120516 Calibrating Dc Outcomes

Calibrating DC Outcomes
Three lenses on UK Workplace Savings
16 May 2012
- Nigel Aston, Business Development Director, DCisions
- Owen Walker, Member Nominated Director, Pearson
Group Pension Plan
- Olivia Mayell, Managing Director, Global Multi-Assets,
JPMorgan Asset Management

May 21, 2012 Copyright © DCisions Limited 2011, All Rights Reserved. Patent No. 7,844,527. 1

The DC eye test


The Three Lenses

• The Scheme Lens
• The Consumer Lens
• The Asset Manager Lens


The data

• 1 million + real DC savers
• 10,000+ schemes
• 1,000+ sources of advice
• Qualitative research
• 24 DC asset managers


What did we find out?

• Use of multi-asset and target date funds is rising
• Pure equity trackers, delivered a poorer risk/return balance
than higher charging funds
• De-risking periods lengthening
• Disconnect between the scheme perception of who makes
the default fund asset allocation decisions and does this in
practice
• New thinking different to the received wisdom
• Default funds that do not use a glide path put members at risk
• Comparing default funds, like-for-like has been a challenge


Reliance on defaults – perceived risk

The perceived risk from reliance on default solutions remains
a question that divides the industry into equal camps..


Member-nominated director, Pearson Group Pension Plan
Committee member, Association of Member Nominated
Trustees
Editor, schemeXpert.com


Structure

• Overview of Pearson Group Pension Plan
• Evolution of the DC market
• Insights from other DC schemes, schemeXpert.com
• Reflections


Pearson Group Pension Plan

• DB scheme open to future accrual, not new members;
£2bn in assets
• DC scheme – 10,000 members (4,300 active; 5,700
deferred); auto-enrolment
• £190m of assets – doubled since March 2009
• Double matching, with 8% cap on employee contribution
(16% employer)


Main priorities of the DC scheme

• Overseeing transition from Winterthur Life to Friends Life
• Relaunch of members’ microsite
• Assess the impact of the Bridge case
• Prepare for auto-enrolment
• Review of default option


Question time

What proportion of employees of the following companies are in
the default?


Change in default rates


Proportion in the default fund

78%


DC fund choices

• Through Winterthur Life/Friends Life platform
• 10 funds available:
• Corporate bond fund
• Over 15 year gilt fund
• Over 5 years gilt fund
• Money market fund
• Passive 30:70 global equity fund
• Passive UK equity fund
• Passive worldwide (ex-UK) equity fund
• ESG fund
• Property fund
• Diversified growth fund


Pearson DC default fund

DC lifestyle glide paths

DC lifestyle glide path

100%
90%
80%
Money market 70%
15 years gilts 60%
15 years corporate bonds 50%
5 years gilts 40%
30:70 global equity 30%
20%
10%
0%
10+ 10 9 8 7 6 5 4 3 2 1 0

Years to retirement


Investment selections by age

Investment splits

Of £7.5m invested by under 30s:
Corporate bond fund

Over 15 year gilt fund

Over 5 years gilt fund

Money market fund

Passive 30:70 global equity
fund
Passive UK equity fund

Passive worldwide (ex-UK)
equity fund
ESG fund

Property fund

Diversified growth fund


Equity Allocations


Investment selections by age

Equity Allocations

Of the £9.1m invested by over 60s:
Corporate bond fund

Over 15 year gilt fund

Over 5 years gilt fund

Money market fund

Passive 30:70 global equity
fund
Passive UK equity fund

Passive worldwide (ex-UK)
equity fund
ESG fund

Property fund

Diversified growth fund


Responsibility for Asset Allocations


White labelling


IBM


IBM revamps DC default to improve flexibility

• Open DC scheme
• 11,300 active members, 6,400 deferreds
• Replaced default with two options:
• Lifecycle – lower levels of capital risk for those
approaching retirement and relying on annuity
• Lifecycle Plus – higher levels of risk in 15 years to
retirement. Aimed at members with DB savings who can
afford to take more risk


ARUP


Why 83% of Arup members make max contributions

• Contract-based DC scheme with 93% take-up rate – previous DB
scheme had just 63%
• Only 27% of members in default due to joining process

“The joining process we put in place was designed to prevent members
going directly into the default. It sounds counter-intuitive, but we actually
made it slightly harder to join and made people make more decisions
when they did.”
- Rosemary Mounce, group pensions manager at Arup


Thomas Miller


Thomas Miller confronts volatility with DC default design

• Default fund originally split between passive UK equities
and passive global equities, with lifestyling in final eight
years
• After negative member feedback in Summer 2009,
switched to:
• 50% in two absolute return funds
• 25% in passive equity fund
• 25% in passive global equities fund


Thomas Miller confronts volatility with DC default design

Fund fees increased, which had to be communicated

“The reasons we did this were to reduce the chance of a bad event having
a big impact, and reduce the chance of different people getting very
different experiences depending on when they start and stop investing.
This should hopefully lead to more even outcomes across the
membership.”
- Grant Lore, group pensions director at Thomas Miller


Scheme Lens: Conclusion

• It’s all about the default
• Asset allocation is critical
• How much fiduciary responsibility do you want to take?
• Who does what?


The consumer lens - savings levels

Contribution rates vary enormously by age


De-risking?

32pc of those over 50 years of age hold 70pc equity or more in
their portfolios.


It’s about individuals


Glide paths are getting longer


Consumer Lens: Conclusion

• It’s the consumer stupid!
• Contributions matter
• Volatility matters
• Glide path matters


Who should be responsible for asset allocation?

Schemes consider themselves largely responsible for asset
allocation with ‘support’ from advisers. Asset managers have a
different view.


A difference of opinion?

There is a mismatch between the solutions actually being
used and those recommended by asset managers.


Also a difference in fund structure

Asset managers are recommending multi-asset solutions.


Asset Manager Lens

Asset managers are reviewing strategic and tactical asset
allocation more regularly.


However, which multi asset fund do you pick?

Multi-asset funds have no common benchmark to facilitate
effective comparison.


Choosing the right default solution is hard

• Name
• Sector
• Self-diagnosed risk-rating
• Objective
• Marketing description
• Performance against benchmark



3 yr risk-adjusted performance for by risk group.



1 yr risk-adjusted performance by risk group.


Asset Manager Lens


Asset Manager Lens

Lower priced products delivered a poorer risk/return balance.


Asset Manager Lens: Conclusion

• Choosing the right default is complex
• Broad range of outcomes
• Make sure you know what you’re buying
• Risk-adjusted net return is critical
• Fees important, but not the be-all


Olivia Mayell
Managing Director
Global Multi Asset Group, JPMorgan Asset Management

How the industry can respond


The inertia of participants

Underlying assumption in DC industry is that plan participants understand how to
invest their retirement savings

Reality is that most simply do not have time, knowledge or interest

And DC schemes often do not make it easy for participants to engage

Plan sponsors must bridge the gap between retirement vision and retirement readiness


Legislation
There are policies governments can and have implemented to encourage saving and saving
in the proper way. Some examples include:
– Tax incentives to contribute to specialized retirement vehicles
– Tax penalties for making early withdrawals from retirement vehicles
– Automatic Enrollment (NEST)
– Employer Protection (Safe Harbor)

Source: Figure 1: Huffington Post, 2010, Figure 2:PLANSPONSOR 2010. Images are for illustrative purposes only.


Legislation
…but with engagement this can be changed…
Participants on track to receive 70% or more of income replacement The chart shows income
100% replacement history for J.P.
87% March 31, 2005 Morgan contributing
90%
December 31, 2011 participants exposed to at
80% 76%
72% least one Audience of One
® programme.
70%
60% 52%
50% 46%
38% 38%
40%
31% 31% 29%
26% 28%
30%
20%
20% 13%
10%
0%
20 to 29 30 to 39 40 to 49 50 to 59 60 to 69 70 and Over Overall

Assumptions: Income replacement results reflect the experience of participants earning between $14,500 and $10 million annually who were contributing to their retirement plan as of December 31, 2011. Retirement age is 65. If over
62, retirement age would be current age plus three years. Based on information provided for annual salary, state of residence, hire date, date of birth and gender. If not provided, gender defaults to female. Tax filing status defaults to
single if state of residency is the same as tax filing state. Includes Social Security which is calculated based on normal Social Security retirement age, as per federal regulations. The assumed income growth rate is 5%. Income growth
rate represents the average increase in salary expected over time, which is the approximate historical rate of growth (including inflation) for a typical person's salary. The projection considers the IRS annual compensation
limit, indexed periodically. Contribution amount is based on current election in defined contribution plan. Annual retirement income estimate and initial risk category are calculated using the investments currently held in retirement
plan account. Balances from brokerage account(s) or loan(s) will not be included in forecast. Income replacement calculation includes balances from other plans that are turned on for Retirement Dream Machine.


1990s/early 2000s - Target Date Funds

1990s/early 2000s - Target Date Funds
The industry’s response to challenges faced by DC participants

Provide automatic asset allocation according to a participant's
TARGET age

Invest more aggressively to build capital early in the
DATE employee’s career
FUNDS Reduce exposure to market volatility to preserve capital as
retirement approaches

What is the target-date portfolio design that will best stand up to the stresses of real life saving?

How realistic is the fund industry’s modeling of participants’ career-long saving and spending patterns?


Participants’ behaviour in practice is different to the theory

Common target date industry J.P. Morgan: Broad participant J.P. Morgan: Defaulted participant
assumptions1 population2 population2

On average, participants get raises On average, defaulted participants
Participants get a raise every year
every other year get raises every other year

On average, contribution rates start On average, contribution rates start
Contribution rates start at 6%,
at 5.8% and increase slowly, at 5% and increase even more
increase year by year, reaching 10%
reaching 8% by age 42 and 10% not slowly, reaching 8% by age 50 and
of salary by age 35
until age 55 10% not until age 65

15% of participants over age 59½ 6% of defaulted participants over
Premature distributions don’t
withdraw, on average, 26% of age 59½ withdraw, on average,
happen
assets 30% of assets

Participants that remain in plan Participants that remain in plan Participants that remain in plan
three years after retirement: 100%3 three years after retirement: 19%3 three years after retirement: 22%3

1 Source: Target-Date Retirement Funds: A Blueprint for Effective Portfolio Construction, Alliance Bernstein 2005 (white paper)
2 Source: JPMorgan Retirement Plan Services participant database, 2006-2008.

3 As measured by participants over age 65 who have stopped working.


Standard Target Date Funds are not enough...
…you need a glidepath…

A broadly diversified portfolio
• Extends beyond conventional stocks and bonds to non-traditional assets e.g. direct and public real estate, EMD and EME and High
Yield bonds
• Brings to the individual participant the diversification and risk efficiency characteristic of sophisticated institutional portfolios
• Can lead to better income replacement outcomes, especially for those participants who need it most

Volatility in participant cash flows
100%
• Must be included in plan design and the evaluation of 90%
target date fund strategies

% of Portfolio Allocation
80%

• Target date portfolios should not be evaluated in terms 70%
60%
of “equity glidepaths”
50%
• Need for broadly defined asset allocation glide paths 40%
30%
• Conventional risk measures e.g. Sharpe ratio
20%
• Monte Carlo simulations that account for sequence of 10%
market returns and participant cash flows in projecting 0%
the range of DC balances at retirement 40 35 30 25 20 15 10 5 0 -5 -10
Years until retirement
Diversification does not guarantee investment returns
and does not eliminate the risk of loss. U.S. Large Cap U.S. Small Cap EAFE Emerging Equity

Global Natural Resources REITs Commodities Emerging Market Debt

High Yield Core Fixed Income TIPS Cash Equivalents

Source: J.P. Morgan Asset Management


J.P. Morgan Asset Management

FOR PROFESSIONAL INVESTORS ONLY | NOT FOR RETAIL USE OR DISTRIBUTION
‘Professional’ means the definition for Professional clients ascribed to it within the European Union Directive 2004/39/EU on Markets in Financial Instruments (MIFD)

Any forecasts, figures, opinions or investment techniques and strategies set out, unless otherwise stated, are J.P. Morgan Asset
Management’s own at the date of going to print. They are considered to be accurate at the time of writing, but no warranty of accuracy is
given and no liability in respect of any error or omission is accepted. They may be subject to change without reference or notification to
you. The views contained herein are not to be taken as an advice or recommendation to buy or sell any investment and the material should
not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments
and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the
full amount invested. Both past performance and yield may not be a reliable guide to future performance. Changes in exchange rate may
have an adverse effect on the value price or income of the product.

You should also note that if you contact J.P. Morgan Asset Management by telephone those lines could be recorded and may be monitored
for security and training purposes.

J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co and its affiliates
worldwide. J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates
worldwide. Issued in the UK by JPMorgan Asset Management Marketing Limited which is authorised and regulated by the Financial
Services Authority. Registered in England No. 288553. Registered address: 125 London Wall, London EC2Y 5AJ.


Conclusion

• It’s complex
• Different perspectives
• Form your own view
• It’s all about the default
• Asset allocation is critical
• Choose your team carefully and
review regularly
• Think about your consumers


What does DCisions bring to the party?

• Calibration and context to the asset allocation decision. This brings the ability to
inform plan design through the analysis of the asset allocation and outcomes of
more than one million savers.
• Robust understanding of performance. Empirical data for both the risk and
return delivered to real consumers shows the true picture of DC outcomes.
• Measures of value not price. Paying more to have greater intervention and
flexibility may be money well spent: the analysis provides objective, robust and
measurable analysis of the ‘value vs. price’ debate.


120516 Calibrating Dc Outcomes

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