Step-change for DC
“Our retirement philosophy is changing the industry”. So says Glenn Dial, head of retirement for Allianz Global Investors (AGI). Dial has been in charge of this business in the US since February 2011, focusing on a target-date strategy that is reinforced by the findings from AGI’s Centre for Behavioural Finance.
Target date funds (TDFs) are a booming category because they are qualified default investment alternatives (QDIA) for defined contribution (DC) plans such as 401(k)s according to the Pension Protection Act of 2006. They offer a pre-mixed portfolio of stock and bond mutual funds that adapts, following a glide path to become more conservative as the participants get closer to the target date, the year they expect to retire.
Currently TDFs manage $380bn (€292bn) in assets and could constitute 40% of all DC assets by 2015, according to Morningstar’s estimates, despite having suffered big losses – ranging from 9% to 41% – in 2008, a very bad surprise for people retiring within two years.
“The first generation of target date funds was focused on obtaining the highest possible returns, but that approach blew up in 2008,” explains Dial. “Those funds had a very aggressive asset allocation even when close to the retirement age. Their idea was that if a person did not save enough, then he or she should risk more with the hope of making up the shortfall in their retirement savings. That sounds like playing at the casino with your last $5, trying to recoup your losses.
“Also, they were aggressive because of longevity risks. If you are going to live 30 more years as a retiree, they thought, you need a higher stock allocation to make your savings last longer. But that reasoning did not take into account the reality that 80% of 401(k) plan participants take their money out of their DC plans within three years after retiring; they don’t stay in the plan for another 30 years. So the first generation TDFs were based on assumptions that were not correct if you look at real people’s behaviour.”
AGI launched its TDFs in December 2008 with a very different approach. “We had real life experience incorporated in their glide path,” says Dial. “First and foremost, we manage our funds to help people retire with dignity also in bad markets, which means being very conservative.
“Second, we publish our risk benchmarks. There are no surprises; it’s totally transparent.
“Third, we have a multi-manager platform that uses three proprietary fund families: PIMCO, NFJ and Allianz Global Investors; and outside managers including Wells Fargo, ING and iShares. This way we avoid group thinking.”
Dial recalls his past personal experience with his 401(k) managed by a top-down investment organisation: “In the 1990s the managers decided to underweight technology stocks, then in February 2000 they decided to overweight the sector, so I didn’t get high returns when tech stocks were soaring, and I got burnt when they crashed. At AGI we diversify risks also among different managers.”
So far, AGI TDFs have $200m assets under management – only last year were they able to begin actively marketing the funds as a fund family usually needs a three or five-year track record for consideration by plans sponsors. “Since last year we’ve been growing very well and our pipeline is full,” says Dial. “We use a lot of research from our Centre for Behavioural Finance. We disseminate its results through advisers and consultants to help plan sponsors make the right decisions. One tool we give them is the ‘90-10-90’ strategy. Every DC plan should seek to achieve a 90% or more participation rate; every participant should defer 10% of more of his/her salary; 90% should be invested in a professionally managed strategy like a TDF.”
Target-date funds are relatively new products and one problem is how to evaluate them.
“We discovered that consultants used the same metric as those used for equity fund managers,” says Dial. “But equity managers are judged for their stock picking, while TDFs’ most important features are the asset allocation, the glide path and the observance of regulatory requirements. So we give advisers another tool to compare TDFs – Allianz funds as well as others – within the industry and find the right one for the plan sponsor’s specific needs. The choice should depend on the participants’ behaviour. For example, if a company has highly-paid workers, they usually have a much higher tolerance for risk than those with a more modestly compensated workforce.”
Last February, AGI started training sessions for advisers on how to use the principles of behavioural finance. It is a three-hour course, based on the book ‘Save More Tomorrow’ by Shlomo Benartzi, AGI chief behavioural economist and Professor of the behavioural decision-making group at UCLA Anderson School of Management. “We give advisers a work sheet to use with plan sponsors for implementing the ‘90-10-90’ philosophy – explains Dial. They love it and are taking it very seriously.”