Fifteen years ago, on the occasion of Pensions & Investments' 25th anniversary, I wrote that covering the changes and challenges of the industry in those 25 years had been intellectually stimulating, and I predicted the next 25 years would see as many changes and challenges.
After 15 years I can say my prediction shows every sign of being correct. There have been multiple changes and challenges, especially challenges.
Take, for example, the structure of the industry. In 1998, 401(k) plans had been in existence for about 18 years, but were still considered by executives at many companies, especially those at large companies, as supplements to traditional defined benefit plans. In 1998, according to the Federal Reserve flow-of-funds data, defined contribution plan assets were $2.263 trillion, just 18% greater than DB plan assets of $1.907 trillion.
That has changed dramatically, as now even many large companies have frozen their defined benefit plans and rely on 401(k) plans to provide retirement income for their employees.
In 2012, according to the flow-of-funds data, defined contribution plan assets, at $4.088 trillion, were more than 60% greater than DB plan assets, which totaled $2.547 trillion.
In the same period, individual retirement account assets surged by more than 150% as retiring employees, and those changing jobs, roll their retirement assets into them, and those not covered by a company plan save for retirement through them.
During the period, private defined benefit plan assets increased 33%, despite the 2008-2009 bear market, while defined contribution plan assets, thanks to the growth of 401(k) plans, increased 80.6%.
The defined benefit plan remains strong only in the state and local government sector, where DB plan assets have increased 65%, to $3.358 trillion.
In the private sector, employees in most companies now take the responsibility for accumulating assets for their retirement, and most of those assets are managed by mutual fund companies, which, in the defined benefit era, were minor players in pension management.
In defined benefit plans, and in the college endowment and charitable foundation arenas, investment management has become ever more complex. In search of higher returns, defined benefit plans and endowments and foundations have invested in hedge funds, private equity and strategies employing complex derivative-based investment vehicles.
Sometimes this complexity has produced good results, but in the 2007-2009 period, it contributed to the financial crisis that shook the country.
Another change and challenge: Fifteen years ago pension funds and other long-term investors assumed stocks would return about 10% a year and bonds about 6%, unadjusted for inflation, because that's what studies of long-term returns by Ibbotson Associates showed they had returned in the past.
Now, because of the investment returns of the past 10 years and research into the conditions behind the strong returns of the 20th century, that comfortable assumption, which allowed pension plan sponsors to minimize their contributions, is being questioned.
Going forward, investment returns might provide less of the asset growth necessary to pay benefits than has been assumed. Perhaps the true long-term rate of return for stocks, given the current rate of economic growth, is only 8%. If so, this has implications for pension plan sponsors, pension beneficiaries, workers with 401(k) plans, and executives overseeing endowments and foundations.
I expect the changes and challenges will continue for institutional investors as they adapt to an ever-changing world economy, and ever-evolving financial markets. The development of the 401(k) plan was a reaction to the changing competitive environment that confronted U.S. companies as trade became more globalized. Perhaps the 401(k) plan will evolve further, or be replaced by something entirely new.
In Alfred, Lord Tennyson's great poem “Morte d'Arthur,” the dying King Arthur, seeing the demise of his Round Table, remarks: “The old order changeth, yielding place to new, and God fulfills himself in many ways.”
So it will be in the pension and institutional investment world.