What if defined contribution (DC) plans were to adopt more of the strategies that have been working for defined benefit (DB) plans?
Rob Capone, Head of Retirement for BNY Mellon, thinks such a development would benefit DC plan participants, especially in a low-yielding, highly correlated marketplace. The correlation between assets — how they move together, up or down in a market — can have a significant effect on performance results. "There are three significant challenges that go with that kind of marketplace," Rob says. "First of all, managing the downside risk within the portfolio. Secondly, achieving better diversification. And third, managing volatility within the portfolio."
Applying best practices from the institutional defined benefit world makes sense: "Looked at historically over the last 10 years," he says, "defined benefit plans have outperformed defined contribution plans by over 180 basis points, and that's significant." Important differences include:
- Home-Country Bias – DC plans tend to have a much higher allocation to domestic securities compared with DB plans, at a time when investors need to expand their investment universe to find return
- True Diversification – DB plans have much higher allocations to non-traditional strategies, such as real assets, emerging markets and liquid alternatives to increase diversification and better manage portfolio volatility and downside risk
- Investment Expertise – DB plans are managed by experienced investment professionals, while individual DC plan participants often feel ill-prepared for the task of choosing appropriate investments, even with existing education tools
Next-Generation DC Plans
With DC plans fast becoming the only retirement vehicle for U.S. workers, and with more retirees living longer in retirement, Rob Capone suggests DC plan sponsors think about ways to:
- Expand the opportunity set to non-traditional investments
- Consider the stability of returns over a longer life span with better downside risk management
- Preserve the purchasing power of retirement plans with inflation-hedging real assets
These suggestions may require a paradigm shift on the part of DC plan sponsors. However, Rob believes these changes are important to helping the next generation of DC plan participants achieve their retirement goals.
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