When I first sat down to write this piece, I was a little intimidated. Anyone can make predictions, but making accurate predictions is difficult. This year, the challenge was compounded by the specter of tax reform. Until late November, reducing retirement plan contributions (or limiting pre-tax contributions) was under active consideration by legislators. Had they made the cut, such changes would have been hugely damaging to Americans’ retirement savings and would have caused difficult-to-imagine changes throughout the retirement industry.
That danger has passed (at least for now), leaving us a much more predictable 2018 to explore. So, what will the new year bring? What nascent trends will emerge in full force in 2018? And how can plan sponsors best prepare for the demands placed upon them as they come into play?
I sat down with several of CAPTRUST’s subject matter experts to capture their thoughts on these questions. What follows is the result of that lively conversation. The trends that we see unfolding in the coming year are well-trod ground at this point. We don’t foresee any radical shifts; mostly extensions of trends already in place.
Prediction: Increasing complexity for plan sponsors
One of our recurring themes lately has been: It’s harder than ever to be a plan sponsor. It has become a harder job in recent years, as the role’s complexity has increased. And we see that continuing into 2018 for some of the same reasons—and a few new ones. Let’s start with litigation. We experienced a steady trickle of litigation over the course of 2017, with a few of the most recent cases filed against 401(k) plans in the $100 to $150 million asset range. So, predicting that fee- and plan-related litigation will continue is easy and obvious. What’s less obvious is this litigation’s indirect impact on retirement plans.
Demand for mutual fund share classes that do not pay 12(b)-1 or sub-transfer agency fees (otherwise known as revenue sharing), passively managed funds, and collective investment trusts (CITs) is rising. This move to more transparent and potentially less expensive investment options is exposing the underlying economics of plan recordkeeping and begging the questions of who is paying plan fees and how are they paying them. As a result, more plan sponsors are pondering what is the fairest method of divvying up plan fees among participants—or between participants and the plan sponsor. What was once a philosophical question has become a practical debate requiring a well-documented answer.
In recent years, we have also seen an explosion of new products and services as service providers responded to new technology capabilities, regulatory shifts, and a desire for risk management. The many new CIT launches, managed account providers, discretionary consulting programs, and environmental, social, and governance (ESG) solutions are evidence of this innovation. That’s the good news. The bad news is that this explosion has created more complexity, and it is too early to know who the winners and losers will be. Mediocre first movers will gobble market share while great ideas fail to get traction. Over-hyped solutions will lose their luster as the winnowing process begins.
One way in which plan sponsors have chosen to deal with this aspect of complexity is to outsource many of their responsibilities and risks. For example, we have seen an acceleration of plan sponsor demand for 3(38) investment management services over the past five years. At the risk of sounding self-promotional—CAPTRUST offers discretionary consulting services—we do not expect demand to abate any time soon.
Regulation is another potential source of complexity. The Department of Labor’s conflict of interest rule—otherwise known as the fiduciary rule—has dominated the headlines over the past year or two. While some aspects of the rule have been delayed, an expanded list of service providers are now considered fiduciaries and must comply with the DOL’s impartial conduct standards. Given the delay and resulting confusion, plan sponsors will be grappling with what the fiduciary rule means for them in the coming year. By now, they should know which of the services that they use are considered to be fiduciary services under the new definition. But they will be challenged to feel confident in their updated approach to monitoring these providers, and they will struggle with just how comfortable they should be in allowing conflicted fiduciaries to interact with their employees.
We may also see other regulators jump onto the fiduciary bandwagon. The Securities Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and several state securities regulators have chimed in with their own thoughts about fiduciary standards and may act to create their own rules in 2018.
Hardly a week goes by without the announcement of a significant cybersecurity breach at a major company. This year, the list of breaches included several banks, brokerage firms, and transaction processors (among others). But, so far, the retirement plan ecosystem has not been impacted by a major breach. This seems surprising since retirement plan recordkeeping systems are treasure troves of personally identifiable information and, no doubt, are appealing targets for hackers. Yet, each day that goes by without an incident, the more likely it is to happen. Despite the best efforts of recordkeepers, asset managers, and other financial institutions, we expect to see a breach of a major retirement provider in 2018.
Prediction: Benefits matter more
The labor market is an interesting conundrum right now. On one hand, the labor market is tight. The U.S. economy added 228,000 jobs in November, and the unemployment rate remained at 4.1 percent, its lowest level since December 2000. Meanwhile, average hourly wages haven’t increased much beyond the pace of inflation—meaning that workers’ incomes are merely keeping pace with rising costs.
Perhaps many Americans are just happy to have a job. Or, it could be that wage statistics don’t consider other perks that workers want, like the ability to work from home more often, get free meals at the office, and have a good retirement plan. Given what we know about Millennials, the 83 million Americans born between 1982 and 2000, this may not be a surprise to some human resources professionals. Millennials now outnumber Baby Boomers in the workforce and define success differently than their older colleagues. They place more value on meaningful work, job satisfaction, and personal growth than on stability and a big paycheck.
That could explain why we are seeing employers build financial advice and wellness programs for their employees in increasing numbers. Many Millennials were victims of layoffs as the economy turned down during the recession. Others who had just joined the workforce were forced to take lower-wage jobs or do more student-loan borrowing than they might have wanted. Years later, Millennials’ incomes are stagnant; many are stressed about their borrowing and haven’t started to save for retirement.
But, while Millennials may have the most to gain by taking advantage of employer-offered financial advice and wellness programs, these programs cater to the needs of all three generations currently in the workforce. Baby Boomers and Gen Xers have their own financial challenges—and have been bogged down in the same stagnant wage environment for the past decade. Boomers are retiring in record numbers—about 10,000 each day! And Gen Xers—the oldest are now in their early 50s—are facing the competing demands of college funding, retirement saving, and aging parents. There is no shortage of financial challenges to address.
Another twist on this subject is the growing demand for financial advice for key employees. Key employees is a general term that encompasses everyone from C-suite executives to law partners to doctors; but the unifying theme is that their needs are more complex than those of the average employee, often because of perks such as nonqualified deferred compensation plans, stock options plans, and other unique benefit offerings. Employers are offering these groups financial advice and wellness programs in increasing numbers.
Plan sponsors have focused on improving their employees’ retirement outcomes for many years. Financial advice and wellness programs are a part of that. But there is one other outcome-oriented aspect that is worth watching in the new year.
While it is too soon to tell what its ultimate impact will be, the fiduciary rule will also reshape—at the margin, at least—retirement benefits. Given increased scrutiny on rollover transactions, more assets will remain in retirement plans after employee termination or retirement. In this environment, plan sponsors will focus on the needs of a population that most have not thought much about before: retirees.
A Government Accounting Office study performed last year showed that only a third of plans offer a withdrawal option other than a lump sum distribution. And less than 10 percent offer an in-plan annuity option or qualified longevity annuity contract (QLAC). In the past, demand for such features was limited. Over time, that will change as retiree assets grow as a proportion of total plan assets. These assets will both drive demand and provide scale to offer new services—such as managed accounts, systematic withdrawal programs, and income guarantees—more widely and cost effectively.
Prediction: The return of market volatility
The markets have performed quite well this year. U.S. large-cap stocks (as measured by the S&P 500) were up more than 20 percent through the end of November. International developed and emerging market stocks are up even more. Bonds and real estate have held their own despite rising interest rates. All major asset classes are in positive territory as we experience the first synchronized global economic expansion in more than a decade. And, of course, this comes on the heels of 2016, a year when U.S. and emerging market stocks were up more than 10 percent; international developed stocks rose more than 7 percent.
We are more than due for a stock market correction. It has been nearly two years since we last experienced a 10 percent sell off. Based on history, we should expect to weather a correction of that size every year. As our chief investment officer, Kevin Barry, reminded me, it is impossible to guess what will be the catalyst for our pending pullback. It could be market reaction to a central bank rate hike or policy surprise. It could be a reaction to drama out of Washington. Or it could be a reaction to a flare-up with North Korea, the Middle East, or some unanticipated part of the globe.
When it happens, retirement plan participants unexperienced in market volatility will seek counsel and perspective around the long-term impact of the catalyst. We will need to reinforce the importance of diversification, the value of dollar cost averaging, and the benefits of staying in the market. A small cadre of participants will be spooked, but most will stay the course. They will continue to contribute and maintain their asset allocations—and learn important lessons from their inaction.
When we look back on the correction, we will realize that the catalyst was immaterial. It was a spark—an excuse for a selloff—that revealed a change in the underlying tenor of the markets as central banks around the world moved away from their accommodative monetary policies to normalizing their balance sheets and raising interest rates to combat rising inflation. The economic regime we had experienced since the financial crisis—characterized by low interest rates, low inflation, and low growth—had ended. A new market had emerged.
When this happens, asset allocation solutions’ performance—most notably target date funds—will diverge as it did in 2008 and 2009. Glidepath variations, fixed income composition, and breadth of diversification will create winners and losers that may force plan sponsors using these options as their qualified default investment alternative (QDIA) to reevaluate. As they do this, they may find that newer options such as managed accounts are better alternatives.
Rising interest rates will also affect capital preservation options such as money market funds and stable value accounts. Money markets will be the first beneficiaries of rising interest rates since they can quickly pass along increased yield to investors. Stable value accounts hold fixed income securities with longer maturities (and durations) than those held in money market funds, so they will lag money market funds as rates increase. They may suffer in the short term as they cope with volatility-driven participant cash flows and lower prices in their fixed income holdings. Longer term, stable value managers, will show they can handle these challenges. But, like asset allocation solutions, we will see divergence in returns across providers.
While short-term interest rates have risen, the impact of higher, longer-term rates on defined benefit plans remains to be seen. Many defined benefit plan sponsors took action to terminate ahead of tax reform and rising Pension Benefit Guaranty Corporation (PBGC) premiums. Yet, many remain on the sidelines waiting for interest rate increases to reduce the cost of plan termination. We anticipate that more plan sponsors will proceed with termination—or at least de-risking—on the heels of years of increasing PBGC premiums, lower return expectations, and the potential for rising rates.
As with most predictions, the only thing we can say with absolute certainty is that at least some of our predictions will be wrong. Thankfully, the danger of radical change has passed, creating a more manageable—and perhaps more predictable—environment. So, hopefully, our team of subject matter experts is on the mark for 2018. Regardless, you can expect to hear more from us on these topics, among others, as 2018 unfolds.