|
© Copyright 2000 Rogers Media. The following article first appeared in the June 2001 edition of
BENEFITS CANADA magazine.
The evolution of asset allocation funds
With new asset allocation products in the defined contribution market, plan members can be as
involved as they want in their asset allocation decisions.
By Damon Williams and Brendan George
Over the past decade, there has been a definite trend in defined contribution (DC) plan design towards
giving members more choice and control over their own retirement funds. However, the popularity of asset
allocation products illustrates that perhaps the first choice plan sponsors should be offering to members
is whether or not they even want that control.
In the late 1990s, there were a variety of asset allocation products to choose from, but most had short
histories. Since then, however, the design of these products has broadened in scope and there is now
sufficient data on their popularity to answer the following questions:
-
How have asset allocation products evolved?
-
How popular have asset allocation products been with DC plan sponsors and plan members?
-
How should plan sponsors incorporate asset allocation products into their DC plans?
Over the past two years, the major developments in the asset allocation market have been the introduction
of a wider range of approaches, the development of distinct approaches to presenting asset allocation
products to plan members and a reduction in fees.
Earlier generations of asset allocation products comprised investor profile questionnaires which guided
plan members into one of several balanced funds, ranging from conservative to aggressive. Today, these
products encompass four main approaches.
FOUR-PART APPROACH
A: Suggested asset mix. The plan member completes the questionnaire which leads to a recommended
asset mix. The member is then responsible for choosing the funds and investment managers to fill that asset
mix, rebalancing the asset mix regularly, monitoring and replacing managers as necessary and periodically
repeating the whole process as their personal circumstances change.
B: Suggested asset mix with rebalancing. The plan member has the same responsibilities as under the
first type of plan, except the service provider takes responsibility for the regular asset mix rebalancing.
This automatic rebalancing ensures the plan member's portfolio doesn't stray from the risk/return profile.
C: Complete asset allocation process. With this type of product, the questionnaire leads the plan
member to one of several funds in which the service provider is responsible for asset mix rebalancing and
for selecting, monitoring and replacing the investment managers who manage the asset allocation funds. The
member's responsibilities are reduced to completing the questionnaire and periodically reviewing it.
D: Retirement year process. With this approach, plan members are presented with several funds. Each
one is designed for a different retirement year. The member selects the fund designed for the retirement
year closest to his or her own. The asset mix of the fund automatically shifts from aggressive to
conservative as the target retirement year approaches. The only input required from the member is his or
her expected year of retirement.
The amount of plan member involvement required in the investment process varies significantly across the
four approaches. The lower the plan member's required involvement, the lower the member's required
investment knowledge.
For example, the type A approach requires significant investment knowledge on the part of the plan member
and education on the part of the plan sponsor. Type D on the other hand, requires almost no investment
knowledge on the part of the plan member.
PRESENTATION METHODS
Two different approaches to presenting asset allocation products to plan members have developed. They are
the keep-it-simple approach and the educate-all approach.
The keep-it-simple approach is to ask plan members early in their decision-making process whether they wish
to build and maintain their own investment portfolio or whether they would prefer that someone else do it
for them.
Members who prefer the first path are directed towards a number of traditional investment funds and are
provided with education materials to aid them in their selection. Members who prefer the second path are
directed towards a type C or D asset allocation product, which requires little investment education.
The educate-all method of presenting asset allocation products treats asset allocation funds like any other
fund option. All members have to read through the same extensive investment education package and fund
information sheets, whether they are interested in building their own investment portfolio or not.
Throughout the 1990s, fees for asset allocation products ranged as high as 1% or more above the fees on
traditional funds. Since then, the fee premium charged by the major providers for their asset allocation
products has come down substantially with most providers charging between 10 and 50 basis points above
their traditional fund offerings.
Asset allocation products have been extremely popular with new DC plans. Providers estimate that 75% to 95%
of new DC plans are including asset allocation products as an option for plan members.
As might be expected, the adoption of asset allocation products by existing DC plans has been slower. But
providers report that these products currently account for between 5% and 10% of total DC plan assets and
up to 25% of new deposits to DC plans. Bearing in mind that most asset allocation products were introduced
in 1998 or later, and that a large proportion of DC plans do not yet offer asset allocation products, these
figures are impressive.
It is worth mentioning, however, that less than 5% of DC plans are adopting asset allocation products as
their only set of investment options. In plans where asset allocation products are adopted, they tend to be
offered in combination with other, more traditional investment funds.
The popularity of asset allocation products depends to a great extent on the manner in which the products
are presented to plan members. Providers report that asset allocation funds presented under the
keep-it-simple approach have been tremendously popular. In DC plans that had offered these products to
their members under the keep-it-simple approach since the plan's inception, over two-thirds of plan assets
were in the asset allocation funds. In addition, providers report that approximately 75% of members of
these plans had at least some of their assets invested in asset allocation funds (see "A case study," page
48).
Providers report that asset allocation products presented under the educate-all approach have a much lower
degree of popularity among plan members. Unfortunately, little supporting data is available.
INTRODUCING ASSET ALLOCATION
In determining how or whether to incorporate an asset allocation product into a DC plan where plan members
have control over their investments, plan sponsors should ask themselves whether plan members should be
required to learn about investments and build and monitor their own investment portfolios.
If the plan sponsor takes the view that plan members should be required to learn about investments and
build and monitor their own portfolios then the plan sponsor should offer a range of traditional funds and
education materials.
Alternatively, if the employer believes that plan members shouldn't be required to learn about investments
then the plan sponsor can consider the following approaches.
-
Offer an asset allocation product in addition to, rather than as a substitute for, traditional funds.
Offering both types of funds allows members to decide whether they want to build and monitor their own
investment portfolios or whether they would prefer the provider to do it for them.
-
Use a keep-it-simple presentation strategy. This strategy allows members to take full advantage of the
benefits of asset allocation products.
Members who do not want to build and monitor their own investment portfolios can make an
appropriate fund selection without having to dig through a large volume of unnecessary investment
education material. Most providers are willing to present their asset allocation products using the
keep-it-simple strategy if requested by the plan sponsor.
-
Use a type C or type D asset allocation product. Consistent with a keep-it-simple presentation
strategy, using a type C or type D asset allocation product allows plan members who do not want to
build and monitor their own investment portfolios to minimize their involvement in the investment
process. Members who want to be involved in the investment process can do so through the traditional
funds.
Asset allocation funds have grown significantly in popularity over the short period since their
introduction, and that growth is expected to continue. It's ironic, though, that in an industry focused on
providing DC plan members with more choices and more control over their own investments, one of the most
popular products is one in which members are handing that control back to others.
Damon Williams (damon_williams@aonconsulting.aon.ca) is
vice-president and Brendan George (brendan_george@aonconsulting.aon.ca) is senior
consultant with Aon Consulting in Vancouver.
A case study
For this one employer, asset allocation funds are a popular choice among plan members.
The experience of at least one plan sponsor that offers asset allocation products demonstrates plan
members' comfort level with asset allocation.
The B.C-based not-for-profit employers' association offers a group registered retirement savings plan that
includes both traditional investment funds and asset allocation funds. The plan was implemented just over a
year ago and has approximately 5,000 members who are spread out across the province.
Plan members control the investment direction of their funds and are offered the choice of five traditional
funds--a Canadian equity fund, a bond fund, a money market fund, a balanced fund and an international
equity fund--in addition to five asset allocation funds and guaranteed investment certificates.
The plan's provider offers a type C asset allocation product (see "Involving plan members," page 45) and
plan member education materials follow the keep-it-simple approach. For this group, the popularity of the
asset allocation funds has been overwhelming--73% of plan assets are currently invested in the five asset
allocation funds, and 79% of plan members have at least some of their assets in these funds.
|
News
News
