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Impact Investing

IPE special report May 2018

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DC assets grow but defaults vary

Defined contribution (DC) pension assets keep growing in the US - even in the public sector. Today, about 14% of full-time public employees - over 2m people - participate in either DC schemes or combined of DC/DB (defined benefit) plans. Their numbers may increase with US states facing budget crises.

Total US retirement assets were $17.829trn at end Q3 2007, according to the Investment Company Institute (ICI). This was 1.9% more than at Q2 and 7.9% higher than at the end of 2006. While assets of private DB plans ($2.482trn) and of state and local government pension plans ($3.264trn) slightly declined or remained steady in Q3 2007, DC plans and individual retirement accounts (IRAs) gained most. DC plans reached $4.504trn (+2.2% from the end of June 2007 and +9.3% from the end of 2006) and IRAs $4.765trn (+3.6% and +10.8%).

Mutual funds managed $2.4trn in all DC plans or 53 % of these assets. Lifecycle funds - which rebalance their portfolios to become more conservative and income-producing by a target date- are growing. They managed $168bn at the end of Q3 2007; 9.8% more than the end of the second quarter and up 43.4% from the end of 2006. Lifestyle funds, which mix equity and fixed-income investments to maintain predetermined risk, are also slowly growing. They managed $234bn as of last September, up from $221bn on June (+5.8%).

Lifecycle funds have grown because they are the most recommended default option in DC plans, so that almost 90% of their assets are held in retirement accounts. They are also the best practice for core DC plans in the public sector, according to a paper by TIAA-CREF, the provider of retirement investment products.

The authors of the research - Roderick B Crane, director of TIAA-CREF institutional client relations, Michael Heller, vice president of TIAA-CREF actuarial consulting services and Paul Yakoboski, principal research fellow at the TIAA-CREF Institute - say that public companies should try harder than private companies to minimise members' risks. In terms of investments the most frequent problems are inappropriate asset allocation and inadequate investment returns. Among the solutions are mandatory or default contributions into lifecycle/target date funds with a limited range of 15-20 participant-directed investments covering the major asset classes.

The TIAA-CREF authors also analysed 11 DC plans sponsored by states and seven promoted by universities. They found that only six of all these schemes offer lifecycle/target date funds as the default option: District of Columbia DC Plan, North Dakota Public Employee Retirement System DC Plan, Indiana University, Purdue University, University of Iowa and University of Michigan. At the opposite end, Michigan 401(k) Plan, University of Michigan, State University of New York and University of Washington offer a money market fund as the default option, while the Alaska DC Retirement Plan has a qualified managed account. In between, Colorado Public Employees' Retirement Association (PERA) DC Plan, Florida Retirement System Investment Plan, Montana Public Employee Retirement System DC Plan, Ohio Public Employee Retirement System Member-Directed Plan and West Virginia Teachers Defined Contribution Plan offer more or less conservative balanced funds as default options.

In Ohio employees have only nine investment products to choose from; at the University of Michigan the options are 150. In order to balance a tougher economic environment and employee interests, "public employers may be looking for more DC pension plan designs that incorporate aspects of the most attractive features of DB plan, such as guaranteed lifetime benefits and limited participant investment risk, while still reducing or eliminating funding risks," the report concludes.

The authors suggest a "next-generation DC plan", including automatic enrolment and auto-save arrangements to increase retirement savings, less but higher quality and reasonable-cost funds that can be more readily understood and used. They also advocate simplified "one or no-decision" investment services such as target-date lifestyle funds, target allocation funds and qualified managed accounts that can help to decrease the risk of poor allocation decisions; mandatory annuitisation of at least a portion of the retirement account balance, as well as variable life annuities or inflation-adjusted fixed annuities to address longevity and inflation. 

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