PLAN SPONSOR | Q1 13
Strategic research report FIDUCIARY LEADERSHIP™: INTRODUCING A TACTICAL ACTION PLAN TO IMPROVE RETIREMENT READINESS Scott Matheson, CFA, CPA Senior Director, CAPTRUST Consulting Research Group
For a working definition, we define “retirement readiness” as the degree to which an individual has accumulated enough savings to provide income in retirement that maintains his or her pre-retirement standard of living. If you’ve been to a retirement industry conference over the past few years, you have certainly heard retirement readiness mentioned; you may have even attended a keynote address or two on the topic. All this talk about retirement readiness reminds me of a famous quote often attributed to Mark Twain: “Everybody talks about the weather, but nobody does anything about it.” In point of fact, the quote was written by Twain’s contemporary, friend, and neighbor Charles Dudley Warner — a novelist, essayist, and editor at the Hartford Courant. Regardless of its source, this timeless maxim provides a perfect metaphor for today’s retirement landscape in the United States. Nonetheless, the CAPTRUST team aims to do more than just talk about the weather; we fully expect to do something about it. We believe that broad retirement readiness is achievable with the right mindset and set of tools, and, equally important, a commitment from plan sponsors to go above and beyond what has historically been required. Our experiences over the years have led us to believe that plan sponsors who invest more in bettering their employees’ retirement readiness will stand out as true fiduciary leaders.
In This Issue Letter from the Editor
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Plan Sponsor Highlights
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In support of reaching this goal, we have developed an approach we’ve coined Fiduciary Leadership to help plan sponsors assess their defined contribution plans and identify specific, tactical opportunities to help truly improve employee retirement readiness. The ideas captured in Fiduciary Leadership have been gleaned from clients, industry colleagues, academic literature, and common sense, then synthesized into a straightforward, action-oriented framework. ™
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Investment Strategy
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Index Returns
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Investment Asset Classes
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CAPTRUST News
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Applying the Fiduciary Leadership mindset to defined contribution plans includes a review of what we believe are the five key areas of successful plan management: 1. Plan design 2. Participant engagement 3. Investment menu 4. Fiduciary process management 5. Vendor management
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LETTER FROM THE EDITOR
IN LIKE A LION, OUT LIKE A LION? Dear Readers, While the title above is an intended riff on an idiom normally affixed to this time of year, it certainly feels like 2013 has begun with much pomp and circumstance. Put simply, a lot is going on across the industry. This publication’s goal is to both ascertain the proverbial hand we have been dealt with respect to capital market, legislative, and retirement plan-specific developments, and also to share best practices. So far, 2013 has provided many opportunities for us to weigh in. This quarter’s centerpiece article is by Scott Matheson who oversees CAPTRUST’s defined contribution efforts. He outlines a significant development in our thinking about how plan sponsors can orient their efforts to become more outcome-focused. We are calling this mindset Fiduciary Leadership ; it’s an important initiative you can expect to hear more about in coming quarters. Scott also offers perspective on target date funds in the wake of the Employee Benefits Security Administration’s late February release on the topic. ™
To complete his yeoman’s work this quarter, Scott collaborated with Mark Paccione from our wealth management team on a piece about participant behavioral biases and how they can interfere with positive outcomes. Seeing these two authors interact highlights the synergies that emerge when our team thinks across business lines. Continuing the behavioral theme, Jason Stephens from our executive benefits team covers the crucial link between maximizing a nonqualified plan’s value and making conscious, active decisions when considering plan financing methods. With respect to the investing climate, Hunter Brackett weighs in on whether global stocks can deliver investors’ expected returns after a decade of frustrating results. Our central thesis is that global growth will remain subdued relative to “potential” growth. Finally, I offer thoughts on global central bank policy, with a more globally interconnected world finding itself disconnected on what monetary effects we may see going forward. The first quarter roared like a lion on many fronts, and as always, we strive to keep you updated on our thoughts across topics like the ones outlined above. If you were hoping we would address other issues, please don’t hesitate to growl. We want to hear from you. Onward,
Eric J. Freedman CAPTRUST Chief Investment Officer
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A successful defined contribution plan provides its participants with the highest likelihood of achieving retirement readiness. In order to enhance your participants’ likelihood of retirement income adequacy, you must shift your focus and mindset toward achieving outcomes. This is conceptually simple, but in practice it’s key to get the “basics” right before leaping into the world of outcomes.
Outcome-focused plan sponsors care primarily about three things: getting employees into the plan, getting them to save enough, and getting them invested well.
We think about the path to outcomes in a defined contribution plan much the same way American psychologist Abraham Maslow described the path to individual “self-actualization” — as a pyramid of needs that builds layer upon layer from foundation to apex. The base of a successful defined contribution plan pyramid is built on the basics: diverse investment options, daily pricing, online participant access, and recordkeeper or third-party administrator relationships. Once the basics are in place, the pyramid builds upon itself to a focus on the “three Fs” — or funds, fees, and fiduciary best practices. Here, you as the plan sponsor have invested time, effort, and often capital into building a plan with proper investment options, reasonable fees, and a tight fiduciary process (e.g., committee process, investment policy statements,
and periodic fee benchmarking). Once this second layer is in place, we can shift the focus to outcomes. Plan Design, Participant Engagement, and Investment Menu Outcome-focused plan sponsors care primarily about three things: getting employees into the plan, getting them to save enough, and getting them invested well. Our experience tells us that crafting a plan that integrates a plan’s design, participant engagement strategy, and investment menu is the key to accomplishing these seemingly daunting goals. Fiduciary Leadership provides a framework to organize these tools in such a way that plan sponsors can pick the right ones for their plan. To buy into this organization, however, is to challenge the status quo. ™
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Figure One: Examples of Specific Tactics to Drive Retirement Readiness
DELEGATORS
EMERGING SAVERS
HYPER-ENGAGED
Get them into the plan
Auto-enrollment
Enrollment meetings One-on-one consultations
Online enrollment and planning tools
Get them saving enough
Auto-escalation
Stretch match formula Gap analysis
Targeted advice meetings
Get them invested well
QDIA
Risk-based model
Self-directed brokerage Managed account
As an industry, we have been trained to solve for the ever-elusive average participant. However, workforces are hardly homogeneous, and employee diversity means that averages can be misleading. As a simple example, think about a workforce of two: perhaps a doctor and an administrative professional. Solving for the average of these two individuals yields a participant that simply doesn’t exist. Building a retirement plan around this average may lead to unsatisfied employees and less-than-desirable outcomes. We propose a new way to think about your participants — one that views your participants across a spectrum of engagement in saving and planning for retirement, rather than potentially misleading averages. This spectrum ranges from those less engaged — even disengaged — employees
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who delegate key saving and investment decisions to hyper-engaged, self-reliant employees actively and personally engaged in retirement planning. Delegators either implicitly turn over their saving and investment decisions to you as plan sponsor when they allow you to automatically enroll them in the plan and place them in the plan’s Qualified Default Investment Alternative (QDIA), or explicitly delegate by selecting investments like target date funds. Meanwhile, hyper-engaged employees are easy to spot; they are the ones asking for self-directed brokerage options and gold funds. In between these two extremes are the “emerging savers.” Emerging savers are moderately engaged and exhibit many of the right savings behaviors. They often just need a nudge to continue making good decisions or an incentive to step it up a notch.
Source: CAPTRUST
Spectrum of Participant Engagement
Let’s now apply this spectrum of participant engagement to our outcomes framework to create a matrix for organizing common plan design, participant engagement, and investment menu tools. As you can see in Figure One, each of these three employee groups can be influenced using different tactics intended to drive retirement readiness. For delegators, auto-enrollment and auto-escalation can help get them in the plan and saving enough; the right QDIA can get them invested well. For emerging savers, a stretch match formula combined with a retirement income gap analysis and one-on-one consultations can reinforce their good behaviors. Meanwhile, even the hyper-engaged may benefit from access to managed accounts or targeted advice on how to know when it’s time to retire.
PLAN SPONSOR | Q1 13
Vendor and Fiduciary Process Management
Conclusion
Vendor and fiduciary process management, the final two Fiduciary Leadership pillars, wrap around all the others and are enablers of successful defined contribution plan management. Fiduciary Leadership requires active vendor management, continuous oversight of vendors to ensure that services contracted for are appropriate, rendered on a timely basis, and that fees charged are reasonable. As part of this oversight, fiduciary leaders will formally benchmark these vendors as a way to assess reasonableness and competitiveness of fees and services over time. This last point is especially relevant given the rapid pace of innovation and retirement industry evolution.
Over the past three decades, participants have been increasingly overwhelmed by the burden of their retirement savings and investing shifting from their employer to them, rising healthcare costs, extending life expectancy, and, for the most recent decade, disappointing capital market performance. As we explain later in this issue in an article titled “Buying High and Selling Low,” participants are further hindered by a number of behavioral biases that challenge their ability to invest well. All of these issues pose challenges to getting participants into the plan, saving enough, and invested well.
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As it relates to fiduciary process management, plan sponsors should develop, document, and follow consistent processes to ensure compliance with their obligations. Fiduciary leaders, however, strive to go beyond the minimum to stay ahead of the curve on behalf of their participants, staying alert to regulatory and legislative threats, and leveraging technology to improve process management.
Nonetheless, whether your focus on outcomes is driven by paternalism or workforce management, the framework for Fiduciary Leadership provides an intuitive approach to managing your plan and participants to successful outcomes. We look forward to discussing Fiduciary Leadership with you and working together to do more than just talk about improving outcomes for your participants. Together, we believe we can do something about it. ™
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PLAN SPONSOR HIGHLIGHTS
EMERGING GUIDANCE: NEW TIPS AND BEST PRACTICES FOR PLAN SPONSORS OFFERING TARGET DATE FUNDS Scott Matheson, CFA, CPA Senior Director, CAPTRUST Consulting Research Group
In late February, the Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA) released a document titled “Target Date Retirement Funds — Tips for ERISA Plan Fiduciaries.” Given target date asset growth since the Pension Protection Act of 2006 (PPA) and the increasing importance of target date funds in defined contribution plans, the retirement plan community has been anxiously awaiting guidance from the DOL on prudent practices for selecting and monitoring these unique investment options. In addition to providing some background and definitions related to target date funds, the DOL tips document provides eight major items to consider in target date fund selection and monitoring. In this article we capture the eight items along with our interpretation of how plan sponsors should practically apply these suggested considerations, as well as our view on fiduciary best practices for oversight. The DOL’s tips are as follows: 1. Establish a process for comparing and selecting target date funds. 2. Establish a process for the periodic review of selected target date funds. 3. Understand the funds’ investments — the allocation to different asset classes (stocks, bonds, and cash), individual investments, and how these will change over time. 4. Review the funds’ fees and investment expenses. 5. Inquire about whether custom or non-proprietary target date funds would be a better fit for your plan. 6. Develop effective employee communications. 7. Take advantage of available sources of information to evaluate the target date funds you have selected and the recommendations you received during your selection process. 8. Document the selection and ongoing review process.
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For reference, a full copy of the EBSA guidance can be found at www.dol.gov/ebsa/pdf/fsTDF.pdf.
Target date funds are still relatively young compared to other more traditional investment options offered in defined contribution plans and do not lend themselves to easy benchmarking. According to the Plan Sponsor Council of America’s 55th Annual Survey of Profit Sharing and 401(k) Plans, 69.7% of plans offer target date funds as their QDIA as of 12.31.2011. Combined with plan design features like automatic enrollment and escalation, these investment options are quickly becoming the primary investment program for many plans’ delegator populations. All of these factors amplify the need for plan sponsors to thoughtfully select appropriate target date funds and revisit their selection periodically. While the DOL tips have upset some in the industry (namely target date fund managers), we applaud the EBSA for committing to paper what they deem important in this critical area of plan management. At a minimum, it has forced a discussion — one we very much look forward to having with you.
PLAN SPONSOR | Q1 13
CAPTRUST CHECKLIST FOR DOL TARGET DATE TIPS RELEASE SECTION 1: TARGET DATE FUND SELECTION
1. Review Investment Performance Review investment risk and return for each target date year in question over one-, three-, and fiveyear trailing periods and since inception against appropriate target date peer groups and indices
2. Review Glidepath and Series’ Underlying Funds Against appropriate peer groups
5. Review the Availability and Applicability of Custom or Non-Proprietary Solutions Inquire with providers as to whether custom and non-proprietary TDFs are available. Weigh the costs and the benefits of custom or non-proprietary target date funds (to include non-financial costs such as administrative burden and complexity for participants and benefits such as the ability to use the plan’s core lineup as building blocks for the target date series)
Against assumptions (in connection with glidepath construction)
Understand the mix of stocks, bonds, cash, and other assets within the target date series, and how this mix changes over time
Understand the manager’s rebalancing
6. Review the Series’ Fees Document the series’ total cost, including any underlying fund’s investment management fees
Document any non-investment management fees and their purpose
methodology and approach to tactical asset allocation (if applicable)
Identify when the series’ glidepath will reach its most conservative point — at retirement or sometime after retirement
Understand the underlying investments of the target date series
7. Review Employee Communications Provide information that describes what a target date fund is and its purpose in the plan
Distribute information to participants regarding the specific target date series offered in the plan
Asset classes utilized Active versus passive management
SECTION 2: ONGOING MONITORING PROCESS
3. Review Management Team and Process
1. Periodically Review the Selected Target Date Fund Series
Team tenure
Periodically review, at a minimum, whether
Approach to asset allocation as well as manager and/or security selection
Roles and ownership of responsibilities Fund firm
there have been any significant changes to the selected target date fund series such as changes to management, asset allocation/glidepath, investment philosophy, fees, and underlying funds
Periodically review investment risk and return *A copy of this checklist can also be found online at
4. Review Plan Demographic Data and Additional Externalities
http://www.captrustadvisors.com/pdf/CAPTRUSTQ113checklist.com.
Employee ages and average retirement age Deferral/contribution rates Savings amounts Employee turnover rate Withdrawal patterns Consider the existence of supplemental retirement plans
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BUYING HIGH AND SELLING LOW Scott Matheson, CFA, CPA Senior Director, CAPTRUST Consulting Research Group
Mark Paccione, CFA, CFP® Director, CAPTRUST Consulting Research Group
In 2012, the average equity mutual fund investor earned 15.56% — just short of the S&P 500’s 15.98% return.1 The average fixed income mutual fund investor earned 4.68%, while the benchmark Barclays Aggregate Bond Index returned 4.21%.2 Unfortunately, average investor outperformance over common market benchmarks is a rare occurrence. For example, in 2011 the S&P 500 Index returned 2.12%, while the average equity mutual fund investor lost 5.73%.3 Admittedly, global equity markets experienced a particularly volatile year as Standard & Poor’s downgraded the U.S. federal government credit rating in August 2011, and the European sovereign debt crisis sent many equity investors to the sidelines. The Barclays Aggregate Bond Index, which tends to react well in volatile equity markets, had a much better year, up 7.84%. The average fixed income mutual fund investor received a meager 1.34% return,4 which is better than the average equity investor did, but significantly worse than the Barclays Aggregate benchmark.
DALBAR notes, “One of the most startling and ongoing facts is that at no point in time have average investors remained invested for sufficiently long periods to derive the benefits of the investment markets.”5 Figure One captures the average investor’s plight — which is especially obvious over longer periods.
More importantly, 2011 is not an isolated incident. Findings by financial research firm DALBAR indicate that the average mutual fund investor consistently underperforms the market. In its annual Quantitative Analysis of Investor Behavior study,
These trends seem illogical, yet they are explainable. Several behavioral biases play a role in contributing to the ill-timed investment decisions, including what psychologists call herding, confirmation bias, and loss aversion.
Timing is a key contributing factor to the average investor’s underperformance. The same DALBAR study also shows mutual fund flows tend to lag market movements, causing investors to unintentionally buy high and sell low. Equity fund inflows tend to increase after run-ups in the S&P 500. Meanwhile, outflows tend to pick up after market sell-offs. For example, fund outflows in the first six months of 2012 were greatest at the S&P 500’s bottom, and fund inflows were greatest in December when the S&P was trading near year-highs. Figure Two, which plots investor fund flows versus market performance for calendar year 2012, illustrates this point.
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Avg. Equity Investor
S&P 500
Difference
Avg. Fixed Income Investor
Barclays Aggregate Bond Index
Difference
1 YR
15.56%
15.98%
-0.42%
4.68%
4.21%
0.47%
3 YRS
7.63%
10.87%
-3.24%
2.85%
6.19%
-3.34%
5 YRS
-0.84%
1.66%
-2.50%
1.64%
5.95%
-4.31%
10 YRS
6.05%
7.10%
-1.05%
1.17%
5.18%
-4.01%
20 YRS
4.25%
8.21%
-3.96%
0.98%
6.34%
-5.36%
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Source: DALBAR
Figure One: Annualized Investor Returns vs. Benchmark as of 12.31.2012
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Figure Two: Investor Fund Flows and Market Performance for Calendar Year 2012 0.4%
6
4
0.0%
0
-0.1%
-2
-0.2% -4 -0.3% Fund Flows S&P 500
-0.4%
-6
-0.5%
-8 Jan
Feb
Mar
Apr
• Herding is the tendency of individuals to follow the group’s actions. If everyone is buying and equity markets are going up, the individual investor is compelled to go along with the crowd. People tend to conform to the group because individuals believe it is unlikely the group is wrong. The dot-com bubble in the late 90s and the more recent housing bubble are perfect examples. • Confirmation bias is the tendency to accept data that confirms existing beliefs—while rejecting data that contradicts them. With every market rally or decline, market participants (assisted by financial news outlets) assign a reason behind the latest capital market move, whether that reason is a recent economic data release, comments
May
Jun
Jul
Aug
Sep
from an influential source, a corporate earnings release, or even the time of year. When equity indices are rising, individuals have a tendency to overemphasize the positive data points, while ignoring the negatives; when equity markets decline, individuals do just the opposite. • Finally, loss aversion is particularly detrimental to investors in market downturns. Research has shown that individuals prefer avoiding losses much more than experiencing gains.7 When equity markets correct, many individual investors reduce equity holdings in order to avoid further losses. In the long run, however, investors would be better served increasing equity holdings in a down market.
Oct
Nov
Source: DALBAR
2 0.1%
Monthly Market Returns
0.2%
6
Fund Flows as % of Total Assets
0.3%
Dec
While the average mutual fund investor’s underperformance is understandable, there is a cure. Asset allocation — while not trendy and certainly not a new concept — can help overcome these behaviors. The principle of combining multiple assets that are not perfectly correlated to one another as a way to reduce overall portfolio risk still holds true. In an accelerating economy, where corporations are doing well and investors are feeling better about the future, equities would likely appreciate. In a decelerating economy where corporate earnings are suffering, equities may perform poorly. Meanwhile, traditionally safe investments like fixed income securities would likely do well and offset some of equities’ declines. If nothing happens and the financial markets move sideways, the investor collects interest and dividends.
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Asset allocation allows an investor to build a portfolio that is not overly dependent on a single factor such as rising equity markets by combining asset classes that respond to different factors. More importantly, an investor with a well-diversified portfolio can maintain a steady course, knowing that, even in volatile markets, some portion of his portfolio is doing well.
number of diverse investment choices, can help. Finally, and ironically enough, hyper-engaged participants may be the most susceptible to behavioral biases. For this subset, targeted and timely communication during times of financial turmoil, advice phone lines, and managed accounts are just a few tools to help avoid missteps.
A disciplined approach to making investment decisions is required if one is to avoid these detrimental behavioral tendencies. For defined benefit plans, this means engaging professional advisors to work alongside a plan investment committee following a well-constructed investment policy statement. The challenge is different for defined contribution plan sponsors where individual participants directing their own investments are susceptible to these tendencies.
The basic takeaway from the DALBAR study is clear. Without assistance, the average individual investor is fighting an uphill battle; however, with the help of asset allocation, a well-thought-out plan design, and the right kind of participant engagement, one can dampen or even eliminate many of the biases that contribute to long-term underperformance. Sources: 1
To mitigate the risk of participants making ill-timed investment decisions, a plan sponsor must understand its audience. Disengaged participants (or delegators) who fail to take action are fundamentally different than hyper-engaged participants who may actively rebalance their investment holdings. To help the delegators, plan sponsors can take advantage of the very inertia and lack of engagement of this population by automatically enrolling them into a QDIA. For those participants who are modestly engaged, asset allocation models, education, and advice, along with a limited
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DALBAR, Inc. Research & Communications Division. 2013, Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. March 2013 page 17.
2
Ibid.
3
DALBAR, Inc. Research & Communications Division. 2012 Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. April 2012, page 9.
4
Ibid.
5
Ibid, page 5.
6
DALBAR, Inc. Research & Communications Division. 2013 Quantitative Analysis of Investor Behavior: Advisor Edition. Boston, MA. March 2013, page 19.
7
Kahneman, D. and Tversky, A. (1984). “Choices, Values, and Frames.” American Psychologist 39 (4), pages 341–350.
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CAN EQUITIES GENERATE ACCEPTABLE RETURNS IN A SLOWER GROWTH ENVIRONMENT? Hunter Brackett, CFA Senior Manager, CAPTRUST Consulting Research Group
In recent years, financial publications ran ominous headlines such as “The Worst Economic Recovery in History,” and “U.S. Hit by Weakest Postwar Rebound.” While the headlines may appear sensationalist at first glance, the current U.S. recovery is, in fact, significantly weaker than prior ones. According to the Congressional Budget Office (CBO), since 2009, U.S. economic growth is less than half of the rate exhibited, on average, during other recoveries in the post-World War II era.1 As shown in Figure One, the current recovery is now in its fourth year since 2009, but U.S. Gross Domestic Product (GDP) growth is still below its long-term average. Likewise, the unemployment rate remains well above the Federal Reserve’s 6.5% target, although recent signs of improvement are encouraging.
Figure One: U.S. Real GDP Growth 1948-2018 10%
6%
Average=3.2%
4%
2%
0%
-2%
-4% 1950
1960
1970
1980
1990
2000
Source: Federal Reserve, Congressional Budget Office
8%
2010
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Figure Two: U.S. GDP and Potential GDP 2000–2023 $20 U.S. GDP Potential GDP
$19
$17 $16 Source: Congressional Budget Office
In Trillions of 2005 Dollars
$18
$15 $14 $13 $12 $11 $10 2000
2002
2004
2006
As illustrated in Figure Two, the CBO reports that U.S. GDP has been below its potential level (the CBO’s estimate of the maximum sustainable level of economic output) since 2008, and the gap is expected to persist until 2017. If this phenomenon occurs, it would mark roughly a decade of U.S. output operating below its potential level. The late economist Victor Zarnowitz, a leading scholar on business cycles, described the historical pattern in which deep recessions are usually followed by sharp recoveries. The current recovery has not followed this precedent due to both long-term demographic trends and cyclical factors. A number of trends unrelated to the financial crisis could provide a headwind for long-term economic growth in the U.S. In particular, the U.S. working age population (typically ages 20 to 65) growth rate
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2008
2010
2012
2014
is declining as baby boomers retire, and cyclical factors related to the financial and housing crisis will likely dissipate as the recovery progresses. Deleveraging is a drag on economic growth, but the household and financial sectors made considerable strides in reducing their debt-to-GDP ratios in recent years. In contrast, the government debt-to-GDP ratio continues to increase at a rapid pace and is currently at historic highs. The fiscal tightening that is necessary to address this issue, likely tax increases and spending cuts, could be a drag on U.S. economic growth. Meanwhile, the housing market normally plays an important role in economic recoveries by increasing consumer spending and net worth. Given the severe housing market decline, consumer net worth fell sharply and grew unusually slowly in recent years. In addition, the economy has been less responsive to
2016
2018
2020
2022
historically low interest rates due to the deleveraging process and tighter bank lending standards. Despite the sluggish recovery, we see encouraging signs in coming years. Referring back to Figure One, the CBO forecasts U.S. GDP growth to remain subdued in 2013 as the economy adjusts to fiscal tightening, but expects improvement in 2014 and beyond thanks to dissipating effects from the housing and financial crises. Market observers expect housing to be a tailwind for the U.S. economy this year as housing starts and sales activity increase. Recent equity market gains provide another boost to consumer net worth, although this impact is more pronounced in higherincome households. Despite the subdued economic recovery, we remain constructive on the capital market opportunity set and
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believe traditionally riskier assets such as equities can still provide reasonable returns. Conventional wisdom states that stronger economic growth should lead to higher corporate profits and, therefore, better equity returns. However, this relationship does not always hold true. Although U.S. GDP growth remains below its long-term trend, equities posted solid returns in recent years, including a 16% total return for the S&P 500 in 2012 and a strong start to 2013.
due to monetary policy and investors’ increased appetite for traditionally riskier asset classes. The Fed’s accommodative monetary policy provides investors an incentive to move away from lower-yielding asset classes. This incentive provides a further tailwind for equity returns, although we caution that it may not be sustainable over the longer term.
In our view, the combination of modest growth, contained inflation, and accommodative monetary policy provides a favorable environment for riskier asset classes. Some observers consider the current environment to be near the “sweet spot” for equity returns; the economy is growing fast enough to avoid another recession but not strong enough to spark inflation concerns and tighter monetary policy. If U.S. GDP growth follows the CBO’s projected path as in Figure One and the unemployment rate continues to improve, the Fed could begin to withdraw its accommodative monetary policy in the coming years. In that scenario, investors will have to weigh a more favorable economic outlook against tighter monetary policy, with an uncertain impact on equity returns.
Our capital market assumptions, which are based on a period of five to seven years, utilize the three building blocks to forecast equity market returns. We forecast a 7% return for U.S. large-cap equity and modestly higher returns for U.S. mid-, small-cap, and international equity. These return forecasts are mainly driven by earnings growth and dividend yields; we do not assume much benefit from valuation1 changes. Our 7% return assumption for U.S. large-cap equity, while reasonable relative to historical returns, is less than half of the 16% return posted last year. This further underscores the favorable backdrop that we are currently experiencing. For more detail on our capital market assumptions, we invite you to read our newly published position paper, Capital Market Assumptions — Opportunities in a More Challenging Environment.
Equity returns are comprised of three building blocks: (1) expected earnings growth, (2) dividend yield, and (3) the impact from valuation changes. Many investors tend to focus on the first factor, but we believe that all three play an important role. While a sluggish recovery hampers revenue growth, earnings have proven resilient as companies reduced their cost structures during the recession. We expect earnings growth to gradually accelerate over the next few years, in line with our expectation for the trend in GDP growth. Dividend yield is an increasingly important component of equity total returns. In a slower-growth environment, companies tend to be more focused on returning capital to shareholders by way of dividend increases and share buybacks supported by a high level of cash on corporate balance sheets. Finally, equities benefit from a positive valuation impact primarily
Although we believe equities can continue to provide reasonable returns, we stress the importance of diversification, both within and among asset classes. Over the five- to seven-year period of our capital market assumptions, we expect equities to generate higher returns than other asset classes such as fixed income, but also exhibit higher volatility. Within equities, we see the strongest returns in U.S. mid- and small-caps as well as international equities, but with the trade-off of higher volatility relative to U.S. large-caps. Investors should consider their return objectives and risk tolerance when determining the amount and composition of equity exposure in their portfolios. While the current environment is quite favorable for equities, we remain mindful of global macroeconomic risks that could reemerge such as the European sovereign debt crisis or an unexpected shift in U.S. monetary policy.
Source: 1
Congressional Budget Office. What Accounts for the Slow Growth of the Economy after the Recession? November 2012, pp. 1-4.
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WATCHING YOUR BEHAVIOR: HOW TO MAXIMIZE NONQUALIFIED PLAN ASSET PERFORMANCE Jason Stephens, CFS, ARPS Director, CAPTRUST Nonqualified Executive Benefits
This circumstance creates a separation between the assets and liabilities of a nonqualified deferred compensation plan and provides the means by which participants avoid constructive receipt of compensation and, in turn, current income taxation. Although there is no requirement to informally fund or finance nonqualified plan liabilities, many sponsors choose to do so. According to a recent study conducted by Plan Sponsor Council of America and the Boston Research Group, more than 60% of plan sponsors manage these obligations by informally setting assets aside.1
In our most recent position paper, A Three-Step Approach to Nonqualified Plan Financing: Now is the Time to Revisit Your Strategy, we introduce a conceptual framework for nonqualified deferred compensation plan sponsors to help them make intentional decisions about how to finance their plans’ benefit liabilities. The paper emphasizes the importance of selecting an appropriate combination of financing method, earnings hedge strategy, and target funding level as key factors for plan optimization. Although understated, a number of behavioral factors are influential to this decisionmaking process. Plan sponsors should be mindful of these influences because they can lead to unintended consequences that are not in the companies’ long-term best interest. Unlike qualified plans where liabilities are funded by assets set aside for the exclusive benefit of participants and beneficiaries, in nonqualified plans, participant deferrals plus any sponsor contributions remain under the company’s control and are subject to general creditors.
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Financing plan liabilities means removing assets from daily operations, which may not always make economic sense. From a capital budgeting standpoint, setting these funds aside suggests that investing in the capital markets is more attractive than investing in company operations. Although this comment oversimplifies the analysis, it illustrates the point that plan sponsors may not always make decisions to finance nonqualified benefit liabilities based purely on economics. This urge to set aside assets against nonqualified plan liabilities demonstrates the impact of mental accounting. Mental accounting is a concept from behavioral economics that describes how people tend to compartmentalize or categorize their current and future obligations into separate, nontransferable “buckets” or accounts — sometimes seemingly contrary to rational thought. Beyond the economics, there are several other good reasons to finance nonqualified benefit liabilities. These reasons include demonstrating the commitment of corporate management to support the plan and reinforcing the perception that the assets are only on loan from the employees (and should be treated accordingly).
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For plan sponsors choosing to finance — because it makes economic sense, is behaviorally helpful, or serves as a goodwill gesture to participants — one common solution is to invest these assets in a manner similar to plan liabilities. This earnings hedge strategy, known as mirroring or mapping, keeps financial statement volatility to a minimum since plan liabilities and assets set aside will tend to move in tandem. While volatility is muted using this approach, the insinuation is that plan participants are better stewards of assets than the corporation. As referenced in an earlier article, recent data refutes this point. This suggests another impact of mental accounting, whereby many companies appear willing to accept suboptimal performance of corporate assets in order to neutralize the growth of a specific liability. One solution available to plan sponsors who wish to informally fund benefit liabilities, while still maximizing the use of corporate funds in light of behavioral tendencies, is to apply discretion over nonqualified assets. With this approach,
the plan sponsor maintains control of plan assets and invests them according to a long-term, well-diversified investment strategy. Using discretion allows the company to better optimize the performance of the asset, while still earmarking the funds in support of the nonqualified plan. If performance of the investment strategy exceeds liability growth, earnings can be used to offset plan costs and potentially increase corporate profits. The opposite outcome is also possible since short-term volatility (both positive and negative) increases whenever assets and liabilities are decoupled. Utilizing a discretionary approach to manage nonqualified plan assets is an interesting concept that should be explored by plan sponsors looking to optimize nonqualified plan performance, while addressing behavioral shortcomings. Understanding and addressing these influences is critical in helping plan sponsors make intentional decisions regarding the management and long-term success of their plans.
Source: 1
Boston Research/PSCA, “A Study of Non-Qualified Plan Sponsor Attitudes and Behavior,” Final Report. p.6, June 2011.
15
investment strategy
THE COUNTERFACTUAL Eric J. Freedman CAPTRUST Chief Investment Officer
Early in my business school tenure, the recently retired Dr. David Crawford began the first day of our Managerial Economics class by asserting that the world consisted of three groups of people, and these three phyla were mutually exclusive and collectively exhaustive. The first group included engineers, physical scientists, and general numerate and facile individuals Crawford affectionately dubbed “gearheads.” Crawford assigned accountants and controllers to a second order titled “bean counters,” prompting smiles among several of my classmates with corporate treasury roles. “The rest of you,” exclaimed Crawford, “are poets.” Raising his voice for effect, Dr. Crawford boomed: “And poets do not do well in my class!” Unsure of how to react, 130 classmates simultaneously self-assessed their newly anointed labels. While some nervous laughter followed, Crawford’s intense-yet-stoic face made it clear the man meant business.
16
that my jeans would be looser each November if I didn’t help my children eat their Halloween candy is a counterfactual; perhaps my waist expanded due to some other reason (or, as the optimist in me hopes, maybe the jeans themselves shrank!). The philosopher and professor Nassim Nicholas Taleb calls these events “potential histories” and argues that when thinking about potential histories before an outcome occurs (in my case before the Snickers bar passed my lips), one must take into account that the actual outcome is likely to be a lot different than one expects.1 Said another way, forecasting is subject to large deviations from perception. The most significant counterfactual in today’s capital market environment surrounds global monetary and central bank policy, with investors thinking about potential histories that may evolve should the Federal Reserve or other central banks scale back their recent pro-growth policies. Put more simply, do we need the Fed and its global peers to keep printing money and buying assets in order for riskier asset classes to deliver returns? Applying data-driven thinking about what the world will look like after easy-money-policies is a challenge for professional investors; we simply haven’t been here before on a global scale.
My classmates and I now joke that even our Leadership and Public Communications courses were highly quantitative. Our alma mater emphasized the need for evidence-based, data-driven conclusions; half-baked hypotheses and unconfirmed solutions were anathema. We were trained to use data whenever possible to confirm or refute claims that are too often evaluated through loose associations. As my marketing professor Dr. Eric Bradlow frequently reminded us as we sifted through analyses, “The math does not lie.”
Since 2007-08, central banks have implemented several policies designed to offset anemic consumer trends, reducing key interest rates and purchasing assets in the open market (via programs like quantitative easing) to help stimulate borrowing. Figure One shows five major central banks’ respective balance sheets, with each moving from the “lower left to the upper right” as banks have purchased sovereign bonds, mortgages, and other assets to try to keep rates down and spur economic output. Six years later, the world is in a very uneven place from a growth perspective, and differing regional responses highlight these variations.
Across disciplines, we spent considerable time pondering what psychologists call the “counterfactual” — loosely defined as what series of events would have transpired had a certain action occurred or not occurred. For example, me stating
In some regions, central bank activity can be characterized as consistent with recent policymaker activity. A centrally planned economy enduring growing pains in the form of property price volatility and high disparities between rich
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Figure One: Select Central Bank Assets (in millions) 2007–2012 $6,000,000 U.K. Monetary Policy Committee
$5,000,000
European Central Bank Bank of Japan U.S. Federal Reserve
$4,000,000
People's Bank of China
Source: St. Louis Fed, Bloomberg
$3,000,000
$2,000,000
$1,000,000
$0 2007
2008
and poor, China continues to offer the market mixed signals about its monetary policy intentions, thus retaining a somewhat neutral positioning relative to some of its peers. The European Central Bank (ECB) has also been in a holding pattern despite weak economic growth; Europe’s GDP dropped by 0.6% in the fourth quarter of 2012, with even the venerable Germany seeing its economy contract by the same amount, yet ECB President Mario Draghi has not budged on stimulus measures. Two major economies that appear to be in transition are the U.S. and the U.K., although they are seemingly heading in opposite directions. The latest U.K. Monetary Policy Committee (MPC) meeting revealed that the MPC, which is currently engaged in a stimulus program where the Bank
2009
2010
2011
2012
of England maintains a stock of £375 billion in asset purchases, was split on maintaining that asset purchase level with three of nine committee members (including outgoing leader Mervyn King) requesting even more asset purchases.2 In the U.S., where central bankers have committed to purchasing $85 billion per month in mortgage and Treasury bonds until the labor market improves, recent Fed-watch chatter has centered on when the Fed may start to scale back its purchases. While Fed Chairman Ben Bernanke has been adamant about a “full steam ahead” orientation, other Fed officials have been more tempered in their public appearances.
Abe campaigned on a platform of bold new action, and his newly installed Bank of Japan Governor Haruhiko Kuroda said he would do “whatever is needed” to combat persistent deflation.3 The central bank surprised markets in early April, communicating a two-year plan to reverse deflation with asset purchases on a large scale (the total size was nearly twice what prognosticators thought) and scope (asset purchases will not be limited to the bond market). Markets anticipated Abe’s accommodative policies, helping push the Nikkei stock index up more than 40% from mid-November 2012 to early April as the yen plummeted.
Japan recently switched to “full steam ahead” to the third power, committing to an aggressive monetary policy path after a decades-long economic malaise. Newly elected Prime Minister Shinzo
While central bankers cite economic growth as the end stimulus goal, it is important to make the distinction between economic growth and asset price returns (e.g., equity market
continued on page 18
17
continued from page 17
returns); several studies have analyzed long-run capital market and economic growth statistics and found very little relationship between GDP growth and stock market returns over time.4 The recent Japanese experience reflects these findings. Japanese economic fundamentals did not improve by more than 40% in the last four and a half months, and the Japanese equity market began its ascent long before Abe and Kuroda communicated their plan. Instead, market perceptions about future easy-money-policies took over, driving riskier asset classes higher before their efficacy is even proven. Similarly in the U.S., since 1994, “there has been a large and statistically significant excess return on equities on days of scheduled FOMC (Federal Open Market Committee) announcements,” according to a 2012 New York Fed staff report conducted by David Lucca and Emanuel Moench, providing empirical evidence that central bank policy moves markets.5 Seemingly, understanding the linkage between central bank policy and asset class returns is more important than what bearing central bank policy may have on broad economic growth. Or is it? Since central bank policy and economic growth are linked in the eyes of policy makers, and central bank policy and riskier asset class returns are empirically linked, by implication we may be in a period where economic growth and riskier asset class returns demonstrate a relationship, although they could move in opposite directions. If economic growth returns in earnest, central banks like China and the U.S. may be reticent
to push forward with or continue stimulative policies, which could hurt stock prices if investors view policy makers’ easy-money departure as premature. If growth is weaker than expected or desired, central banks may step up asset purchases and other easy-money policies, supporting riskier asset classes. In other words, seemingly good economic news may be interpreted as bad for equity prices if markets don’t perceive it to be good enough. This, of course, assumes reasonable expectations for corporate profits and riskier asset class valuation doesn’t get out of hand. So, what is our investment strategy in a world with a few too many potential histories? What counterfactuals should we focus on to benefit client outcomes, and will markets be driven by perceptions about future actions or more focused on the present? In addition to an intense focus on valuation, we continue to center on central bank policy, leading economic indicators, and market psychology. We see the glass as half full for asset classes to ascend higher, and we do not share the consensus view that interest rates will be on a potentially quick upward trajectory, hurting bondholders as they rise. Given how uneven the world is — and potential histories subject to central banks treading where the data has not yet traveled — gearing for more growth, while being respectful of downside potential, particularly after such strength across many asset classes since late 2012, is our baseline mindset heading into the second quarter, a mindset we deem appropriate for gearheads, bean counters, and poets alike.
Sources: 1
Taleb, Nassim Nicholas. The Future Has Thicker Tails than the Past: Model Error as Branching Counterfactuals (May 23, 2011). NYU Poly Research Paper. Available at SSRN: http://ssrn.com/abstract=1850428 or http://dx.doi.org/10.2139/ssrn.1850428
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2
http://www.bankofengland.co.uk/publications/minutes/Documents/mpc/pdf/2013/mpc1303.pdf
3
http://www.nytimes.com/2013/03/05/business/global/05iht-yen05.html
4
See for example Inker, Ben. Reports of the Death of Equities Have Been Greatly Exaggerated (GMO White Paper, August 2012).
5
http://libertystreeteconomics.newyorkfed.org/2012/07/the-puzzling-pre-fomc-announcement-drift.html
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index returns
2000
2001
2002
2003
2004
Small Cap Value
Small Cap Value
Fixed Income
Small Cap Growth
Mid Cap Value
22.83%
14.02%
9.84%
48.54%
23.70%
14.02%
Mid Cap Value
Fixed Income
Cash
Small Cap Value
Small Cap Value
19.18%
8.96%
46.03%
Mid Cap Value
Fixed Income
Cash 3.64%
10.12%
2007
2008
2009
2010
2011
2012
YTD 2013
Large Cap Growth
Fixed Income
Mid Cap Growth
Small Cap Growth
Fixed Income
Mid Cap Value
Mid Cap Value
26.86%
11.81%
5.08%
46.29%
29.09%
7.84%
18.51%
14.21%
Mid Cap Value
Small Cap Value
International Equities
Cash
Large Cap Growth
Mid Cap Growth
Large Cap Growth
Small Cap Value
Small Cap Growth
22.25%
12.65%
23.48%
11.63%
37.21%
26.38%
2.64%
18.05%
13.21%
Mid Cap Growth
International Equities
Mid Cap Growth
Large Cap Value
Mid Cap Growth
Small Cap Value
Small Cap Growth
Mid Cap Value
Large Cap Value
International Equities
Large Cap Value
-9.64%
42.71%
20.70%
12.10%
22.25%
11.43%
-28.92%
34.47%
24.75%
0.39%
17.90%
12.31%
Cash
Large Cap Value
Small Cap Value
17.51%
11.63%
1.68%
2005
2006
International International Equities Equities
1.51%
Large Cap Value
Mid Cap Value
Small Cap Value
International Equities
Large Cap Value
Large Cap Value
Mid Cap Value
Fixed Income
Large Cap Value
Mid Cap Value
Small Cap Value
7.02%
2.33%
-11.42%
39.17%
16.49%
7.05%
20.22%
7.39%
-36.85%
34.21%
24.50%
Cash
Large Cap Value
Large Cap Value
Mid Cap Value
Mid Cap Growth
Large Cap Growth
Small Cap Growth
Small Cap Growth
Mid Cap Value
International Equities
Large Cap Growth
Mid Cap Value
Mid Cap Growth
Mid Cap Growth
-5.59%
-15.52%
38.07%
15.48%
5.26%
13.35%
7.05%
-38.44%
32.46%
16.71%
-1.38%
15.81%
11.51%
Mid Cap Growth
Small Cap Growth
International Equities
Large Cap Value
Small Cap Growth
Small Cap Value
Mid Cap Growth
Cash
Large Cap Growth
Small Cap Value
Large Cap Value
Mid Cap Growth
Large Cap Growth
Large Cap Growth
-11.75%
-9.23%
-15.66%
30.03%
14.31%
4.71%
10.66%
-38.44%
20.58%
15.51%
-1.65%
15.26%
9.54%
International Equities
Mid Cap Growth
Mid Cap Growth
Large Cap Growth
Large Cap Growth
Small Cap Growth
Large Cap Growth
Large Cap Value
Small Cap Growth
Large Cap Value
International Equities
Small Cap Growth
Small Cap Growth
International Equities
-13.96%
-20.15%
-27.41%
29.75%
6.30%
4.15%
9.07%
-0.17%
-38.54%
19.69%
8.21%
-2.91%
14.59%
5.23%
Large Cap Growth
Large Cap Growth
Large Cap Growth
Fixed Income
Fixed Income
Cash
Cash
Mid Cap Value
International Equities
Fixed Income
Fixed Income
Small Cap Value
Fixed Income
3.35%
5.08%
Fixed Income
Fixed Income
6.36%
-22.42%
-20.42%
-27.88%
Small Cap Growth
International Equities
Small Cap Growth
-22.43%
-21.21%
-30.26%
4.31%
3.04%
Cash
Cash
1.05%
1.44%
1.58%
4.08%
4.71%
-1.42%
-43.06%
Small Cap Value
Mid Cap Growth
-9.78%
5.89%
-5.50%
Cash
Cash
International Equities
0.21%
0.13%
5.24%
-44.32%
0.10%
4.22%
Cash 0.11%
-11.73%
Cash 0.02%
Fixed Income -0.12%
Small-Cap Value Stocks (Russell 2000 Value)
Large-Cap Value Stocks (Russell 1000 Value)
International Equities (EAFE)
Small-Cap Growth Stocks (Russell 2000 Growth)
Mid-Cap Growth Stocks (Russell Mid-Cap Growth Index)
Fixed Income (Barclays Capital U.S. Intermediate Govt./Credit)
Large-Cap Growth Stocks (Russell 1000 Growth)
Mid-Cap Value Stocks (Russell Mid-Cap Value Index)
Cash (Merrill Lynch 3-Month Treasury Bill)
Sources: Markov Processes Inc., Bloomberg, Mobius
2013 1ST QUARTER ASSET CLASS RETURNS
2013 1ST QUARTER INDEX PERFORMANCE Q1 ’13
YTD ’13
2012
2011
2010
2009
2008
1-YEAR
3-YEAR
5-YEAR
S&P 500
10.61%
10.61%
16.00%
2.11%
15.06%
26.46%
-37.00%
13.96%
12.67%
5.81%
10-YEAR 8.53%
Dow Jones Industrial Average
11.93%
11.93%
10.24%
8.38%
14.06%
22.68%
-31.93%
13.37%
13.32%
6.50%
8.94%
8.21%
8.21%
15.91%
-1.80%
16.91%
43.89%
-40.54%
5.69%
10.86%
7.47%
9.31%
10.96%
10.96%
16.42%
1.50%
16.10%
28.43%
-37.60%
14.43%
12.93%
6.15%
8.97%
Russell 1000 Growth
9.54%
9.54%
15.26%
2.64%
16.71%
37.21%
-38.44%
10.09%
13.06%
7.30%
8.62%
Russell 1000 Value
12.31%
12.31%
17.51%
0.39%
15.51%
19.69%
-36.85%
18.77%
12.74%
4.85%
9.18%
Russell Mid-Cap Index
12.96%
12.96%
17.28%
-1.55%
25.48%
40.48%
-41.46%
17.30%
14.62%
8.37%
12.27%
Russell 2000
12.39%
12.39%
16.35%
-4.18%
26.85%
27.17%
-33.79%
16.30%
13.45%
8.24%
11.52%
Russell 2000 Growth
13.21%
13.21%
14.59%
-2.91%
29.09%
34.47%
-38.54%
14.52%
14.75%
9.04%
11.61%
Russell 2000 Value
11.63%
11.63%
18.05%
-5.50%
24.50%
20.58%
-28.92%
18.09%
12.12%
7.29%
11.29%
MSSCI Europe, Australia, Far East
5.23%
5.23%
17.90%
-11.73%
8.21%
32.46%
-43.06%
11.79%
5.49%
-0.40%
10.19%
Wilshire REIT Index
7.43%
7.43
17.59%
9.24%
28.60%
28.60%
-39.20%
14.02%
17.35%
6.32%
12.23%
NASDAQ Composite Russell 1000
Barclays Govt. Intermediate Bond
0.14%
0.14%
1.73%
6.08%
4.98%
-0.32%
10.43%
2.26%
3.91%
3.70%
4.02%
Barclays Corporate IG Bond
-0.11%
-0.11%
9.82%
8.15%
9.00%
18.68%
-4.94%
7.47%
8.12%
7.88%
6.05%
Barclays Aggregate Bond
-0.12%
-0.12%
4.22%
7.84%
6.54%
5.93%
5.24%
3.77%
5.52%
5.47%
5.02%
Barclays Intermediate Govt./Credit
0.26%
0.26%
3.89%
5.80%
5.89%
5.24%
5.08%
3.53%
4.75%
4.61%
4.49% 10.12%
Barclays High Yield
2.89%
2.89%
15.81%
4.98%
15.12%
58.21%
-26.16%
13.13%
11.24%
11.65%
90-Day U.S. Treasury
0.02%
0.02%
0.11%
0.10%
0.13%
0.21%
2.06%
0.12%
0.11%
0.34%
1.75%
1.25%
1.25%
1.74%
2.96%
1.50%
2.72%
0.09%
1.34%
2.22%
1.71%
2.35%
Consumer Price Index (Inflation)
Sources: Morningstar, Mobius, MPI
INDICES
The information contained in this report is from sources believed to be reliable, but are not warranted by CAPTRUST Financial Advisors to be accurate or complete. Index performance depicts historical performance and is not meant to predict future results.
19
investment asset classes
U.S. EQUITIES Market Performance, 1st Quarter 2013
• U.S. stocks closed at record levels in the first quarter. U.S. large-cap stocks rose 10.6%, shrugging off calendar 2012 Q1-13
2012
Large Value (R1000 Value)
12.31%
17.51%
Large Blend (S&P 500)
10.61%
16.00%
2012 momentum, once again leading their small- and
Large Growth (R1000 Growth)
9.54%
15.26%
large-cap peers in total returns.
Mid Value (Russell)
14.21%
18.51%
Mid Blend (Russell)
12.96%
17.28%
Mid Growth (Russell)
11.51%
15.81%
Small Value (R2000 Value)
11.63%
18.05%
Small Blend (R2000 Blend)
12.39%
16.35%
Small Growth (R2000 Growth)
13.21%
14.59%
year-end fiscal cliff concerns. Mid- and small-caps were up 13% and 12.4%, respectively. Mid-caps continued their
• All 10 major S&P 500 sectors were positive in the first Source: MPI Stylus Pro
quarter, but surprisingly the best sectors were historically defensive in nature. Health care (+15.8%), consumer staples (+14.6%), and utilities (+13%) were sector leaders, while traditionally higher beta sectors like technology (+4.6%) and materials (+4.8%) lagged. • Since the U.S. equity market touched its March 2009 low, large-caps, mid-caps, and small-caps are up 153%, 204%, and 193%, respectively, including reinvested dividends.
INTERNATIONAL EQUITIES Market Performance, 1st Quarter 2013
• Developed and emerging international equities had mixed performance to start the year, with developed up 5.23% in Q1-13
2012
International Equities (MSCI EAFE)
5.23%
17.90%
The developed-equity-focused MSCI EAFE Index has
Pacific Stocks (MSCI Pacific Ex-Japan)
7.05%
24.74%
been higher 13 out of the last 16 quarters, while the MSCI
European Stocks (MSCI Europe Ex-UK)
3.01%
22.54%
Japanese Stocks (MSCI Japan)
11.70%
8.36%
UK Stocks (MSCI UK)
2.49%
15.30%
Emerging Markets (MSCI EME)
-1.57%
18.63%
Source: MPI Stylus Pro
U.S. dollar terms but emerging market stocks down 1.6%.
Emerging Markets Index has been higher 12 out of the last 17 quarters. • Japan was a significant outlier within developed equities, closing up 11.7% in dollar terms but almost twice that percentage in yen terms. Market participants anticipated aggressive monetary policy from new Japanese central bank leadership, which arrived after the quarter ended. European performance was mixed in the quarter with Cyprus-driven fears subsiding toward the quarter’s conclusion. • Emerging markets were noticeably weak for the quarter with China (-4.5%), Russia (-3.2%), India (-2.6%), and Brazil (-0.8%) all posting negative returns as investors questioned growth trajectory after the sharp equity market run-ups in 2012 for most emerging market indices.
20
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FIXED INCOME Market Performance, 1st Quarter 2013
• The Barclays Aggregate Bond Index fell for only the second quarter out of the past 18, shedding a mere 0.1%. 2012
Broad Market (Barclays Capital U.S. Aggregate)
-0.12%
4.22%
Barclays Capital U.S. Treasurys
-0.19%
1.99%
Barclays Capital Mortgage Backed Securities -0.05%
2.59%
Barclays Capital Municipals
0.29%
6.78%
Barclays Capital Intermediate Corporates
0.57%
8.84%
Barclays Capital High Yield
2.89%
15.81%
The index has not had a negative annual return in 13 years. • Within the broad fixed income space, historically riskier Source: MPI Stylus Pro
Q1-13
parts of the bond market were mixed this past quarter, despite the run-up in global stocks, with emerging market debt falling 1.5% but high yield rising almost 3%. Treasurys, investment-grade corporates, and mortgages were mostly flat. • Despite relentless calls for interest rates to rise and a “great rotation” out of bonds following a nearly 40-year bull market, early 2013 fund flow data suggests that bond flows remain sticky with investors continuing to allocate net new capital into the asset class.
HEDGE FUNDS / PRIVATE EQUITY Market Performance, 1st Quarter 2013
• Hedge fund strategies posted a solid start to 2013, with the HFRX Global Hedge Fund Index posting a 3.3% return 2012
HFRI Fund Weighted Composite Index
2.86%
6.38%
HFRI Equity Hedge Index
3.47%
7.42%
HFRI Relative Value Index
3.68%
10.59%
HFRI Fund of Funds Composite Index
2.34%
4.79%
HFRI Fund of Funds Conservative Index
1.65%
4.21%
through the end of March. • Global macro remained a challenging subcategory after losing 1% for 2012 and registering weak 2010 and 2011 Source: HFRI
Q1-13
calendar years as global central bank policy and unstable trends plagued managers. Equity-hedged strategies were strong in the first quarter with returns comparable to long-only global equity indices. • Alternatives research firm Prequin highlights that private equity fundraising was strong for the first quarter, with total capital raised expected to be similar to 2012’s first quarter. Based on survey data, it appears interest in large- to mega-market deals is increasing, as is interest in secondary funds.
21
COMMODITIES Market Performance, 1st Quarter 2013 Q1-13
2012
Dow Jones UBS Commodity Index
-1.13%
-1.06%
S&P GSCI Commodity Index
0.55%
0.08%
-4.62%
6.33%
Natural Gas (U.S. Spot Henry Hub)
11.67%
14.95%
Crude Oil (U.S. Spot, WTI Cushing)
5.89%
-7.09%
Gold (Spot, $/oz)
Sources: MPI Stylus Pro, Bloomberg
• The Dow Jones UBS Commodity Index fell 1.1% in the first quarter after a disappointing 2011 and 2012. Dollar strength did not help the broad index to start 2013. • At the sub-index level, energy was strong thanks to a mid-quarter rally in oil and natural gas strength. Industrial metals fell 7.8%, agriculture dropped 3.2%, and livestock fell 6.4%. • Precious metals were also hit by dollar strength with the index falling 5.5% after posting a 6% return in 2012. Individually, silver and gold flirted with bear territory as both metals have fallen close to 20% from all-time highs.
Market Performance, 1st Quarter 2013 Q1-13
2012
MSCI U.S. REIT Index
8.07%
17.77%
Wilshire REIT Index
7.43%
17.59%
Source: MPI Stylus Pro
REAL ESTATE • Public real estate, as measured by the NAREIT Equity REIT index, increased 8.1% in the first quarter after returning 3.1% in Q4 2012. REITs underperformed U.S. equities for only the third quarter out of the last eight. REITs are up a staggering 204.6% cumulatively over the past 10 years. • Capital raising continues to be robust for REITs, with NAREIT data showing that REITs raised $22.6 billion of total capital thus far in 2013, with $16.1 billion in equity. This total exceeds the capital amounts raised in the fourth quarter of 2012 as well as the first quarter of last year. • Several REIT subsectors exhibit attractive fundamentals based on changes in buyer behavior, but cap rates and other valuation metrics reflect strong REIT performance coming out of 2012 and into the new year.
22
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PLAN SPONSOR | Q1 13
captrust news
CAPTRUST GROWTH CAPTRUST started 2013 with a new addition to our advisory team in Clarkston, Michigan. Mary Draayer joined CAPTRUST as a Financial Advisor, Relationship Manager, and is responsible for building relationships and meeting existing client needs in the institutional retirement market. Prior to joining our firm, she worked at the Principal Financial Group as senior relationship manager for more than 30 years. Mary studied accounting at Iowa State University.
RECOGNITION
GIVING BACK
Ronald McDonald House, February 2013
We are honored to have helped support these charities throughout the first quarter of 2013: • Junior Achievement of Eastern North Carolina
Todd Jones, CAPTRUST Senior Vice President and Financial Advisor, was recently named one of the Triangle Business Journal’s “40 Under 40,” a list of professionals from the Raleigh, NC, area under the age of 40 who are recognized for their outstanding contributions to their organizations and the community.
• Autism Society of Ohio • Special Olympics of North Carolina • American Liver Foundation • NC Coalition Against Sexual Assault • Boys and Girls Club of Las Vegas • Starfish Family Services • Big Brothers Big Sisters of the Triangle • Lucy Daniels Center • Seedlings Braille Books • St. Baldrick’s Foundation
CONGRATULATIONS
• John Owen’s Adventure • Muscular Dystrophy Association • East Coast Migrant Head Start Project • MeFine Foundation • Myco • Assistance League of the Triangle
On January 30, 2013, LipoScience, Inc., a medical diagnostics company pioneering a new field of personalized diagnostics based on nuclear magnetic resonance technology, closed a successful initial public offering of 5,000,000 shares of common stock at a price to the public of $9 per share. Headquartered in Raleigh, NC, LipoScience employs approximately 200 employees in the United States. The company’s common stock is listed on the NASDAQ Global Market under the trading symbol LPDX.
• Frankie Lemmon School • 200 Club of Wake County • West Johnson High School Band Program • The Miracles of Mitch Foundation • Junior Achievement of Central Virginia • Ronald McDonald House of Chapel Hill • Duke Children’s Hospital
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PLAN SPONSOR | Q1 13
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UPCOMING INDUSTRY INVOLVEMENT The following is a list of topical discussions to
May 15, 2013 | Bedford, VA
be led or attended by CAPTRUST at upcoming
Council of Independent Colleges in Virginia Spring Conference
industry events in the second quarter of 2013. May 2, 2013 | San Francisco, CA Western Pension Benefits Council Spring Conference Participant Engagement Moderator: Karen Casillas, Financial Advisor
Enhancing Retirement Readiness through a Focus on Total Retirement Speaker: Beryl Ball, Financial Advisor June 4, 2013 | Chicago, IL PLANSPONSOR National Conference
May 7, 2013 | Greensboro, NC North Carolina Association of CPAs Enhancing Retirement Readiness through a Focus on Total Retirement Speaker: Shaun Eskamani, Financial Advisor
Retirement Income Speaker: John Pickett, Financial Advisor 401(k) Boot Camp Speaker: Phyllis Klein, Senior Director Target Date Fund Environment Speaker: Pam Popp, Financial Advisor
May 8, 2013 | New Orleans, LA SouthWest Benefits Association Annual Meeting
June 4, 2013 | Chicago, IL
Stable Value and Cash Equivalent Landscape Speaker: Marshall Cobb, Financial Advisor
Mid-Sized Retirement & Healthcare Plan Management Conference
Quantifying Success for Your 401(k) Plan Moderator: Marshall Cobb, Financial Advisor
Enhancing Retirement Readiness through a Focus on Total Retirement Speaker: Jason Stanicek, Financial Advisor
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The opinions expressed in this report are subject to change without notice. This material has
material in this publication may be reproduced
been prepared or is distributed solely for informational purposes and is not a solicitation
in any form without the express written
or an offer to buy any security or instrument or to participate in any trading strategy. The
permission of CAPTRUST: 919.870.6822.
information and statistics in this report are from sources believed to be reliable but are not warranted by CAPTRUST Financial Advisors to be accurate or complete. Performance
©2013 CAPTRUST Financial Advisors
data depicts historical performance and is not meant to predict future results. CAPTRUST Financial Advisors, Member FINRA/SIPC.
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