It’s been 10 years since the release of the CAP Guidelines. What’s changed, and what developments will we be celebrating 10 years from now?
Anniversaries are often marked with gifts according to the number of years being celebrated. Traditionally, the 10th wedding anniversary called for a gift made of tin—not a very exciting prospect for most. So, to the joy of spouses (and retailers) everywhere, diamonds have become the modern gift of choice for the 10th anniversary.
In the spirit of humanity’s evolving tastes—from tin to diamonds—let’s celebrate this 10-year anniversary by exploring how the DC industry has evolved and will continue to evolve. While we’ve celebrated many accomplishments as an industry, this anniversary also marks prospects for future improvements.
The Big Day
When the Guidelines for Capital Accumulation Plans (CAP Guidelines) were published in May 2004, they formalized a set of industry best practices for plan sponsors, plan members, recordkeepers, investment managers and consultants. Looking back, the most important impact of the CAP Guidelines was that they brought more attention to the DC industry—and with more attention came more progress.
The CAP Guidelines helped the DC industry to accept that there is a shared responsibility to remain vigilant with DC programs—not only for plan sponsors and members, but also for investment managers, recordkeepers, consultants and other service providers. Over the years, the industry has increased efforts to provide plan members with information and education around their DC programs, with the hope that more knowledge would lead to better decisions.
However, the industry has also realized that turning all plan members into investment experts is a challenge that often proves detrimental to outcomes. Despite the increase in information and education, plan members consistently underperform broad market indexes. Furthermore, plan sponsors that maintain balanced structures with less investment choice have typically seen their returns outperform those of plan members who do have choice.
As member education has advanced, there have been many positive developments on the investment side as well. One of the biggest evolutions in the Canadian DC industry over the last 10 years was the introduction of target-date funds (TDFs). It may feel as if TDFs have been around a lot longer, but they were first introduced in Canada six months after the release of the CAP Guidelines. Since their introduction, there has been greater variety in the Canadian DC market, with many investment managers and recordkeepers launching their own TDFs.
TDFs were an acknowledgement that members will gravitate toward easier, rather than complex, investment decisions. As a result, there has been a movement away from offering members access to a traditional menu of investments and a move toward TDFs.
While there are a lot of good things to celebrate over the last decade, the industry remains grounded in the fact that members are still not saving enough for retirement. According to Benefits Canada’s 2013 CAP Member Survey, 74% of members agree that they are leaving “free money” if they don’t contribute to their maximum company match level; however, only 17% maximized their contributions last year.
Renewing Our Vows
As the DC industry celebrates its evolution over the past decade, it also looks forward to a bright future.
During the next decade, the focus will likely shift from turning plan members into investment experts to developing outcome-based education and enhanced investment structures. This approach leaves investment expertise to the professionals, while member education focuses on saving more through financial plans. Every additional dollar saved goes a long way, as savings rates and time horizons—not investment strategies—have the greatest impact on achieving retirement objectives.
Over the next 10 years, as the baby boomers move into retirement within their DB plans, the bulk of retirement assets are expected to shift to DC plan structures. With this shift, plan sponsors and service providers will increase their focus on DC solutions. As a result, sponsors will offer further sophistication of objective-based investment products to plan members.
This creates a paradox: if plan members are not expected to have sophisticated investment knowledge, then how can plan sponsors offer them more sophisticated investment products? The answer lies with the investment industry, which needs to distill sophisticated strategies into easy-to-understand products.
By using solutions such as single-balanced funds (which combine stocks and bonds in a single portfolio and offer no choice) and TDFs (which are age-based), plan members aren’t impaired in their choices. The sophistication happens beneath the surface of the investments and allows the use of best-in-class tools. This keeps the investment focus in the hands of DC committees, plan sponsors, investment managers and consultants.
The next generation of TDFs and balanced funds will offer several key elements.
Broader investment tools – DB and DC plan sponsors have been looking for ways to reduce the volatility of their investments. Some DC programs now offer alternative investments, such as real estate. However, even in that area, the DC industry is looking beyond indirect (listed) forms of alternatives—such as real estate investment trusts (REITs)—and toward direct forms, such as direct real estate and infrastructure.
REITs and listed infrastructure offer some diversification but, unfortunately, they also offer equity-like volatility because they are traded like stocks on public exchanges. The DB industry has understood that direct forms have the potential to offer better diversification over their indirect (listed) cousins, which should lead to a reduction in the overall volatility of retirement portfolios.
Best-in-class risk management – The sophistication of risk management tools available to DB plan sponsors will also make its way to DC plans. For example, most TDFs base risk management on equity weight. As the DC industry evolves, there will be greater focus on the risk of how all asset classes interact over time—much like in DB plans today. The definition of risk will change to incorporate challenges relevant to DC plans, such as shortfall risk (not having enough in retirement to pay for your expenses) and longevity risk (outliving your retirement savings).
Objective-based investing – In DB plans, objective-based investing has translated into the evolution of liability-driven investing. Essentially, the objective of a DB plan is to fund pension liabilities, and the investment approach should be in line with that objective.
In DC plans, objective-based investing means taking a step back and understanding that the overall goal is to help fund the member’s retirement. With this objective in mind, investments must be built using a similar retirement-driven investing approach, which calls for an alignment of assets with savings and retirement goals.
Since the release of the CAP Guidelines, the DC industry has made great strides toward helping members achieve their retirement objectives. Over the next 10 years, the industry must remain vigilant and enhance DC plan and investment designs as new solutions emerge. Asking the right questions and enlisting the right people to help will keep the CAP market sparkling well into the future so that it won’t lose its lustre.
Zaheed Jiwani is senior vice-president, client strategy, with Greystone Managed Investments Inc.
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