The COVID-19 pandemic has transformed the macroeconomy, spawned the Great Resignation and jolted markets – including changes that are accelerating evolution of the defined contribution (DC) landscape. At the same time, plan sponsors confront regulatory developments such as the SECURE ACT, substantial growth in assets, pressure to align plan features with participant needs and preferences, and disruptive trends such as inflation. Here we outline five key themes we believe plan sponsors will need to address as they cultivate and evolve their plans to meet participant demands and expectations.

1. Offer a more personalized approach to QDIA participants

Advances in technology, data and analytics are driving demand and expectations for more personalized experiences and customized solutions – and this is increasingly the case for qualified default investment alternative (QDIA) options.

To be sure, off-the-shelf target date funds (TDFs) have been – and continue to be in our view – an effective tool to guide participants through the retirement savings journey. However, the degree of personalization and appropriateness can be limited because TDFs are based chiefly on a single factor – the participant’s age.

Managed accounts, of course, are at the opposite end of the customization continuum. They generally offer greater personalization. Yet adoption has been historically limited by the need for participant engagement, perceived complexity and often significant incremental costs.

In between these two poles of customization lie new solutions that may offer personalization without significant additional cost or burden on participants. These include personalized target date funds and dual QDIAs. They can respond to the increasingly wide range of circumstances and objectives investors face as they approach retirement (see Figure 1).

2. Seek the most from fixed income in a low-return environment

After a decade-long bull market, driven in its latter stages by pandemic-related fiscal stimulus measures, many asset classes have enjoyed significant and above-average returns. Not surprisingly, many expect more muted returns that could jeopardize retirement savers’ chances of achieving their objectives.

There are, of course, less desireable options. These include modifying spending profiles and living standards, or increasing investment risk exposure. Yet these have obvious drawbacks, especially for participants near or in retirement.

Fortunately, active management of fixed income has the potential to overcome or offset a potentially lower- return environment. Thus, we believe sponsors should assess whether their plans offer an appropriate degree of active management.

A thorough analysis of the data can lead one to argue that active fixed income management can offer strong potential for excess return generation, both in absolute and relative terms. Indeed, as Figure 2 shows, nearly 80% of active fixed income managers outperformed their median passive peers over the past five years ended 31 December 2021. This compares with less than 30% for active equity managers.

Importantly, potential excess return generated from fixed income allocations in DC plans could have a substantial impact on plan participant outcomes. Taking longevity of assets as an hypothetical example (as shown in the bottom panel), the possible excess return generated by active management of fixed income allocations throughout a full plan-participant horizon could extend the longevity of assets in retirement by more than seven years, or approximately 26%. Given these trends, we suggest DC plan sponsors make it a priority to evaluate whether participants are getting the most from fixed income allocations – both on core menus and within the QDIA option.


3. Help participants weather higher-inflation environments

While inflation had been muted for years, it has resurged powerfully in recent months and could create problems for plan participants seeking to preserve purchasing power. Recovering demand, easy access to credit, and broad government stimulus to confront the economic impact of the pandemic coincided with constrained global supply chains – resulting in inflation rising to its highest level in almost 40 years. Inflation may remain a major concern for investors and participants given its potential volatility and both upside and downside risks.

Amid high or rising inflation, stock-bond correlations have tended to be high, and many traditional portfolios can lack a sufficient allocation to real assets, which often serve to help mitigate the impact of inflation on portfolios (see Figure 3).

DC core menus generally take more varied approaches to mitigating inflation risk than QDIAs. Recently, we have seen particular interest in multi-real-asset solutions to help hedge against inflation. This is likely driven by the desire to outsource the management of all-in-one comprehensive portfolios of inflation fighters to investment managers.

QDIA options such as TDFs often incorporate assets meant to mitigate inflation, especially for investors in retirement age. Unfortunately, in our view, many TDFs may not have sufficient allocation to inflation-mitigating assets. The average real asset exposure among the top 10 TDF; providers ranges from about 2% for younger participants to about 9% for those in retirement. In our view, exposure to real assets in glide paths should be meaningfully higher.

Bottom line, plan sponsors should evaluate their current inflation-hedging options – both in the QDIA and core menus – and determine how well they complement participants’ existing equity, bond, and capital preservation options.

4. Help participants pursue their ESG aspirations

There is growing attention to investments related to environmental, social and governance (ESG) concerns. While a focus of institutional investors, ESG investment options will increasingly be demanded by DC plan participants and other individuals, in our view, and DC consultants are heeding that call. About two-thirds of those surveyed in our 2021 PIMCO U.S. Defined Contribution Consulting Study were considering adding ESG strategies to DC investment lineups; more than half were evaluating or already recommending ESG options. (This trend is advancing despite uncertainty with respect to the 2020 Department of Labor final rule, “Financial Factors in Selecting Plan Investments.”)

That said, implementation remains challenging and plan sponsors might still be cautious about offering ESG funds pending additional regulatory guidance. As a first step, we believe sponsors should evaluate investment managers on their ability to integrate ESG into their existing investment and research processes.

Longer term, we believe ESG options may offer solutions for plan sponsors seeking alignment with the sustainability objectives of their business, the values of their participants, and, as a means to retain and attract talent. They may also fulfill fiduciary obligations that consider material risk-return analysis, including climate and other ESG factors.

5. Introduce investment options better suited to participants in or near retirement

Plan sponsors increasingly want to reduce costs by retaining workers in-plan after retirement. To do so, many more will need to offer plan features that match the diverse and unique needs of retirees, aided by the new flexibility afforded by the SECURE Act. Indeed, many plans have recently added educational tools or begun offering distribution flexibility (see Figure 4).

While great first steps, they will only be helpful and impactful if participants use that education and implement a decumulation solution within the plan. The big milestone is adding retirement income solutions or products, either as part of a retirement tier on the core menu or within a dual QDIA structure.

So far, it appears implementation of these types of solutions has been fairly limited – in part because of the perceived complexity and the number of elements that plan sponsors are trying to solve for when evaluating such strategies.

It won’t happen overnight, but as a first step we recommend that DC plan managers consider making it a near-term priority to introduce a relatively simple retirement income solution, or set of solutions, that can address the most basic, yet also most important, needs of both retirees and plan sponsors. That is, a solution that incorporates elements such as liquidity, capital preservation, and explicit monthly distributions – all in a package that can easily be understood by participants.

THE YEAR AHEAD

While the pandemic sent the world into rolling lockdowns over the past two years, we believe collective retirement liabilities are like approaching objects in the rear-view mirror – they are closer and larger than they appear. Yet the mission of plan sponsors and investment staff has not changed. They remain responsible for helping participants prepare for retirement in the face of a complex web of legal, regulatory and market challenges. The pandemic has been a catastrophe, but it will serve to hasten the substantial evolution of the DC plan landscape and give plan sponsors an opportunity to continue cultivating their plans and participant experience.



1 Source: Morningstar and PIMCO as of 8 February 2022. Real assets include TIPS, long duration TIPS, emerging markets debt, and real estate.

The Author

Rene Martel

Head of Retirement

James Bentley

National Retirement Sales Manager

Richard Colasuonno

Head of U.S. Corporate Client Practice

Lauren Tracy

Head of Consultant Relations Americas

Related

Disclosures

The analysis included here is not based on any particular financial situation, or need, and is not intended to be, and should not be construed as a forecast, research, investment advice or a recommendation for any specific PIMCO or other strategy, product or service. Investors should consult their investment professional prior to making an investment decision.

The analysis contained in this paper is based on hypothetical modeling. HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

Return assumptions are for illustrative purposes only and are not a prediction or a projection of return. Return assumption is an estimate of what investments may earn on average over the long term. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods.

Past performance is not a guarantee or a reliable indicator of future results.

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Diversification does not ensure against loss.

The correlation of various indices or securities against one another or against inflation is based upon data over a long time period. These correlations may vary substantially in the future or over shorter time periods, resulting in greater volatility.

Target Date Funds are designed to provide investors with a retirement solution tailored to the time when they expect to retire or plan to start withdrawing money (the “target date”). Target Date Funds will gradually shift their emphasis from more aggressive investments to more conservative ones based on their target dates. Target Date Funds invest in other funds and instruments based on a long-term asset allocation glide path developed by PIMCO, and performance is subject to underlying investment weightings, which will change over time. An investment in a Target Date Fund does not eliminate the need for an investor to determine whether a Fund is appropriate for his or her financial situation. An investment in a Fund is not guaranteed. Investors may experience losses, including losses near, at, or after the target date, and there is no guarantee that a Fund will provide adequate income at and through retirement.

Glide Path is the asset allocation within a Target Date Strategy (also known as a Lifecycle or Target Maturity strategy) that adjusts over time as the participant’s age increases and their time horizon to retirement shortens. The basis of the Glide Path is to reduce the portfolio risk as the participant’s time horizon decreases. Typically, younger participants with a longer time horizon to retirement have sufficient time to recover from market losses, their investment risk level is higher, and they are able to make larger contributions (depending on various factors such as salary, savings, account balance, etc.). Generally, older participants and eligible retirees have shorter time horizons to retirement and their investment risk level declines as preserving income wealth becomes more important.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Please note that 2021 PIMCO Defined Contribution Consulting Study contains the opinions of the manager and respondents as of the date collected, and may not have been updated to reflect real time market developments. All opinions are subject to change without notice. Published results were based on responses with firms with more than $10 billion in DC assets under management with data collected between January 4, 2021 through February 26, 2021. Please refer to the study for a full explanation of methodology and results.

The Consumer Price Index (CPI) is an unmanaged index representing the rate of inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics. There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at any given time.

S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The Index focuses on the large-cap segment of the U.S. equities market.

It is not possible to invest directly in an unmanaged index.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2022, PIMCO.

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