Panel 3: Use of Default Vehicles: Different Countries, Different Takes

Panel 3: Use of Default Vehicles: Different Countries, Different Takes Stephen P. Utkus, Moderator Vanguard Center for Retirement Research Jaime de la Barra Compass Group Nick Callil Towers Watson Richard Gröttheim AP7

Chilean Pension System June 2014

Chilean Pension Fund System > Inception: 1981 > Three Pillars: Mininum Government Guarantee, Mandatory DC, Voluntary (Tax incentives)defined Contribution Individual Accounts > Managed by private sector single purpose Pension Fund Management Companies (AFPs) that act as fiduciary third party manager > AFPs manage mandatory and voluntary accounts > Individual worker choice: Between AFP and type of Asset allocation fund Freedom to change manager and fund Flexible pension redemption schemes > Universal rules > Asset allocation funds serve as savings vehicles and building blocks for glide paths. > Funds differ among each other based on the range of equity and fixed income allocation allowed by law. (asset class based guidelines) 3

Chilean Pension Fund System Number of AFPs 6 Asset Allocation Funds Offered 5 Total Industry AUM Worker Contribution USD 162bn 59% of GDP 10% of gross salary Employer Contribution 0 AFP Fees Number of Accounts Number of Contributing Accounts 1.45% of salary 1.26% disability Insurance 9.5 million 4.9 million Average Real Return since inception 8.9% 4

Multifund Asset Allocation > Maximum total foreign investment for funds A+B+C+D+E is 80% of total assets. Fund A B C D E Minimum 40 25 15 5 0 Maximum 80 60 40 20 5 5

Pension Fund current Allocation Data in USD billion 100% 26.0 bn 26.8 bn 61.8 bn 25.3 bn 22.2 bn 162.2 bn 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% A B C D E Total Domestic Equity Foreign Equity Domestic Fixed Income Foreign Fixed Income Alternatives 6

Default Path & Fund Options Men 35 or youger Between 36 and 55 Older than 56 Retirees Women 35 or youger Between 36 and 50 Older than 51 Retirees A B Default C Default D Default Default E

Challenges & Current Issues > Focus on Replacement Rate or Risk Profile? > Default Path > Choice v/s implied guarantees > Once you choose you are on your own > Multi asset funds as building blocks > Investment guidelines based on asset class and issuer limits > Role of Alternative Investments > Peer group competition > Pricing not a relevant issue for informed / high income participants > Fees on contributions v/s AUM > Service > Performance > State owned AFP 8

AUD Australian System a Snapshot 1,800 1,600 1,400 Superannuation assets (LHS) Assets (% of GDP) (RHS) DC Assets (% of total assets) (RHS) 106% 120% 100% 1,200 76% 84% 80% 1,000 800 54% 60% 600 40% 400 200 20% - 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 30-Jun Mandatory employer contributions commenced in 1992» now 9.25% of earnings, increasing to 12% by 2023 No mandated income stream in retirement» investment defaults must cater for both to and through investors 0%

Member Choice Occurs at Two Levels An individual employee may choose:» the fund to which employer contributes ( fund choice )» investment option(s) within their chosen fund ( investment choice ) Default funds are typically selected by employer, or (in unionised sectors) through industrial agreements Default investment option (and other default settings) is chosen by the fund operator or trustee

MySuper Commenced 1 July 2013 Standardised product offering for funds accepting default fund members Investment default must be diversified or lifecycle No fee cap, but» uniform fees for all members» limits on types of fees Standardised member reporting (returns, fees, risk) Default insurance cover

Default Design Static vs Lifecycle Not-for-profit funds only 2009 2013 Lifecycle, 5% Lifecycle - derisks in retirement zone only, 18% Lifecycle, 14% Static, 77% Static, 61% Lifecycle - derisks in retirement zone only, 25% Some growth in age-based lifecycle Some lifecycle funds are static in accumulation phase, derisk in retirement phase only

Default Option Asset Allocation Not-for profit funds with static defaults only, 2013 Distribution of strategic growth weightings among funds 61% 2% 6% 16% 16% 50% and under 50% - 60% 60% - 70% 70% - 80% 80% - 100%

Default Option Asset Allocation Not-for profit funds with static defaults only, 2013 Distribution of strategic growth weightings among funds 61% 16% 16% 2% 6% 50% and under 50% - 60% 60% - 70% 70% - 80% 80% - 100% 37% 35% Average allocation within growth assets 7% 6% 5% 2% 8% Australian equities International equities Unlisted infrastructure Australian unlisted property Private equity Hedge funds Other

Allocation to growth assets Lifecycle glidepath design 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Wide range of derisking start and end ages Some funds do not have any declared default beyond retirement age 30 35 40 45 50 55 60 65 70 75 80 85 Age AustralianSuper Auscoal Super First State Super HESTA Super Fund SunSuper Telstra Super QSuper (balance <$300K) QSuper (Balance >=$300K) Local Govt Super (NSW) LG Super Australian not-for-profit funds with lifecycle design, December 2013

Topical Issues Default funds Focus on fees and pressure on inclusion of expensive asset classes (e.g. alternatives) Provision of annual estimate of retirement income Better illustration of investment/retirement outcome risk How to mitigate sequencing risk in retirement risk zone Dynamic or adaptive lifecycle

2014 Global Retirement Savings Conference, Geneva 18 June 2014 Use of Default Vehicles - The Swedish case of AP7 Richard Gröttheim CEO AP7

The Seventh Swedish National Pension Fund Acts within the defined contribution system which is a part of the government pension plan Manage premium pension means, mainly for those that do not appoint a private fund manager The default fund AP7 has been invested since September 2000 A new setup, Såfa since May 2010 Has the same investment rules as a private mutual fund Some restictions on what we can invest in Equities Bonds A part in private equity (max 10% commitments)...and there is a equity risk premium i.e. equities will over longer periods give better returns than bonds Then you need to take the financial risk i.e. The volatility in the assets

The mission - Those who do not want or can t choose should have just as good a pension as others Good pension is our contribution to creating security We shall minimize the likelihood that someone who retires talks to their neighbour and discovers that he/she has a lower state pension than the neighbour To get a good pension you need to take financial risk We need to glance at the rest of the system (just as good as others)

Good pension or low volatility?

In the long run we are all dead... IJa oji- DJ Industrial Average, Quart erly DJIA Quartly Log Do stocks go up..iong term..? Yes, if you hold the position over 30 years l!!llij 18000.[ 16000.[ 14000.[ 12000.[ 10000.[ 8000.[ -----L3 6000.[ 11 years and counting? 2000.[ ( RANGE 16 yrs 1Byrs J 5yrs RANGE 13 yrs 3yrs 5yrs 13yrs 1910 1 920 1930 1940 1950 1960 1970 1980 1990 2000 Source: CQG Inc. 2011 All rights reserved w orldw ide. http://w w w.c qg.c om Tue Feb DB 2011 10:32:54

How did we build the portfolio in 2000? (AP7 up to. 21st May 2010) Premium savings fund Lower risk than the other funds in the system Target to have a return as good as the average of the other funds New guidelines in 2009 The default fund Holistic perspective on the government pension Choice o Take in consideration the risk in the income pension o Higher total risk level in the premium pension creates possibility for higher government pension Lifecycle perspektive o One product for life o Adjust the risklevel to the savers age

Payments to Government pension Income pension Premium pension

New products Cohort management Såfa Building block Funds Equity Fund Bond Fund Government Fund portfolios Conservative Balanced Offensive

E (R) The thinking behind the AP7 Såfa Swedish Equities Risk free interest rate Global Equity portfolio Risk

Cohort Management Risk 1,5 1,0 Global Equity Fund 55 75 Age 3-4 % yearly decrease in the equity Fund

11/2/2000 5/2/2001 11/2/2001 5/2/2002 11/2/2002 5/2/2003 11/2/2003 5/2/2004 11/2/2004 5/2/2005 11/2/2005 5/2/2006 11/2/2006 5/2/2007 11/2/2007 5/2/2008 11/2/2008 5/2/2009 11/2/2009 5/2/2010 11/2/2010 5/2/2011 11/2/2011 5/2/2012 11/2/2012 5/2/2013 11/2/2013 5/2/2014 Return since inception 80.00% 60.00% 40.00% 20.00% 0.00% -20.00% -40.00% -60.00% Sparfond o Såfa avkastning % De privata fonderna %

Developments in US default funds Steve Utkus Vanguard Center for Retirement Research June 2014 For institutional investor use only. Not for public distribution.

US retirement income system For private sector employees Social Security First pillar PAYGO Contributions: 12.4% (split ER/EE) Progressive benefits Payouts: inflation-indexed annuity DC / 401(k) plans Voluntary, funded occupational system Median 9% contributions (6% + 3%) with great variation Payouts: ad hoc or periodic withdrawals or lump sum Individual Retirement Accounts (IRAs) Individually managed accounts offered by all financial institutions Recipients of rollovers from DC / 401(k) system Payouts: ad hoc or periodic withdrawals or lump sum For institutional investor use only. Not for public distribution.

Default funds in US DC plans History of 401(k) default fund policy Since founding in 1980s, 401(k) plans characterized by high degree of investor autonomy (Benartzi and Thaler, 2002). Past decade has seen shift toward reliance on defaults, such as default contributions through automatic enrollment (now, >60% of new system entrants). In 2006/2007, government authorized new default investments (QDIAs), including target-date funds, traditional balanced strategies, and managed accounts Employer choice of defaults Over 85% of DC plans offer target-date funds, and of those selecting a default, over 95% are target-date funds (Vanguard, 2014). Target-date assets are expected to reach over half of all DC assets in the coming decade (McKinsey, Cerrulli Associates). For institutional investor use only. Not for public distribution.

Assets under management in $B The power of defaults (and voluntary choice) $900B $800B Annual target date assets under management 2013 AUM: $850B Annual industry cash flow exceeds $100B $700B $600B $500B 2006 AUM: $126B Pension Protection Act passed 2003 AUM: $25B Vanguard enters the market $400B $300B 1997 AUM: $2B Fidelity enters the market $200B $100B 1993 AUM: $0 BlackRock and Wells Fargo launch first TDFs $0B 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Vanguard Fidelity Investments T. Rowe Price BlackRock JPMorgan Other For institutional investor use only. Not for public distribution.

Equity allocation Target-date glide paths of leading providers 100% 80% 60% 40% 20% 0% 2050 2045 2040 2035 2030 2025 2020 2015 2010 Income Industry Industry Avg Vanguard Fidelity T. Rowe Price BlackRock JPM Source: Morningstar, Vanguard analysis. As of December 31, 2013. For institutional investor use only. Not for public distribution.

Contemporary issues in target-date fund design Should the glidepath be to versus through are assets used at retirement or throughout retirement? What asset diversification strategies are appropriate at each stage of the lifecycle? Liquid market asset classes and allocations to them? Any role for alternatives? Should the default be invested with a passive or active approach? Should TDF strategies be integrated with a guaranteed income feature? Or will nonguaranteed drawdown services suffice? For institutional investor use only. Not for public distribution.

Important information For more information about Vanguard funds, call +1 610-669-3348 (collect calls accepted), to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing. This information is intended for investors outside the United States. The information contained herein does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. Vanguard Marketing Corporation, Distributor of the Vanguard Funds. Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments (stocks) to more conservative ones (bonds and short-term reserves) based on its target date. An investment in a target-date fund is not guaranteed at any time, including on or after the target date. 2014 The Vanguard Group, Inc. All rights reserved. For institutional investor use only. Not for public distribution.