MEETING TODAY S CHALLENGES FOR 401(K) SPONSORS OCTOBER 22, 2014 Liana Magner Amy Reynolds
Today s speakers Liana Magner, CFA Partner US Delegated DC Leader MERCER W EBCAST Amy Reynolds, ASA Partner US DC Consulting Leader 1
In a relatively short period, DC plans have become retirement plans. The implications though aren t all positive $330 B $5,900 B 1,687% Growth in DC Assets 5 240% Growth in # of Options 17 >80% <30% Workers Expecting to Retire at 65 Sources: Investment Company Institute & 2014 Retirement Confidence Survey, EBRI Issue Brief, no. 397, March 2014
Today s plan sponsors need to maximize the opportunity their plans present - in a thoughtful, effective manner Invest to Leverage Design to Enable Objective is to secure acceptable retirement outcome for participants Enhancements in design and delivery can have favorable impact Manage to Protect To achieve the organization s objectives, cost and risk must also be managed 3
Yet too many plan sponsors are distracted by operational issues Objectives & Strategy Benefit and Investment Structure Strategy Time Allocation 20% Financial Impact 80% Delivery Model and Manager/Provider Selection Implementation and Processing Execution 80% 20% Monitoring For illustrative purposes only 4
Enhancing the investment menu can significantly improve the retirement outcome for participants 50bp decrease in fees = 20% increase 2% improvement in return = 59% increase Assumptions: 6% savings begins at age 25 with salary of $40k (2.5% annual increases); 5% net annual return 5
The opportunity to enhance investment performance grows with plan assets The Maturing of a DC Plan Many options Mutual funds Bundled recordkeeping Streamlined menu Best in class managers Some institutional vehicles Some custom funds ERISA budgets Best in class managers Custom, multi-manager funds Broad use of institutional vehicles Custom target date funds Direct payment of administrative fees Plan Size 6
Diverse menus offer flexibility but can result in choice overload Tier I Target Date Options Tier II Passive Core Options Tier III Active Core Options Tier IV Specialty Options Capital Preservation Diversified Fixed Income Diversified Fixed Income Target Date Funds 5-year increments Diversified Inflation Large Cap Equity Large Cap Value Small/Mid Cap Equity Large Cap Growth World ex-us Equity Small/Mid Cap Value Small/Mid Cap Growth World ex-us Equity Managed Accounts 7
A more streamlined approach can provide diversification with greater efficiencies and lower costs Tier I Target Date Options Tier II Passive Core Options Tier III Active Core Options Tier IV Specialty Options Capital Preservation Diversified Fixed Income Diversified Fixed Income Target Date Funds 5-year increments Diversified Inflation US All Cap Equity US All Cap Equity World ex-us Equity World ex-us Equity Managed Accounts Simplified. Customized. Diversified. 8
Custom funds are not inherently complex Diversified Fixed Income Fund Liquidity Buffer 5% Manager 2 47.50% Manager 1 47.50% Combines complementary styles/strategies Index allocation is liquidity buffer and provides beta at a lower cost Vehicles and number of managers/strategies depends on size Efficient implementation of changes under the hood Enables plans to leverage less costly investment vehicles 9
but can provide diversification without requiring participants to take action All Cap Equity Fund SMID Growth 10% SMID Value 10% Low Volatility 20% Index 5% Large Cap Growth 25% Large Cap Value 35% Diversification without the need to actively allocate and rebalance among styles Combining strategies with low or negative excess return correlations could reduce tracking error and increase expected information ratio and excess return Most record keepers / custodians strike daily net asset value to facilitate same day trading 10
Plan sponsors should align their external resources with their internal capabilities and needs Where do you fall on the spectrum? RESEARCH & TOOLS ADVICE DELEGATED SOLUTIONS Internal resources and expertise High Low Committee meetings Regular Infrequent Speed of decision-making Timely; Proactive Delayed; Missing Opportunities Comfort with decision-making High Low Level of plan oversight High Low 11
Why do plan sponsors consider delegation for their DC plans? Investment Expertise Disciplined decision making Comprehensive Outsourcing Increased committee support, vendor management, and regulatory oversight Investment Buying Power Opportunity for lower investment fees Custom Funds Simplified, diversified choices for participants Portfolio Execution More nimble execution of investment decisions 12
Delegation allows plan sponsors to focus on areas of greatest value Plan Sponsor Delegated 3(38) Solutions Responsibilities Plan Sponsor Provider Strategy Define objectives/plan design Set policies (IPS, fees) Define investment structure Implementation Manager selection Manager termination Coordination of managers/recordkeeper Contract and fee negotiation Liquidity management/rebalancing Evaluation Performance monitoring Manager and recordkeeper monitoring Compliance oversight May be shared responsibilities 13
Governance is a key component of a holistic delegated service COMMITTEE SERVICES RECORDKEEPING/ ADMINISTRATION OVERSIGHT PARTICIPANT COMMUNICATION OVERSIGHT MANAGED ACCOUNT OVERSIGHT COMPLIANCE SERVICES 14
Plan sponsors have a variety of questions 1. Do we have to change all of our current investments? 2. What happens to the relationship with our other vendors (custodian, record keeper, investment managers)? 3. How can we get lower manager fees under this model than we can negotiate for ourselves? 4. What notice is provided before a change is made to our plan s investment managers? Are our participants notified?
Case Study: Before delegation Plan sponsor was struggling with a lean, inexperienced staff, a desire to reduce governance risk and a goal to implement a proactive DC strategy Tier I Lifecycle Fund Tier II Passive Core Options Tier III Active Core Options Capital Preservation XZY Stable Value Tier IV Specialty Options Target Date Funds Passive Target Date Funds Core Fixed Income XYZ Fixed Income US Large Cap Growth XYZ Large Cap Growth All Cap Global Equity XYZ Equity Index US Large Cap Value XYZ Large Cap Value US Mid Cap Growth XYZ Mid Cap Growth US Mid Cap Value XYZ Mid Cap Value US Small Cap Growth XYZ Small Cap Growth US Small Cap Value XYZ Small Cap Value International Equity XYZ Int l Equity 16
Case Study: After delegation Investment line-up was streamlined, investment fees were reduced by $2.2m and increased governance support allowed sponsor to focus on strategy Tier I Lifecycle Fund Tier II Passive Core Options Tier III Active Core Options Capital Preservation XYZ Stable Value Tier IV Specialty Options Target Date Funds Passive Target Date Funds Global Fixed Income XYZ Global Fixed Index US Equity XYZ Equity Index Core + Fixed Income XYZ Fixed Income Diversified Inflation US Equity XYZ US Equity Multimanager custom funds Non-US Equity XYZ Equity Index Non-US Equity XYZ Intl Equity 17
Case Study: Spin off company with new plan and limited internal resources seeking to establish strong governance structure and competitive plan Tier I Target Date Options Tier II Passive Core Options Tier III Active Core Options Tier IV Specialty Options Capital Preservation Money Market No target date fund exposure Diversified Fixed Income Inflation Protection TIPS High Yield Balanced Exclusive use of mutual fund vehicles US Large Cap Equity US Large Cap Equity Large Cap Value Large Cap Core Large Cap Growth US Small/Mid Cap Equity US Small/Mid Cap Equity REITS World ex-us Equity 18
Case Study: New streamlined investment menu with lower cost funds overseen by enhanced governance structure delivered Tier I Target Date Options Tier II Passive Core Options Tier III Active Core Options Tier IV Specialty Options Capital Preservation Target Date Funds Passive Target Date Funds Replaced static balanced fund with target date series Diversified Fixed Income US Large Cap Equity US Small/Mid Cap Equity World ex-us Equity Diversified Fixed Income Diversified Inflation US Large Cap Equity Large Cap Value Large Cap Growth US Small/Mid Cap Equity World ex-us Equity Consolidated TIPS and REIT exposure into diversified inflation strategy Expanded passive tier to include fixed income and international equity Use of commingled fund vehicles where appropriate, for cost savings 19
Plan sponsors have an opportunity to enhance the retirement outcomes of participants Invest to Leverage Manage to Protect Design to Enable Streamlined investment menu Institutional, customized approach Enhanced governance and oversight Improved diversification Efficient, effective delivery Potential for cost savings Mitigate fiduciary risk 20
Questions Liana Magner, CFA Partner US Delegated DC Leader Amy Reynolds, ASA Partner US DC Consulting Leader QUESTIONS FEEDBACK Please type your questions in the Q&A section of the toolbar and we will do our best to answer as many questions as we have time for. Please take the time to fill out the feedback form at the end of this webcast so we can continue to improve. The feedback form will pop-up in a new window when the session ends. To submit a question while in full screen mode, use the Q&A button, on the floating panel, on the top of your screen. www.mercer.com/webcasts CLICK HERE TO ASK A QUESTION TO ALL PANELISTS MERCER W EBCAST October 23, 2014 View past recordings and sign up for upcoming webcasts 21
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