The devastation defined contribution plans suffered in last year's market mayhem is expected to lead to major changes in plan design and asset allocation, as well as increased emphasis on retirement income, industry professionals say.
Lessons learned by plan executives and their service providers should produce:
• Decreased equity exposure, especially in target-date funds;
• Increased use of existing automatic features and introduction of new ones, such as auto diversification;
• Renewed emphasis on annuities and other investment vehicles to improve the chances participants will have enough money for a secure retirement; and
• Even more investment education on the virtues of diversification.
Last year — when most participants' accounts were gutted — also might be described as the year in which the defined contribution system was a victim of its own success. After providing excellent returns for more than 25 years during the biggest equity bull market in modern times, participants and those who oversee and manage their plans then suffered deeply as that same market plummeted.
Bottom line: The focus on equities in an investment portfolio and the traditional equity and fixed-income split revealed a basic flaw in plan design.
Already that stock-to-bond ratio is changing. Statistics from Pacific Investment Management Co., Newport Beach, Calif., show the ratio in defined contribution plans now is 54% equities and 46% fixed income, compared with roughly 70/30 at the end of 2007, said Stacy Schaus, senior vice president of PIMCO's defined contribution practice.
“Since the majority of DC assets are typically held by longer-tenured, older participants, the ... 70/30 (ratio) was likely far too high,” Ms. Schaus said. “Clearly, we need to bring this risk level down. Now, the market has adjusted the allocation for us as equity values have declined. Going forward, we suggest that the balance be retained at a more conservative level.
“Further, we encourage plan sponsors to focus on managing the risk and seeking to meet an acceptable retirement income target for the plan.”
Ms. Schaus said a more appropriate ratio would be 50/50. The equity component would include all U.S., international developed and emerging markets stocks, as well as real estate and commodities. The fixed-income allocation would include cash or stable value, core bonds, Treasury inflation-protected securities, emerging markets debt and high-yield bonds.
“We could see a more back-to-basics investing approach” in the future said Fran Ruderman, senior director, benefits and compensation, Leviton Manufacturing Co. Inc., Little Neck, N.Y.
Ms. Ruderman believes the typical stable of investment options is too much for most employees to understand. Leviton's $150 million plan, for example, has 15 options.
“It's like a Chinese menu, and employees hope they've made the right choice,” she said.