Another Step Forward for US DC Plans: Managing Volatility
We’re seeing more US defined contribution (DC) plan sponsors looking at a variety of ways to help their participants manage volatility—and the accompanying anxiety and doubts that can often push participants to abandon their long-term investing goals.
Many DC plan participants are investors only because of their DC plan participation. That, coupled with the recent history of the markets and the effect of participants’ emotions on their investing behavior, makes managing volatility especially worthwhile for DC plans.
We’ve seen the S&P 500 Index rise some 10% higher than its previous peak in mid-2007—nearly 150% from the market bottom of early March 2009. But what most investors have felt are the jagged ups and downs over the past several years, not the overall upward movement. And what they fear most is a significant loss happening at a time when they can least afford it.
Today, there’s little confidence among American workers that they will attain a comfortable retirement. Although their confidence levels aren’t as bleak as they were in the midst of the financial crisis, two-thirds of workers that AllianceBernstein surveyed still doubt they’ll have a comfortable retirement.1
It’s not surprising, then, that many retirement savers feel wary about investing in anything that poses more than modest risk. But with bond yields still so low, plan participants need the greater long-term growth potential of stocks to generate sufficient assets for a comfortable lifestyle in retirement.
That’s why DC plan sponsors have shown increasing interest in providing strategies to participants that help smooth the pattern of returns as they pursue long-term investment growth for their retirement savings.
There are a variety of methods and tools for managing volatility, but each generally seeks to reduce the risk associated with equity-related assets, in order to mitigate the likelihood of extreme losses and narrow the range of potential outcomes. Examples include dynamic asset allocation, hedge fund strategies, risk parity portfolios and tail hedge strategies, to name a few. The wide range of approaches makes tailoring solutions for different plans important, as what works for one plan may not be equally suitable for another plan.
To date, large plans have led the way with incorporating ways for participants to manage volatility, but the search has also picked up in midsized plans.
In our DC plan sponsor survey,2 we specifically asked sponsors of plans with assets of less than $50 million their opinion about a hypothetical, enhanced risk-based asset-allocation (or lifestyle) portfolio. We told them that the strategy can aim to help mitigate the negative impact of extreme market volatility to participants’ balances by having a professional investment manager make adjustments to the portfolio’s asset allocation when certain market performance criteria are triggered. This type of investment would offer participants:
- the ability to select an investment option based on their personal tolerance for risk (conservative, moderate or aggressive) versus their age
- automatic asset-allocation adjustments by a professional investment manager in response to market conditions to help mitigate risk/loss
- competitive management fees.
The response was strong: 53% of sponsors from these plans found this enhanced risk-based strategy to be appealing or extremely appealing (only 8% of responses were not favorable). And 72% of these plan sponsors said they would consider adding such an option to their plans within the next three years.
Enhanced risk-based strategies are just one of many evolutions in DC plans today that are designed to help participants stick to their long-term savings strategies. In my next post, I’ll discuss what may be the best way to connect a large number of DC plan participants with the benefits of managing volatility.
1AllianceBernstein’s web-based survey of more than 1,000 full-time employees, 18 years or older, who worked for companies that offered DC plans was conducted in February 2013.
2AllianceBernstein’s web-based survey of more than 1,000 DC plan sponsors was fielded in November 2011 and included a national sample providing balanced representation of plans ranging in size from less than $1 million to more than $500 million in plan assets.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Daniel J. Loewy is CIO and Co-Head of Multi-Asset Solutions at AllianceBernstein.