It’s certainly no secret that during the last decade, the trend within the Canadian pension landscape has been for plan sponsors to move away from traditional DB plans and toward DC plans. This need was primarily driven by the desire to do away with plan risks around longevity, interest rates and investments that were becoming increasingly difficult to manage.
As a result, these risks were passed on to plan members under DC schemes. Plan sponsors were convinced that, provided with the proper tools and education, DC plan members would be adequately equipped to develop their own personalized investment solutions to mitigate these risks. DC recordkeepers worked with DC plan sponsors to develop appropriate investment solutions, and the DC plan industry witnessed the evolution from single asset class funds to single balanced funds, to target risk balanced funds or target date balanced funds and, just recently, a combination of both target date and target risk balanced funds.
Meanwhile, the jury is in, and the evidence clearly indicates that most plan members feel they are no further ahead than they were. Consequently, when it comes to making investment decisions, member engagement levels are still too low and member inertia is still too high.
According to a Towers Watson capital accumulation plan (CAP) survey of Canadian DC plan sponsors in 2010, 66% of respondents think they will face legal challenges from DC plan members in the future. The three main reasons they quote are poor investment performance, insufficient retirement income and inadequate education and communication. Therefore, it seems as though we have come full circle and that plan sponsors believe plan members are now trying to shift the investment risks back to them.
The pressure on DC plan sponsors to make sure their investment solutions are aligned with the investment policies of plan members is now greater than ever. This challenge is also fuelled by the current trend toward including auto-enrollment, auto-default and auto-escalation in DC plan designs. This implies that every element of the portfolio construction process must be taken into consideration when designing or choosing an investment solution such as target risk or target date funds. The trend, therefore, is clearly toward prepackaged investment portfolio solutions. In fact, many DC plan sponsors now feel they’re in a Catch-22, in that they will be blamed if they take on too much or too little risk in the investment portfolio design.
One of the key elements that DC plan sponsors must decide on is whether to opt for a proprietary single investment manager prepackaged investment solution or a non-proprietary multi-manager investment solution. Both options have advantages and disadvantages, but, in the end, it will depend on the particular needs and characteristics of the investment policy of each unique DC plan member universe.
When evaluating which option is preferable, a plan sponsor should take into account the following portfolio construction considerations:
- the level of broad asset class representation required;
- the level of diversification required among and within each asset class; and
- the level of risk-adjusted returns required versus a relative benchmark over a specific time period.
Other important decisions the promoter (i.e., the investment manager or provider) makes revolve around the risk and return dimensions, the number of managers and passive versus active investment management. And, an often overlooked element is the level of interest and knowledge of plan members.