PLANSPONSOR - April/May 2018 - 14

value low volatility and full control over
drawdowns, and prefer to source income
from interest and dividend distributions
rather than principal. They're willing
to forgo insurance for the absence of
the complexity, high cost and other
drawbacks noted above.
In practice, of course, participant preferences
may vary widely. But momentum to
embrace practical solutions appears to be
building.
One sign is the surging interest among
plan sponsors to retain plan participants
after they retire. According to the 2018
Callan Defined Contribution (DC) Trends
Survey, 48% of plan sponsors with a
written policy for employee retention seek
to retain participants in plan post retirement,
up from 28% in 2016. Sponsors see
benefit in scaling up assets as a means to
reduce fees on behalf of all participants.
We're also seeing more sponsors
reviewing plan structure, including
retirement income options. Interest has
centered on evaluating risk-managed,
market-based solutions that have the
potential to convert wealth into steady
monthly payouts, provide a measure of
principal protection and some assurance
of asset longevity, as opposed to insurance
guarantees.
PIMCO and others also are calling for the
addition of a fourth tier on DC menus
for retirement income. This would be an
important step forward and spur innovation.
In addition, if paired with appropriate
participant education and retirement
income tools, a fourth tier would
provide participants with clarity around
investment solutions that are appropriate
for the decumulation phase.
Fortifying fixed income
Over recent decades, the secular decline
in interest rates boosted the value of core
fixed income allocations in defined contribution
(DC) plans. Core bonds provided a
source of income, total return, low equity
correlations and capital preservation
potential.
An income-focused
strategy may
provide needed
diversification to
traditional core
bonds and needed
retirement income.
While core bond allocations should
remain a cornerstone for many DC
investors as an anchor to windward and
a source of diversification to equity exposures,
enhancements may be needed for
the prospective environment.
Given today's low starting yields, the
potential for a gradual increase in interest
rates, growing inflation risks and surging
demand for income by participants in
retirement, an income-focused total
return strategy may provide needed
diversification to traditional core bonds
and offer potential benefits to DC plan
sponsors and participants. Specifically,
income-focused strategies can:
* Expand the bond opportunity set to
include the global fixed income markets.
Core bond strategies allocate assets to
less than 20% of the global bond market,
potentially sacrificing returns and diversification.
*
Mitigate the risk of rising rates by
seeking total return primarily from
income and allowing for tactical adjustments
in interest rate exposure.
* Consolidate DC menus by combining
non-core bond options into a single,
optimal, multi-sector and globally
oriented solution, while potentially
mitigating the behavioral challenges
associated with offering participants too
many choices.
We detail our views on this topic in
" Income: An Important Source of Growth
and Stability for DC Investors. "
Overcoming the active
equity challenge
Equities remain critical to long-term
capital appreciation in DC portfolios.
However, high valuations may limit
prospective long-term returns. Moreover,
equity investors face a quandary: The
traditional approach to active equity
investing, stock-picking, has underperformed.
Indeed, the majority of actively
managed equity mutual funds and ETFs
underperformed their median passive
peers over the 1,3,5,7 and 10 years ending
December 2016.iv
The good news is investors have more
access to systematic and index-plus strategies.
These approaches seek to combine
some of the key benefits of passive
investing, including broad diversification,
efficiency and low fees, with the potential
for excess return.
As noted above, while the majority of
active equity stock-pickers have underperformed
their benchmarks and median
passive peers, the value proposition is
starkly different for active bond managers.
More than half of active bond mutual
funds and ETFs beat their median passive
peers in most categories over the past 1, 3,
5, 7, and 10 years ended December 2016.v
Thus, in our view, plan sponsors should
consider index-plus approaches, particularly
those that seek alpha from bonds. For
younger participants, in particular, indexplus
strategies that pair equities and long
14 | planadviser
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PLANSPONSOR - April/May 2018

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