DC forum: An ounce of prevention

In the benefits world, plan administrators and healthcare practitioners work to save lives and costs by ensuring that preventative measures are addressed before serious illnesses become a problem.

Administrators and plan members in DC and capital accumulation plans (CAPs) are also concerned with preventative issues. They, too, have to prepare their members for retirement—whether that’s decades down the
road or just a few years into the future. In their case, the important question becomes, what preventative measures should plan members employ today to avoid insufficient (or no) savings
upon retirement?

This question and the fine balance that is retirement planning represented some of the major themes at Benefits Canada’s DC Investment Forum at the Royal York Hotel in Toronto on September 28.

Markets in general
Before plan sponsors and members can adapt strategies to their individual plans, they have to develop a measure of understanding around the overall markets.

Speaking in a panel session on the economy, Aron Gampel, vice-president and deputy chief economist with Scotiabank, stressed the uncertain nature of domestic-led growth in many parts of the world that could be a roadblock to sustained growth over time. “It’s whether or not many of the larger emerging market economies can generate sufficient domestic demand that is needed to offset the weakening in their export-based growth now constrained by the softness in economic conditions throughout the developed world. This changeover will not happen dramatically…it will take time and require significant policy support in many of these economies to nurture more consumer-based support.”

Douglas Porter, deputy chief economist and managing director with BMO Capital Markets, cautioned that investors should be aware of the risks of the coming U.S. fiscal cliff, which will see a number of tax cuts end at the same time as spending cuts to several government programs take effect. If legislators don’t agree on how to handle this conundrum, said Porter, it raises the possibility of another recession and ultimately greater risk for investors. As well, minority governments in Canada’s largest provinces will add to fiscal and political risks with uncertainty surrounding their upcoming budgets.

As far as Canadian interest rates are concerned, Craig Wright, senior vice-president and chief economist with RBC, expects increases and a move to “normalization.” “I think when we get some clarity on the risk factors, we’ll see the bank restart that process that it started when it moved from the emergency setting of 25 [basis points] up to one a couple of years ago.”

Strategies with impact
It’s one thing to pontificate on the challenges facing investors and the markets now and in the future. But it is still necessary to look for the best strategies to redirect jaded investors shocked by the events of the past few years. Investors are increasingly uninterested or simply not engaged, said Jeff Poulin, senior consultant, investment program, group savings and retirement, with Standard Life Canada. As a result, investors are looking for complete and comprehensive investment solutions.

Poulin recommended lifecycle and target date funds as potential solutions. By controlling the asset mix decision at each stage of the investment horizon, he said, these funds have the ability to de-risk, diversify and generally offer investors a “superior balanced fund.”

Poulin added that plan sponsors need solutions that also appeal to investors who are more sophisticated and hands on. Plan sponsors need to provide these members with access to alternatives such as real estate, infrastructure and private equity. Where once these alternatives were seen as too risky, they are increasingly being adapted for the DC market.

A DC state of zen
According to Zaheed Jiwani, senior vice-president, client strategy, with Greystone Managed Investments Inc., the capital value of an alternative investment such as real estate may fluctuate (much like an equity investment will); however, the cash flows generated from the investment remain relatively stable. Jiwani said that having this “embedded in the [alternative] asset” helps mitigate portfolio volatility, something most investors are looking for.

There are challenges in finding this Zen in the DC context, for example, the ability to buy and sell in traditional assets, such as equities, are immediate and therefore liquid. An investor can make a trade and sell in real time without delays.

However, in the alternative world, investors are forced to deal with lag times. Money being committed today may take time to find the right asset—for example, the purchase of a commercial building. And when redemptions are made, a sale in a different part of the portfolio might be necessary to pay for that redemption.

In order to adapt this to a DC context, institutional parties (plan sponsors or vendors) could rebalance the portfolio between traditional and non-traditional assets, which allow for daily valuations and liquidity.

“We’re talking about building an optimal portfolio—which can be in target date funds, target risk funds or balanced funds,” he said. Equities and bonds remain the core of the portfolio, but providing alternative assets as a portion of the investments, in a direct way, can help get closer to that “state of Zen” of an optimal portfolio with lower volatility.

Risk factors
Retirement preparedness does not come from the right investment, but rather from the right risk balances in a portfolio, according to Vincent de Martel, managing director, multi-asset class solutions, with BlackRock Asset Management Canada Ltd. “All asset classes are linked together through risk factors,” he said.

The list of macro risks, according to de Martel, which appear in all public portfolios, include interest rates, inflation, default, economic, political and liquidity. Even within a very diversified portfolio, most assets are pro-cyclical and can be negatively affected by economic cycles.

But there are ways to balance a portfolio to mitigate risk. Said de Martel, “If you want to know you’ll have the benefits of diversification in the future, you need to understand what each asset class is exposed to.” In other words, what kind of rewards will you get for the risks you take?

Portfolios need to rebalance according to risk (i.e., the above-listed items) and not necessarily to traditional asset allocations, said de Martel. “In the [DC] market, we are seeing major plans embrace this approach for their portfolio.”

The expectations for future economic growth are low, he said, due to factors such as the cleanup needed in the global banking sector. Therefore, investors need to find different ways to achieve returns.

One of the more interesting historical side notes has surrounded the relationship between returns realized and portfolio volatility. Conventional wisdom might suggest that portfolios with a great level of stock volatility will achieve greater rewards. But as Bill Hoyt, head of quantitative equities and portfolio manager with Pyramis Global Advisors, suggested the opposite is true. By selecting a portfolio that attempts to minimize risk from equities traded on the S&P in the U.S. and the TSX in Canada over the course of 80 years, returns come out higher. Therefore, the goal should be to create a portfolio that can provide the maximum return with the least amount of risk.

“It is this sort of education that is critically important, definitely for plan participants who need to understand what risk is and how it can be mitigated, but also for plan sponsors, which have to understand that it’s so important that their participants be educated,” he noted.

Hoyt stressed that this way of looking at portfolios might be an additional tool for DC participants to consider, and is something that plan sponsors should learn more about. Ideally, sponsors should go to their advisors to explore if there is room for low-volatility investment options.

Going forward
Overall, plan administrators, sponsors and participants need to better address issues around retirement preparedness. The financial crisis of 2008/09 and the slow movement of the economy since have

DC participants seeking solutions that can weather such storms. As was explained throughout the forum, there are newer ways to achieve this beyond long-term investing in a 60/40 weighted portfolio.

Alternative investments and low volatility options, for example, should be made part of the selections offered to plan members along with the education that allows them to make the right choices. Slow economic growth and volatile markets cannot be avoided in the current environment; however, with proper diversification and more openness to alternative strategies, DC sponsors and participants will have a better chance at navigating market turmoil in the future.

Joel Kranc is director of Kranc Communications in Toronto. joel@kranccomm.com

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