan assets were in TDFs.

Vanguard concludes, “Over time, investment defaults remain ‘sticky.’ This reinforces our findings that re-enrollment is an effective strategy to improve portfolio diversification.”

A report about the case study can be found here.

Setting Rate and Return Assumptions Is Tough

Predictions vary around market returns and interest rates for 2017, although some have predicted rates solidly above 5% by the end of 2018. 

 

In the Milliman Pension Funding Index (PFI), released in January, under an optimistic forecast with rising interest rates (reaching 4.55% by the end of 2017 and 5.15% by the end of 2018) and asset gains (11.2% annual returns), the funded ratio would climb to 92% by the end of 2017 and 105% by the end of 2018. Under a pessimistic forecast with similar interest rate and asset movements (3.45% discount rate at the end of 2017 and 2.85% by the end of 2018 and 3.2% annual returns), the funded ratio would decline to 75% by the end of 2017 and 69% by the end of 2018.  

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However, Jason Shoup, senior portfolio manager and fixed income strategist with LGIMA, believes sponsors should remain somewhat wary.

“What we’re contending with is an expectation of only modestly improved growth in the U.S.—and an outlook that has fatter tails to it. As a result, we have a rate outlook that has much more risk,” Shoup says. “Through the lens of a pension administrator and pension plan, you really need to be ready to act here, and you need to be poised in thinking about these issues. On the one hand, we may be seeing the highs of the market in terms of where rates can go right now. On the other we may be seeing the beginning of real normalization.”

Shoup adds that uncertainty about federal policies injects a new risk factor into considerations about rates. “The new administration may succeed in extending the current business cycle,” he speculates, pressuring rates higher over time, “but the possibility that the policies fail to live up to expectations, at least in some areas, seems remarkably high and argues for some degree and caution about the U.S. outlook.”

Shoup further expects there to be “quite a bit of uncertainty with respect to how high rates can go, and once again on the other side, if you have a misstep from the administration on corporate tax reform, on trade, on immigration, it’s quite possible that you have significant downside risks as well.”

NEXT: Market volatility should inform de-risking strategies  

A recent report from Northern Trust, which surveyed 100 investment managers, found that 78% anticipate inflation to increase throughout 2017, a large increase from the previous quarter’s 47%.

Still, Mark Meisel, senior investment product manager of the multi-manager solutions group at Northern Trust, believes managers will not actually see inflation increase dramatically over the course of the year—increasing the likelihood of a slow and steady rate picture.

“If I were a participant and I saw the results, I would be making sure that I have enough allocated to asset classes that do OK in a rising rate environment—not dramatically rising rates—but a slow rising rate environment, and one where inflation is beginning to have an impact again,” he says.

Meisel recommends real asset classes, including real estate investment trusts (REITs), Treasury Inflation Protected Securities (TIPS), and the global listed infrastructure. However, he warns that while commodities can offer protection from inflation, they also have high volatility.

“That may be something that, depending on the risk tolerance of the client, they may not want to invest in,” Meisel says. “Some of these other real assets I think would be important to have within a well-balanced portfolio.”

A related State Street Global Advisors market outlook report for 2017 found that forward return expectations for equities are less than 5%, while expectations for fixed income (post-inflation) came in between 1% and 2%.

Lori Heinel, deputy global chief investment officer for State Street Global Advisors, believes that because of this, most plan sponsors will have a tough time setting expectations during 2017.

“Think a lot about volatility management, because in an era of lower returns, higher volatility can be a big problem,” she says. “Also, look at things like illiquid assets, whether it be private equity and private real estate or infrastructure, or other kinds of low correlation assets.” 

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