“We have come a long way as an industry, and I think plan sponsors are much more astute in their risk orientation, their understanding of the role of the defined contribution plan and what they’re actually solving for,” Latham said.
“The aim is not a design that works really well in the perfect situation,” Lee said. “The aim is a design that works well across a range of different scenarios and different individual circumstances, to make sure that people have the best chance of meeting their retirement needs. I have joked with clients that if everybody started saving 15% of their salary at age 22 and got an 8% market return every year and only needed to take out 4% of their assets annually throughout retirement, my job would be really, really easy. But plan sponsors don’t want us as solutions providers to just solve for the average, they want their target-date solutions to be as broad as possible and deliver successful outcomes across a wide range of individual circumstances.”
A big part of the challenge is identifying the intended outcomes, analyzing the many risks to those outcomes and then stress-testing those risks across a range of portfolio designs. Lee said he focuses on the market and behavioral variables that can influence a successful retirement outcome, how those variables can influence fund design and how they can interact with each other. This approach enables him to model and stress-test realistic portfolio behavior across a range of scenarios, he said.
SHORT-TERM STRESS & THE GROWTH CONUNDRUM
In glidepath design, one of the biggest questions — and potentially one of the most important variables in retirement outcomes — is preretirement derisking: reducing the equity and growth focus in the 10-year window before retirement. In highly volatile markets, sensitivity to that issue can be raised for all stakeholders, including plan participants, plan sponsors and solutions providers.
“Prioritizing risk means not just looking generically at risk over the long term, but also making sure you’re taking the right risks at the right point in time,” Lee said. “In that regard, it’s important to keep in mind that the current environment is extremely focused on a narrow window. However, realistically, when you broaden it out, you have to look at the whole cycle.”
He cites substantial short-term market downturns during the SARS crisis, the European debt crisis and the U.S. debt downgrade, among others. After each of these major events, markets eventually rebounded.
“The benefit of portfolio growth over the long term, to support your ability to generate the desired outcome, is absolutely critical,” Lee said.
“You can’t manage to a single risk only. You have to think about the wide range of risks and variables, and then consider the trade-offs,” Latham said. She said she believes that it’s unhelpful to anchor too much to a worst-case scenario — especially in the midst of one — and then let that drive decision-making, because markets do smooth out over time and cycles do come and go.
“Even in difficult markets, that period of time leading up to retirement is still a critical compounding opportunity, when you presumably have your highest asset balance, your most complex scenario and your highest savings rate,” she said. That means that if you reduce “equity too soon, you may lose an attractive compounding opportunity that has a material impact on your landing point.” ■