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Should You Rock Alternative in Your Lineup?
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The term "alternative investments" may conjure images of classic automobiles, fine wine, rare art and valuable jewels. Some may think about the Honus Wagner baseball card that sold for $3.12 million at auction in 2016. Or about the 1962 Ferrari 250 GTO that sold at auction for a whopping $34.65 million in 2014. Or maybe they set their sights even higher and think about the Hope Diamond, with an estimated value of $200-$250 million.
While these treasures are fun to picture, they would not be permissible or practical investments within a retirement plan. So what exactly is an alternative investment in this context? A simple way to comprehend these investments is right in their name-alternative-they are not conventional investment types, e.g. stocks, bonds and cash. Alternative investments include private equity, hedge funds, managed futures, real estate, commodities and derivatives contracts.
Alternative investments, like REITs (real estate investment trusts) and Commodities, have their place in a well-managed portfolio within proper asset allocation parameters and with regular oversight. The danger is when participants misuse and/or don't fully understand this asset class. Alternative investments can be difficult to valuate and can be subject to enhanced volatility. Consider the most recent financial crisis. In the aftermath of global equity markets plummeting, some investors sought safe haven in gold which buoyed its price to record levels. As a result, some plan participants
observed this phenomenon and were swayed to reallocate some, or even all, of their retirement plan assets there.
Subsequently, along with the meteoric rise in the price of gold, came a decline. Gold peaked at $1,920.70 in August 23, 2011
and fell to $1,048.30 by December 17, 2015.¹ An investor who bought at the high and sold at the low, realized a loss of 45.4
percent over this time period. A $100,000 investment would have fallen to $54,579. Let's contrast that with a diversified portfolio with its foundation in core asset classes and only a portion allocated to alternatives. Consider a hypothetical portfolio allocated as follows: 40% U.S. Equity, 10% International Equity, 40% Core Fixed Income, 5% Commodities, and 5% Global REITs.¹ Over the same time period, this portfolio achieved a positive return of 46.48 percent. So a $100,000 investment would have grown to $146,480.
A broader stand-alone Commodities fund would have proven just as dangerous. Commodities (as measured by the Bloomberg Commodity Index) produced a negative return every year between 2011 and 2015, for five consecutive years. Annualized five-year returns in Commodities were negative 10.27 percent.¹ This means a $100,000 investment would have fallen to $58,169 during this time period. Again, if an investor instead used a diversified portfolio during this time period they would have achieved annualized returns of 7.62 percent, turning the original investment into $144,366. Again resulting in a much better outcome in the diversified portfolio.
Under both scenarios, participants would have been disappointed had they invested their retirement plan assets exclusively in alternative investments. As seen in the examples above, if these were just portions of a well-diversified portfolio, the effects could have been minimal. Some exposure could have been helpful in 2016, with Commodities finally turning the corner and returning almost 12 percent and Gold up almost 8 percent.¹
While alternative investments can perform well and occasionally produce great returns, you may want to think twice about using them as stand-alone investment options in a retirement plan. Risk/reward optimization can be maximized within the confines of a well-constructed asset allocation, such as a target date fund. These funds are professionally managed, rebalanced and enjoy constant oversight to appropriate asset allocation across various asset classes.
¹All return data derived from MPI Stylus and Morningstar Direct. Hypothetical diversified portfolio is comprised of U.S. Equity (S&P500), International Equity (MSCI EAFE), Core Fixed Income (Barclays Aggregate), Commodities (Bloomberg Commodity), and Global REIT (S&P Global REIT).
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Millennial Workers Require Special Sponsor Menu Design
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Millennials are the largest demographic cohort in the nation, U.S Census Bureau data shows. And up to 80 percent are already saving in their employer-sponsored retirement plans, according to a 2015 report from Bank of America Merrill Lynch.
The newest generation of workers-which the Pew Research Center defines as those born between 1981 and 1997-has exhibited distinctive attitudes and behaviors that plan sponsors and their advisors must consider when designing menus. Plan administrators, too, must rethink some long-held beliefs about participant behavior.
For starters, millennials tend to be more risk averse and gravitate toward conservative investments that they believe will be less exposed to bouts of volatility. Millennials also tend to be highly educated and research-oriented. Given these inclinations, plan sponsors should consider providing education about the benefits of long-run investing, since they have just begun their accumulation phase.
The number of millennial plan participants is likely to rise, particularly if the U.S. economy-and the job market- continue their slow but steady recoveries.
Investment Lineups
Employers with growing millennial populations should adjust their lineups to accommodate this generation's more conservative sensibilities. Current research-including a study published by the retirement and trust unit of Wells Fargo-suggests that millennials may be inclined to choose managed options with customizable and adjustable glidepaths. Forward-thinking sponsors would do well to get ahead of the curve by looking widely across all age groups within their plans, making sure all cohorts have access to these types of solutions.
Plans geared toward millennials can offer a menu that includes conservative balanced funds, a mix of core funds and, for an added measure of diversification, funds in non-core asset classes, such as emerging markets and small-cap equities.
The mix can also include a risk-managed option to help young investors build up their balances and gain experience with markets until they feel comfortable assuming greater risk levels.
About a third of millennials say that they find socially responsible investing "very appealing," and another 59 percent say it's "somewhat appealing," according to a June 2016 survey by Legg Mason and Naissance. Options that include some socially responsible element stand a good chance of aligning with millennials' social and environmental learnings.
Communication and Education
A targeted communications effort can help satisfy millennials' appetite for understanding the different possibilities available for a given financial transaction. These materials should explain the types of investment choices available through the plan. For instance, plan sponsors can teach millennials about Roth 401(k) options, which allow them to contribute to their plans on an after-tax basis, so they don't have to pay taxes when they cash out. That can help save total taxes, since millennials are typically in a lower tax bracket when they make initial contributions than when they are ready to pull assets from these accounts.
As millennials enter the workforce and age through it, plan sponsors and their financial advisors will need to adapt their retirement plans to suit this growing cohort. A well-considered and robust investment lineup, supported by strong communications, can help plan sponsors provide an appealing, competitive retirement plan that retains younger workers and helps them invest their way toward a more secure retirement.
This is an excerpt of Macquarie Investment Management's article Millennial Workers Require Special Plan Sponsor Menu Design.
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Partial Plan Terminations
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A partial plan termination occurs when 20 percent or more of a company's employees are laid off in one year. Routine turnover during the year is generally not considered a partial plan termination.
To determine whether your turnover rate is routine, consider the following factors:
- What was your turnover rate during other periods and what was the extent to which terminated employees were actually replaced?
- Do the new employees perform the same functions as the previous employees? Do they have the same job classification or title? Do they have comparable compensation?
There is no requirement to notify the IRS of a partial plan termination, but all affected employees must be 100 percent vested in their account balance as of the date of the plan termination. If this hasn't happened, a Voluntary Correction Program would be appropriate.
For more information on partial plan terminations, please contact your plan advisor.
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May Any Employee Join the Retirement Committee?
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Upon first blush, to the extent an employee from the general populace can and wishes to make a contribution as a committee member, there seems to be no reason why they shouldn't participate on the committee. In practice, most committees consist of executives from finance (preferably the CFO), benefits and human resources. Due to the potential personal liability exposure, if there is interest from other lay people who wish to represent the vote of the participant base, they are best served participating as a non-voting member with no discretionary capabilities. This type of person should be identified and documented as a non-voting member assuming there is no intent to take on fiduciary status and the potential liability attached to all retirement committee members.
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Communications Corner:
Retirement Plan Puzzle
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This month's employee memo offers participants a fun word search puzzle featuring important retirement terms.
Call or email your plan consultant if you have questions or need assistance.
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Dan Halle, Regional Director
Direct: (716) 362-5405 E-mail: Click
here.
Richard Swanson, Regional Director
Direct: (716) 362-5404 Cell: (585) 330-2566 E-mail: Click
here.
Chad Wilkinson, Director of Retirement Plan Sales
Direct: (716) 362-5401 Cell: (315) 415-8254 E-mail: Click
here.
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The "Retirement Times" is published monthly by Retirement Plan Advisory Group's marketing team. This material is intended for informational purposes only and should not be construed as legal advice and is not intended to replace the advice of a qualified attorney, tax adviser, investment professional or insurance agent.
(c) 2016. Retirement Plan Advisory Group.
Mutual funds are sold by prospectus only. Before investing, investors should carefully consider the investment objectives, risks, charges and expenses of a mutual fund. The fund prospectus provides this and other important information. Please contact your representative or the Company to obtain a prospectus. Please read the prospectus carefully before investing or sending money.
Using diversification as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.
Distributions before the age of 59 ½ may be subject to an additional 10% early withdrawal penalty. ACR# 240529 05/17
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. P&A Group is not affiliated with Kestra IS or Kestra AS. This e-mail message and all attachments transmitted with it may contain legally privileged and/or confidential information intended solely for the use of the addressee(s). If the reader of this message is not the intended recipient, you are hereby notified that any reading, dissemination, distribution, copying, forwarding or other use of this message or its attachments is strictly prohibited. If you have received this message in error, please notify the sender immediately and delete this message and all copies and backups thereof.
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