Defined contribution plan members are contending with volatile equity markets, ultra-low interest rates and the threat of inflation as the country’s economy begins its tentative recovery.
In the first half of 2020, equities took an almost round trip, dropping significantly in the first quarter and recovering to the point that most markets are in neutral or positive territory today, said Mazen Shakeel, partner and practice leader for asset risk management at Morneau Shepell Ltd., during a session at Benefits Canada and the Canadian Investment Review‘s 2020 Plan Sponsor Week mid-August.
Nevertheless, he noted, equities continue to feel riskier as uncertainty contributes to unusually high volatility. As well, historically low interest rates are boosting the value of fixed income in DC plan member portfolios. However, for those members closing in on retirement, the higher value of fixed income will make purchasing an income product more expensive.
Finally, concerns are rising about the potential inflationary side-effects of the federal government’s fiscal stimulus throughout the coronavirus pandemic, said Shakeel. While March and April saw an unusual bout of deflation, DC plan members may see their purchasing power eroded by higher than typical inflation in the years to come.
Looking to the issue of equities, a significant chunk of DC plan member investments are in target-date funds, he added. These vehicles typically feature rebalancing mechanisms, often on a quarterly basis, to ensure the maintenance of a pre-established mix of asset classes. Many of these funds rebalanced at the end of March, just as equity markets were feeling the full force of pandemic panic, shrinking stocks’ presence in the fund. As a result, capital poured into stocks, which then benefited from the market rebound just a few months later.
“It’s really important as plan sponsors to understand the rebalancing feature that your target-date provider has in their plan — to what extent those are automatic versus discretionary, to what extent does it happen at quarter end versus other times of the year, because that can have an impact on how the target-date funds perform when markets change like they did,” said Shakeel.
To compare, he examined seven different 2020 target-date funds. Equity allocation among the funds ranged materially, from just under 30 per cent to 60 per cent. In measuring the impact of the market crash, he noted, it’s important to distinguish between fund performance and the income it has the potential to generate. For example, after Mar. 31, the funds’ income generation potential dropped more (between 10 and 15 per cent) than the actual returns (between five and 10 per cent).
“While returns are important, they only tell part of the story,” he added. “And you need to be able to tell the whole story, especially as folks get closer to retirement, it becomes more important to look at income.”
Also speaking during the webinar, Anne Ananddakopal, principal for capital accumulation plan-focused retirement consulting at Morneau Shepell, suggested DC plan sponsors reassess whether members are on track for the retirement they envisioned. When the pandemic hit, inquiries from members spiked, with many asking for password resets as they sought to access their retirement accounts for the first time in a while.
To better understand what members were thinking, she said, the company examined inter-fund changes, new investment directions and withdrawals. “What we saw was there was a definite increase in transactions relating to inter-fund transfers, while there was a decline in transactional activities relating to new investment directions as well as withdrawals.”
While DC plan member actions represented an increase from the same period last year, only a small number of members actually made changes, mostly in withdrawals, said Ananddakopal. Most members making inter-fund changes moved funds into foreign equities, while almost all new investments were directed to money market funds or fixed income, “as members were looking to park their future money coming into the plan into safer investments.”
The upshot is most members took no action, she said, noting it’s unclear whether this was a case of member inertia or intentionality. “Regardless of their mindset, I think we need to start to engage the members . . . . Now is the time for them to really take stock of their financial position and reassess their retirement goals.”
To view a recording of this session, visit our webinar page.