PLAN SPONSOR | Q2 13
Strategic research report Applying Fiduciary Leadership™ Notes from the 2013 PLANSPONSOR National Conference Scott Matheson, CFA, CPA Senior Director, CAPTRUST Consulting Research Group
Dan DiGiacomo Vice President, CAPTRUST Financial Advisor
Several CAPTRUST professionals attended this past June’s PLANSPONSOR National Conference in Chicago, themed “Designing Retirement Plans That Work: Getting from Where You Are to Where You Want to Be.” For those unable to attend this annual event for plan sponsors, we wanted to share highlights from this year’s sessions to keep you abreast of what the industry and, perhaps more importantly, your plan sponsor peers are discussing. As the conference title suggests, topics focused on creating and managing outcome-oriented retirement plans. TransAmerica Retirement President of Pension Sales and Distribution Stig Nybo’s keynote titled “Will You (b)e O(k)?” challenged attendees not only to acknowledge America’s retirement readiness problem but also to accept the retirement industry’s responsibility to change behavior and drive better outcomes. Nybo’s presentation focused on the need to transform people’s context in order to transform their behavior. He insisted change was needed if defined contribution plans are going to work as Americans’ primary retirement savings vehicle. His comments successfully set the tone that outcomes matter for the rest of the conference. Similar to Nybo, we insist successful defined contribution plans are those with high participation levels, adequate deferral rates, and well-invested participants.
In This Issue Letter from the Editor
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Plan Sponsor Highlights
6
Investment Strategy
15
Index Returns
19
Investment Asset Classes
20
CAPTRUST News
23
As we listened and participated in this year’s conference sessions (CAPTRUST subject matter experts presented in six sessions), we couldn’t help but note how many components of our recently introduced Fiduciary Leadership program were represented by speakers. Yet, missing was the integration of each of the pillars; in other words, plan design is great and helpful but must be combined with the right investment menu and education or advice program to be truly successful. And, of course, a sound fiduciary process and well-priced and managed provider relationship must persist for true leadership status. ™
On page three we highlight some of the components of the five pillars noted this June in Chicago and look forward to discussing how the Fiduciary Leadership framework can be integrated into your plan. ™
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LETTER FROM THE EDITOR
HALFTIME! Dear Readers, It’s hard to believe that the year is more than half over; it seems like just yesterday that fiscal cliff headlines dominated the newswires, basketball personality Dennis Rodman embarked on his first diplomatic mission to North Korea, and my kids were still in school. 2013’s first half was busy enough for everyone. As always, our goal is to provide institutional clients with content that is both timely and actionable given the many crosscurrents enveloping the investment and regulatory climate. Bond market volatility was a significant second quarter development, with fixed income securities hurt by the anticipated Federal Reserve asset purchase slowdown. I explore this issue through an update to an intra-quarter piece we put out in response to the recent Fed communique. I also discuss portfolio construction and asset class performance in my regular Investment Strategy article. CAPTRUST’s Grant Verhaeghe, who leads our defined benefit plan practice, teams up with Joe Litka from October Three and discusses cash balance plans coming out of 2006’s Pension Protection Act. Grant and Joe highlight that market rate cash balance plans can provide a core retirement solution used in conjunction with a defined contribution plan — and that these plans may be poised to become popular beyond professional services organizations. Back by popular demand, Scott Matheson, head of our defined contribution business, and CAPTRUST advisor Dan DiGiacomo recap the 2013 PLANSPONSOR National Conference, weaving in themes from our Fiduciary Leadership framework that readers should find helpful when thinking of their own plans. If we can follow up with specifics on any highlighted session, please don’t hesitate to let us know. ™
We will keep you apprised of what will be an exciting finish to 2013, including whether or not Rodman takes home the Nobel Peace Prize for which he is currently angling. As my teenager would say, don’t hold your breath. Onward,
Eric J. Freedman CAPTRUST Chief Investment Officer
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Plan Design ™
Plan design is the first Fiduciary Leadership pillar and one of the most influential tools driving plan outcomes, as it can be impactful in getting participants in the plan and saving enough. The most noteworthy session at the conference on the topic was titled “Automating Success.” The presenters noted that plan sponsors are seeing meaningful increases in participation and deferral rates in their plans as auto-feature utilization continues to take root. According to the Plan Sponsor Council of America’s (PSCA’s) 55th annual survey, 49 percent of respondents used automatic enrollment as of plan year 2011 versus only 8 percent in plan year 2004. As plan sponsors experience successful changes in participant behavior through these programs, they quickly entertain additional plan design changes like automatic increases in deferral rates. Some plan sponsors are going even further, opting to reenroll existing participants (or eligible employees) who were hired before automatic enrollment features were implemented. The panelists believe that using automatic features will increase in the future and positively affect participant outcomes. We could not agree more. Participant Engagement Engaging participants continues to challenge the plan sponsor community and the efficacy of participant-directed retirement plans. The session “Participant Behavior and What It Means to Maximize It” explored participant retirement plan engagement levels and what can be done to improve them. Similar to our Fiduciary Leadership message, the session suggested that using averages can lead to the wrong conclusions and instead encouraged attendees to focus on participant personas as a way to develop tailored retirement messages more likely to hit their mark. ™
Additional sessions focused on engaging participants included “Metric Taking” and “Financial Wellness at the Workplace.” The dialogue is evolving between companies and their participants; today’s successful strategies reach and impact multiple, specific employee cohorts rather than solving for the average participant (who rarely exists). Gone are the days of general education presentations, with a movement toward custom integrated campaigns driven by social networking,
We know that when CAPTRUST is engaged to provide one-on-one participant advice, participants take action following an advice session more than 50 percent of the time.
mobile device apps, and retirement income calculators. Our view is that — while it is appealing to sign on with the new regime of “auto everything”— employees engaged in their savings and investing decisions benefit from targeted outreach and advice. As evidence, we know that when CAPTRUST is engaged to provide one-on-one participant advice, participants take action following an advice session more than 50 percent of the time. continued on page 4
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were “Target Practices: Are TDFs on Target?” and “Build or Buy,” a session on the pros and cons of custom target date funds. With interest rates hovering near historic lows and a consensus building that the next movement in rate levels is higher, plan sponsors are increasingly concerned about the fixed income and stable value options in their plans. The session “Stable as It Goes” featured three panelists from the industry discussing the differences and attributes of stable value products, considerations for the asset class, and benchmarking tips. Investment Menu As is often the case, the investment menu receives the lion share of time at industry events, and this conference was no exception. The four most discussed investment topics this year included target date funds, stable value, fees, and alternative investment options. Per the 55th annual Plan Sponsor Council of America’s Survey of 401(k) and Profit Sharing Plans, 69 percent of defined contribution plans in the United States now offer target date funds, with an increasing majority using them as a qualified default investment alternative (QDIA). Following the growth of target date funds, and this year’s Department of Labor Tips for ERISA Plan Fiduciaries release, evaluating these programs was top of mind for many at the conference. Some of the most well-attended sessions
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Fiduciary Process Management For a fiduciary leader, fiduciary process management is about more than simply having and following a prudent process; it entails managing your retirement plan as if it were a chess game, thinking two to three moves ahead. Sessions on topics ranging from “Fiduciary Fundamentals: Best Practices to Stay Out of Trouble” to a keynote titled “401(k)s Under Attack” outlined emerging trends in plan management and procedural prudence that plan sponsors might want to be aware of.
According to the PSCA's Survey Fees were once again a hot topic at this year’s conference. Fee fairness or fee leveling, as it relates to the equity of revenue sharing that is common in defined contribution plan lineups, remain a focal point. Additionally, meaningful debate ensued over the use of active versus passive management in defined contribution plan lineups—the case for passive temporarily bolstered by the difficulties faced by active managers over the past four years. Finally, regarding investment menu construction, “Thinking Outside the Box” explored the latest in investment alternatives and asset allocation tools and funds. Speaking of nontraditional investment offerings, presenters on the “Inside or Out” panel explored the pros and cons of retirement income solutions as an option inside a defined contribution plan versus a rollover solution.
of 401(k) and Profit Sharing Plans, 69 percent of defined contribution plans in the United States now offer target date funds, with an increasing majority using them as a qualified default investment alternative (QDIA).
On the legislative front, presenters expressed concerns that the retirement industry finds itself squarely in the crosshairs of lawmakers as they seek politically palatable ways to lessen the budget deficit. Many proposals have already found their way onto the floor of the U.S. Congress, and panelists expect to hear more by year’s end. Beyond that, experts anticipate continued regulatory
PLAN SPONSOR | Q2 13
focus on fee transparency and disclosure for projected participant income streams. The updated fiduciary definition remains a wildcard, with resolution expected later in 2013. Vendor Management Vendor management was woven through many of the sessions at this year’s conference, with particular focus on the aftermath of fee disclosure. In the sessions “After Fee Disclosure: Negotiating a Better Deal” and “Fees: What Is Reasonable and What Is Required” panelists consistently advised sponsors to follow a routine and scheduled methodology to evaluate service providers paid by plan assets. Part of this process includes interviewing vendors to appropriately document fees and services provided. Leveraging the scale and resources of your providers as a way to maximize results was a vendor management opportunity highlighted in several sessions. “Time for a Change” featured a panel discussion on what to do if you have issues with your current provider, focusing on techniques to fix your current relationship and conduct a provider search. Panelists suggested such strategies as establishing an annual calendar of events, requesting changes to your relationship management team, and leveraging thirdparty consulting relationships as ways to improve a strained provider relationship.
Until Next Year As we strive for enhanced participant outcomes, we continue our focus on getting employees in the plan, getting them saving enough, and getting them invested well. Success across all three of these facets drives successful defined contribution plans and retirement-ready participants. At the conference, during the session titled “Creating a Successful Retirement Plan,” responses from the audience of over 200 plan sponsors provided some bleak statistics including: •
82 percent of plan sponsor respondents have no definition of success for their plans
•
50 percent have no written goal for their plans
•
86 percent do not track “retirement readiness”
Participant outcomes will only improve if we work together as plan sponsors and advisors to define plan goals, implement processes to affect positive change, and measure our progress. So until next year’s conference we’ll be working to further educate our clients on the tenets of Fiduciary Leadership and driving participant outcomes. We look forward to discussing any and all of these topics with you. ™
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PLAN SPONSOR HIGHLIGHTS
DEFENSE OF MARRIAGE ACT FINDINGS IMPACT PLAN DISTRIBUTIONS Phyllis Klein Senior Director, CAPTRUST Consulting Research Group
In late June, the U.S. Supreme Court declared a portion of the Defense of Marriage Act (DOMA) unconstitutional, which will likely result in changes to how retirement benefits are handled in the cases of divorce and death. These changes will also likely affect beneficiary regulations and spousal rights at the time of certain distributions.
What to Expect: • Both the Internal Revenue Service and the Department of Labor will issue guidance for processing benefits for same-sex couples. • Employers will need to put in place new procedures for identifying same-sex couples, processing distributions, and providing spousal rights according to the new rules. • Pension plans will need to consider that same-sex partners may be entitled to joint and survivor benefits. • Defined contribution plans require that the spouse receive one-half of the death benefit if the right to receive it has not been waived. • Many defined contribution plan documents provide that if a participant dies without having named a beneficiary, then the spouse is the first beneficiary in the hierarchy, often followed by the children, parents, and estate. It will be important to understand who the legal spouse is, in light of this ruling, before paying out benefits. • States differ as to whether or not they recognize same-sex marriage, so identifying a legal spouse will be an issue for employers who have employees in a wide variety of states or employees who move among states.
There are still many outstanding questions about how the rollback of DOMA provisions will impact the benefits landscape. We will do our best to keep you informed as we learn more. In the meantime, please contact your financial advisor with specific questions or to request more information.
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PLAN SPONSOR | Q2 13
WHAT’S NEXT FOR THE BOND MARKET? Eric J. Freedman CAPTRUST Chief Investment Officer
Figure One: “All Things Yield” Q2 2013 Performance 3%
2.0% 0%
-3.0%
-3.2%
-3%
-6%
-3.3%
-7.0%
-9% BarCap Aggregate Bond Index
BarCap Municipal Bond Index
BarCap BarCap U.S. U.S. Corporate Treasury: U.S. High Yield Treasury TIPS Index Index
Following a 30-plus-year bull market in the fixed income or bond market, the path forward is much more uncertain. While investors await the next move for fixed income, unless bond prices move higher (and, by definition, bond yields move lower), historically low interest rates indicate that bonds will offer lower total returns than most bond investors have experienced during recent periods. May 2013 represented the worst monthly return for the bond market
S&P U.S. Preferred Stock Index
Alerian MLP Index
Source: Bloomberg, Zephyr
Return
-1.4% -2.3%
Dow Jones U.S. Real Estate Index
since the 2008 financial crisis, with the Barclays Capital Aggregate Bond Index (BarCap Agg) losing 1.78 percent. Fears that the U.S. Federal Reserve would soon begin to rein in its bond-buying program hurt fixed income in general. The 10-year Treasury yield rose from 1.64 percent on May 1 to 2.16 percent on June 1, which in percentage terms was the largest month-over-month increase in yield history. The 10-year Treasury continued its rise in June,
Figure Two: U.S. 10-Year Treasury Yields (January 2010–June 2013) 4.0% Source: Robert Shiller, U.S. Treasury, Bloomberg
3.5% 3.0%
Yield
2.5% 2.0% 1.5% 1.0% 0.5% 0% 2010
2011
2012
reaching a high of 2.66 percent before closing the quarter at 2.48 percent. Many yield-sensitive asset classes and sectors fell in sympathy, including corporate bonds, municipal bonds, public real estate, utility stocks, and master limited partnerships. For the quarter, the BarCap Agg was down 2.32 percent. “All things yield” appeared vulnerable as government bond prices sold off and interest rates moved higher. Where Will Interest Rates Go from Here? Looking at Figure Two, one can see that since the summer of 2011, 10-year Treasury yields have been firmly below 3 percent. This is due to global central banks’ active suppression of interest rates through buying fixed income securities in the open market in an attempt to encourage lending and spark economic activity. However, the U.S. Federal Reserve has recently hinted that those open market purchases could begin to slow, leaving investors to question who will replace the Fed and buy bonds. This speculation led to the second quarter’s weak bond market returns. Per Figure Two, it appears we are approaching interest rate levels that are halfway between the lows seen in the summer of 2012 and the higher levels seen before the summer of 2011. From here, rates can do one of three things: move lower, remain flat, or move higher.
2013
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•
Rates move lower This scenario could happen for several reasons, most likely driven by economic weakness that causes the Fed and other central banks to continue their bond purchases. Sticky unemployment, a slowing China, continued European market malaise, and weaker equity and riskier asset classes could all cause this development. While this may seem implausible given where interest rates sit right now, we have seen them at even lower levels; the 10-year Treasury touched below 1.4 percent in July 2012, a full percentage point lower than today.
•
Rates remain flat A goldilocks economy — growing neither too fast nor too slow — where inflation remains tame (the Bureau of Labor Statistics notes that month-over-month change in the Consumer Price Index has fallen over the past two months) and employment and wage growth remain tepid could cause interest rates to hover at or near current levels.1
•
Rates move higher An economy showing resilience, the Fed backing off its recent bond purchase trend (or anticipation thereof), inflationary pressures, or asset allocation movement toward riskier asset classes or foreign bonds could all drive interest rates higher. As described earlier, rising prevailing interest rates tend to hurt bondholders.
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Figure Three: Periods Where 10-Year Treasury Yields Increased More Than 0.3% and Corresponding Barclays Capital Aggregate Index Returns, 1979–2013
Dates
Number of Months
Increase in the 10-year Treasury Yield
BarCap Agg Total Return
6.1.79–2.28.80
9
3.81%
-10.73%
6.1.80–8.31.81
15
5.63%
-5.81%
5.1.83–5.31.84
13
3.42%
-0.85%
1.1.87–9.30.87
9
2.51%
-2.88%
10.1.93–10.31.94
13
2.48%
-3.07%
1.1.96–5.31.96
5
1.20%
-2.53%
10.1.98–12.31.99
15
1.91%
-0.40%
3.1.04–4.30.06
26
1.22%
1.83%
12.1.08–3.31.10
16
1.41%
8.76%
5.1.13–5.31.13
1
0.52%
-1.78%
Our base case scenario is for rates to rise, but to do so at a gradual pace over the next 18 to 24 months subject to numerous fits and starts depending on the economy’s health and central bank involvement. If we are wrong, we suspect it will be because a move higher happens faster than we expect — perhaps accelerated by investor overreaction to market news. The Need to Gauge Speed While higher interest rates could hurt bond investors, as Figure Three shows, rising yields do not always translate into bond investor losses. Two key variables will likely determine how acutely rising rates may impact bond investors: the magnitude of the rate increase and the speed at which rates increase. The higher rates move and the shorter the time period, the more painful the experience.
Source: Bloomberg, Zephyr
Let’s Explore the Case for Each Scenario:
PLAN SPONSOR | Q2 13
20% 10-year Treasury Yield (beginning of year) Barclays Aggregate (5-year forward return)
18%
16%
Yield/Return
14%
12%
10%
8%
6%
4%
2%
0% 1977
1982
1987
For example, from December 2008 through March 2010, the 10-year Treasury yield rose by almost 1.5 percentage points while the BarCap Agg returned more than 8.7 percent. This was the result of a modest rate increase (as a percent of the starting yield) and a timeframe long enough for coupon payments to outweigh the price decline. Also, because the BarCap Agg is a diversified index that includes corporate and mortgage bonds, some decoupling from government bonds may have occurred.
1992
1997
2002
By contrast, in May, a mere 0.5 percentage-point increase in 10-year Treasury yields set the bond market back as coupons failed to offset falling bond prices over such a truncated period. In addition, since interest rates are very low, the starting yield did not provide much of a cushion against higher rates. What Can Bond Investors Expect Moving Forward? CAPTRUST research suggests that current interest rates often portend future returns. As Figure Four displays,
2007
Source: Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2), Bloomberg
Figure Four: 10-Year U.S. Treasury Yield Vs. Barclays Capital Aggregate Index Five-Year Forward Return, 1977–2012
2012
the prevailing interest rate as measured by the 10-year Treasury provides a reasonable approximation of five-year forward annualized fixed income returns as measured by the BarCap Agg (note that forward returns starting in 2009 are for less than five years and are as of June 7, 2013). So, you would interpret the chart this way: in 1997, the 10-year Treasury started the year yielding 6.43 percent. During the period encompassing 1997–2002, the BarCap Agg delivered a 7.42 percent annualized return.
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Over time, the correlation between the 10-year Treasury’s starting yield and five-year forward return has been over 0.9, a strong, positive relationship. Correlation cannot be higher than 1.0, and a correlation of 0.6 to 0.7 is considered high. Therefore, given the 10-year Treasury’s current low level, if the relationship described holds, investors should expect bond portfolios to deliver lower nominal (non-inflationadjusted) returns than in prior periods.
•
Jerry Lanzotti, who comanages the Lord Abbett Total Return Fund, thinks the Fed is serious about tapering its bond purchase program and that interest rate volatility will persist along with consequent volatility in other asset classes.
•
Managers at Fidelity’s $13 billion Total Bond Fund are most focused on the Fed’s new data-driven approach. They believe, if the Fed tapers on the aggressive end of expectations, the worst case scenario for 10-year yields is a climb to 4 percent from their current mid-2-percent range. Given low core inflation and growth expectations, they expect a much slower climb in rates going forward.
•
Lastly, PIMCO’s Bill Gross believes the Fed’s economic outlook currently driving policy is too optimistic since inflation is running close to 1 percent. Given this view, in his opinion, the recent yield increase appears overdone.
Active Manager Investment Perspective We polled a diverse set of bond portfolio managers for their perspectives on the bond market since the Federal Reserve’s communication, and while their views are subject to change, their perspectives are as follows: •
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TCW MetWest’s Steve Kane, who comanages the $25 billion MetWest Total Return Fund, believes there is a 100 percent probability that the Fed will maintain its zero interest rate policy through 2013 — and a 95 percent probability through 2014.
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These perspectives reflect very conditional and temporal approaches and views, and investors may be left wondering what to do given the uncertain path.
PLAN SPONSOR | Q2 13
Investor Choices Generally speaking, bond investors have several options available to help combat the impact of rising interest rates on their portfolios:
Option One Do nothing. Either hold individual bonds to maturity and ignore price noise, mindful of credit quality, or rely on a diversified mix of bond funds with a long-term view. Remember, barring default, an unexpected early bond call, or poor trading, fixed income delivers positive absolute returns regardless of interest rate moves. Option Two Reduce interest rate sensitivity by raising cash or seeking shorter-maturity bonds or bond funds. Option Three Rotate away from fixed income and toward other asset classes while being mindful that other asset classes possess their own risks. Option Four Attempt to counteract adverse bond market movements through hedging techniques involving inverse bond exchange traded funds, options, or other tools. Option Five Adopt a combination of options two through four for a portion of the bond portfolio.
In summary, the bond market was especially volatile in the second quarter because of a significant rise in prevailing rates. While interest rates could move in any direction from here, we believe the path forward will most likely be a gradual rise over the next 18 to 24 months. In the end, bond returns will be impacted by the speed of any rate rise; the faster yields rise, the more adverse for investors. Investors can take a number of actions to reduce the potential interest-rate headwind; though, historically low interest rates have indicated that bond investors should expect total returns to be lower than recent years. We encourage you to reach out to your CAPTRUST financial advisor if you are interested in exploring concepts discussed in this article. Source: 1
http://www.bls.gov/cpi/cpid1304.pdf
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PLAN DESIGN AND INVESTMENT STRATEGIES FOR MARKET RATE CASH BALANCE PLANS Grant Verhaeghe Senior Director, CAPTRUST Consulting Research Group
Joe Litka Partner, Enrolled Actuary, Member of the Academy of Actuaries, October Three, LLC
Cash balance plans are a type of “hybrid” defined benefit plan that originated in the 1980s. Quite popular, their use has grown by over 500 percent over the last decade.2 During this time, many corporate plan sponsors converted their traditional annuity-based plans to cash balance plans, delivering tangible “account balance” benefits similar to popular and fast-growing 401(k) plans. Cash balance plans also became the preferred means for professional service firms to provide significant retirement benefits to their owners and partners.
The Pension Protection Act’s (PPA) passage in 2006 clarified the legal framework for cash balance pension plans. Since then, the Internal Revenue Service (IRS) has provided further guidance on the interest crediting rates plan sponsors can choose from in new tax regulations.1 This article explores the merits of several cash balance plan designs available under the “market rate rules” relative to traditional cash balance plans and why corporations might consider this plan design. Further, we provide a brief perspective on the inherent risks of various cash balance designs and issues to consider when developing investment strategies for them.
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While traditional cash balance plans reduce many of the risks associated with traditional defined benefit pension plans, they do not effectively address one important area — managing contribution volatility. This shortcoming is a result of the potential annual mismatch between the specified interest crediting rate on participant account balances and the actual return realized on underlying plan assets. Most traditional cash balance plan sponsors set the interest crediting rate equal to a Treasury rate published by the IRS. Typically, plan assets are invested to meet or beat this rate each year. However, any deviation in plan asset return from the interest crediting rate in a given year results in
contribution volatility. Plan sponsors with mature plans quickly learn that even a small deviation can result in significant contribution volatility. As a result, many plan sponsors opt to invest conservatively in an attempt to limit this volatility. The market rate cash balance plan design — the latest evolution of the cash balance structure — is quickly becoming the design of choice because it addresses the issue of contribution volatility. In addition to delivering all the beneficial features of the traditional cash balance plan, this design addresses investment risk by taking full advantage of the flexibility afforded under regulations. PPA cleared the air on several cash balance legal issues. More importantly, it provided, for the first time, a framework for rationally sharing and apportioning retirement-related risks, rather than simply shifting them between employers and employees. PPA-related final regulations published in 20113 explained how plan sponsors can now provide interest credits based on “market rates of return” tied to external indices — such as mutual funds — or may be based on the pension trust’s rate of return. Now, plan sponsors no longer have to develop an investment strategy that attempts to
PLAN SPONSOR | Q2 13
Figure One: Projected Contributions — Index-Based Vs. Market Return-Based Interest Crediting Rate $160 Market Return Interest Crediting Rate Index-Based Interest Crediting Rate
$140
Source: October Three, LLC, U.S. Treasury, S&P 500
Contribution (in Thousands)
$120
$100
$80
$60
$40
$20
$0 Year 1
Year 2
Year 3
Year 4
Year 5
match the way their plan liabilities move. They can structure market rate cash balance plans to invest plan assets to reflect their specific risk tolerance and base the plan’s interest crediting rate directly on plan assets’ underlying performance.
Year 6
Year 7
Year 8
Year 9
Year 10
equities. All yield data is based on the last 10 years, only in reverse, with the bond portfolio returns calculated to reflect the change in rates from the prior year.
Advances in plan administration technology allow sponsors to credit interest daily — as opposed to monthly or even annually — further mitigating contribution volatility, while providing participants with a more 401(k)-like experience. Participant account balances, and therefore plan liabilities, now move in tandem with plan assets on a daily basis. Not only can this design structure substantially eliminate investment risk, but it also frees plan sponsors to adopt investment strategies that make sense for them and are not driven by an annual goal to achieve a predetermined bogey that has little or nothing to do with their plan objectives each year.
The explanation for these two very different contribution patterns is quite simple. For the market rate cash balance plan, as long as the cumulative earnings of the plan are within a design-imposed corridor (typically zero to seven percent compounded annually), the plan sponsor is not required to adjust contributions. Meanwhile, for the traditional cash balance plan, any deviation of the actual earnings from the stipulated rate requires an adjustment to the contribution for the year to maintain desired funding levels. Given the attractive nature of this new plan design for partnerships and corporations, it is important to consider the implications when developing investment strategies.
Figure One compares the hypothetical annual contribution requirements over a 10-year period for two plans that are identical except for the interest crediting rate. In this example, the index-based interest crediting rate is the 30-year Treasury yield, a common choice among non-market return cash balance plans; the market return interest crediting rate is based on historical data reflecting a hypothetical portfolio invested 80 percent in fixed income and 20 percent in
Selecting the appropriate design and interest crediting rate for a cash balance plan is important, and no single solution is universally appropriate. The inherent risks in these choices are equally important when developing investment solutions. Plan sponsors often design investment strategies to hedge the capital market and economic risks inherent in the actuarial measurement of liabilities or crediting rates selected during plan design. While the new market rate rules go a long way continued on page 14
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to addressing these risks, hedging in cash balance plans can be far more complex than in a traditional final average pay pension plan for a variety of reasons. Actuaries determine funding levels by making interest crediting rate assumptions about the future value of account balances and then discounting back the same value using a high-quality corporate bond rate similar to traditional pension plans. These assumptions and discounting methods create a clear disconnect by crediting a long-term rate of return on a short-term basis. They also introduce what is termed basis risk between interest rates on high-quality corporate bonds and the interest crediting rate selected. This is further complicated by the prevalence of floor and ceiling rates, which are very difficult to hedge. Plan sponsors who have legacy benefits from traditional plans also experience interest rate sensitivity in the measurement of plan liabilities from previous benefit structures. Additionally, many partnerships have design features or employment contract features that override funding flexibility beyond statutory requirements. These provisions essentially force higher funding levels over shorter time horizons and are often set up to ensure consistent tax deferrals associated with plan contributions or to ensure equitable benefit cost burden with the addition or departure of partners. Positive or negative shocks to these contribution rates can be painful events for these organizations. While these are complex issues, the important takeaway is that cash balance plan design and investment strategy selected should be a function of each plan or plan sponsor’s unique combination of objectives, plan design, and interest crediting rate. Plan sponsors should design an investment strategy to address risks including but not limited to: interest rate risk, basis risk, and volatility in funding levels or deferrals. The following list includes questions plan sponsors should consider when evaluating cash balance plan design and investment policy:
• Is my investment strategy aligned with the interest crediting
rate selected while addressing the associated risks? • Are
we trying to optimize risk and return in the traditional asset-only context, relative to the interest crediting rate, relative to our actuarial liability, or relative to cash flow and funding concerns?
• Are
we trying to generate a rate of return that covers:
•
Interest crediting rate;
•
Interest crediting rate and plan costs;
•
Interest crediting rate, plan costs, and service credit; or
•
The disconnect between the interest crediting rate and the discount rate used for funding purposes?
While IRS regulations go a long way toward addressing criticisms of cash balance plan design and associated investment strategies, there is no universal hedging solution appropriate for all cash balance plans. The solution implemented should be customized and specific to the unique plan sponsor’s objectives, constraints, and risk tolerance. Only measured risks should be taken relative to these objectives, and there is no shortage in complexity in the potential solutions. Plans sponsors should balance the desire for return with the risks necessary to accomplish the objective. More conservative objectives generally create more certain outcomes, while more aggressive objectives often lead to more uncertain outcomes. While market rate cash balance plans are becoming more prevalent among professional service firms, it might be time for forward-thinking corporations to consider their advantages as well. Implemented properly, a market rate cash balance plan could form the core of a company’s retirement benefit package. Employers may wish to consider this design option — in conjunction with employee 401(k) deferrals — as a way to help produce stable, predictable costs while still providing crucial help to employees as they plan for retirement.
Sources:
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1
http://www.irs.gov/Retirement-Plans/Employee-Plans-News---November-5,-2010---Hybrid-Defined-Benefit-Plans---Final-and-Proposed-Regulations
2
http://finance.yahoo.com/news/cash-balance-retirement-plan-growth-181300964.html
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investment strategy
ALL-TIME HIGHS? Eric J. Freedman CAPTRUST Chief Investment Officer
My oldest daughter, Hailey, started to really concentrate on golf this year. Many readers who chase after “the little white ball” can attest that golf is a cruel game, even recreationally between friends. Tournament golf, however, can be especially punishing, and I am not just talking about juniors facing the same tough greens, pin positions, and, in some cases, distances as players 50 years their elders. A 7:00 am tee time is not in sync with a 13-year-old’s normal sleep schedule; pre-round breakfast, stretching, and warm-ups necessitate waking up long before the sun. Living in North Carolina provides Hailey with ample opportunities to play at some of the finest courses anywhere, and a few years ago when she first showed interest in playing golf beyond the recreational round with me, my wife, Jamie, and I signed Hailey up for a low-key tournament at a very playable golf course. When the starter announced her name and hometown, followed by claps from the handful of fellow caddie parents standing behind her, Hailey turned to me with
one part anxious, one part proud smile. She ripped her drive down the fairway, and we were off with a spring in our steps. She loved the experience, and I never had more fun on a golf course than when I was carrying her bag that day, helping her with yardages, raking sand traps, and reading putts. As her play progressed, we scouted additional tourneys, including one hosted by a tour rumored to be a notch above her initial training tournaments. We found a two-day event in Colonial Williamsburg, and on a warm late June day, we headed up for her first round. Her tee time was early afternoon, and as we drove north, my car’s external thermometer rose to 92 degrees. No worries, I thought. I will subtract a few yards per club to adjust to the high humidity. All she has to do is hit shots and stay hydrated. Piece of cake; I had enough sports drinks with me for the entire Commonwealth. As we approached the first tee, a tour official stopped me and asked where I was going. I told her I was caddying for my
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daughter, and we were up next. The tour official scowled and spoke into her Secret Service – style microphone, indicating to a colleague that a father was intending to carry his daughter’s bag. “That’s a negative” she quipped. “No caddies allowed. Parents must remain on the cart path at all times and not interact with their children while playing except to deliver snacks.” It had been a hectic week in the office, and I neglected to read the fine print. I remember saying to Jamie “We don’t need to bring a push cart with us” just as Hailey’s playing partner strolled by with a shiny red contraption, complete with an umbrella to shade the sun on what turned out to be the hottest June day in Virginia history. “Well, there goes my father-of-the-year nomination,” I muttered sarcastically.
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They called Hailey’s name as I was breaking the news to her. “But Dad, I don’t really remember how far I hit each club.” She quickly wrote down the ranges I had memorized, as if cramming before a midterm. I blurted a stream of advice; this would be the last time Hailey and her advanced tournament neophyte father would speak outside of yours truly pouring Gatorade down her parched throat. Just after invoking timeless morsels straight from Ben Hogan’s Five Lessons, I ended my brain dump with “Remember Hailey, golf is like what Papa says all the time don’t let the highs get too high and the lows get too low. Birdies will happen, double-bogeys will happen. Just keep a level attitude and have fun out there.” She nodded, looking one part anxious and two parts overheated; I couldn’t tell if the latter was due to the weather or my ineptitude. Investors have had their share of highs and lows over the past 10 years. As measured by the S&P 500, U.S. equities hit their all-time high in late May, and as we have documented in several publications, interest rates remain near historical lows despite recent selling pressures. So with U.S. stock and bond prices so high, why are broadly diversified portfolios not following suit? The answer rests in asset class performance outside of the more familiar domestic equity and fixed income asset categories. Before we
explore those asset classes, let’s take a step back and consider some of the core asset allocation tenets that drive our portfolio construction. First, no one knows with any degree of certainty what the future holds. While my investment committee and I track key upcoming events like Federal Reserve meetings and macroeconomic statistical releases, we do not know three important things: (1) those events’ outcomes, (2) what the capital market reaction to said events may be, and (3) likelihood of any “unscheduled” events like political tumult in Egypt or an influential company’s surprisingly positive earnings preannouncement. Because of future uncertainty, we believe investors should have exposure to a variety of asset classes that protect them in the event of both highs (positive earnings preannouncement) and lows (political unrest). Asset classes tend to react differently to various events, and having a mix of asset classes to absorb whatever event permutations unfold should help investors over time. Second, irrespective of market events, we want to provide investors with what are termed factor exposures or longterm trends that will benefit investors.1 Stocks are a great example; they provide access to corporate profits, and as long as indices and active managers (stock pickers) capture “winning” companies, having exposure to rising
PLAN SPONSOR | Q2 13
Figure One: Individual Asset Class Vs. Asset Allocation Portfolio Returns
2003 MSCI EME 56.3% Russell 2000
2004
2005
REITs
MSCI EME
31.6% MSCI EME
34.5% DJ UBS Cmdty
2006
2007
2008
2009
REITs
MSCI EME
Barclays Agg
MSCI EME
35.1% MSCI EME
39.8% DJ UBS Cmdty
47.3%
26.0%
21.4%
32.6%
16.2%
MSCI EAFE
MSCI EAFE
MSCI EAFE
MSCI EAFE
MSCI EAFE
39.2%
20.7%
REITs
Russell 2000
37.1% S&P 500
18.3%
DJ UBS Cmdty
376.0%
16.9%
S&P 500
S&P 500
REITs
REITs
2.9%
13.8%
204.6%
11.8%
Market Neutral
REITs
Russell 2000
Russell 2000
19.7%
Russell 2000
Barclays Agg
MSCI EME
32.5%
26.9%
7.8%
18.6%
REITs
MSCI EME
Market Neutral
MSCI EAFE
28.0%
18.4%
9.3%
-24.0%
27.2%
16.8%
S&P 500
Asset Allocation
Russell 2000
S&P 500
S&P 500
Cash
S&P 500
26.5%
15.1%
0.1%
16.0%
19.2% DJ UBS Cmdty
4.5%
17.9%
S&P 500
Russell 2000
2.1%
7.4%
-33.8%
Asset Allocation
Barclays Agg
DJ UBS Cmdty
6.1%
15.2%
7.0%
-35.6%
22.2%
12.5%
-0.6%
S&P 500
Market Neutral
S&P 500
S&P 500
DJ UBS Cmdty
MSCI EAFE
Russell 2000
5.5%
-37.0%
4.9%
9.1% Market Neutral
Russell 2000
7.1%
6.5%
4.6%
Barclays Agg
Barclays Agg
1.2%
15.9%
REITs
8.3%
REITs 12.2%
23.9%
Cash
3.1%
REITs
Russell 2000
S&P 500
1.0%
MSCI EME
REITs 27.9%
1.1%
8.3%
Cash
ANN.
MSCI EME
Asset Allocation
Market Neutral
4.3%
CUM.
Russell 2000
11.6%
Market Neutral
4.1%
Market Neutral
YTD ’13
Russell 2000
Market Neutral
12.5%
DJ UBS Cmdty
1.8%
2Q ’13
26.9%
15.8%
25.1%
Cash
MSCI EAFE
2012
Russell 2000
Asset Asset Allocation Allocation
10.9%
79.0%
2011
14.0%
28.7% Asset Allocation
5.2%
2010
Cash 3.0%
11.2% Cash
Cash
REITs
4.8%
4.8%
-37.7%
Barclays Agg
Russell 2000
MSCI EAFE
4.3%
Barclays Agg
DJ UBS Cmdty
2.4%
2.1%
-1.6%
-43.1%
REITs
MSCI EME
-15.7%
-53.2%
16.3%
1.4% Cash 0.0% Asset Allocation
5.8%
152.8%
9.7%
Asset Allocation
MSCI EAFE
MSCI EAFE
4.5%
130.3%
8.7%
MSCI EAFE
Asset Asset Allocation Allocation
-0.6%
4.5%
117.7%
8.1%
MSCI EAFE
Market Neutral
S&P 500
S&P 500
2.2%
98.6%
7.1%
11.3%
-0.7%
Barclays Agg
REITs
Cash
Barclays Agg
Barclays Agg
-2.1%
0.0%
Asset Asset Asset Asset Allocation Allocation Allocation Allocation
18.9%
8.2%
-4.2%
4.2%
Barclays Agg
Barclays Agg
MSCI EAFE
Market Neutral
Barclays Agg
Barclays Agg
5.9%
6.5%
-11.7%
0.9%
-2.3%
-2.4%
61.5%
4.9%
Cash
DJ UBS Cmdty
Cash
MSCI EME
MSCI EME
DJ UBS Cmdty
DJ UBS Cmdty
49.3%
4.1%
Cash
Cash
18.2%
1.7%
Market Neutral 4.1% Cash 0.1%
0.1%
-13.3%
0.1%
-8.0%
-9.4%
Market Neutral
MSCI EME
DJ UBS Cmdty
DJ UBS Cmdty
DJ UBS Cmdty
-0.8%
-18.2%
-1.1%
-9.5%
-10.5%
65.7%
5.2%
Market Neutral
Market Neutral
Source: 3Q | 2013, J.P. Morgan Asset Management, Market Insights, Guide to the Markets®, Russell, MSCI, Dow Jones, Standard & Poor’s, Credit Suisse, Barclays Capital, NAREIT, FactSet.
10-yrs. ’03–’12
The “Asset Allocation” portfolio assumes the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCI EAFE, 5% in the MSCI EMI, 25% in the Barclays Capital Aggregate, 5% in the Barclays 1-3m Treasury, 5% in the CS/Tremont Equity Market Neutral Index, 5% in the DJ UBS Commodity Index and 5% in the NAREIT Equity REIT Index. Balanced portfolio assumes annual rebalancing. All data represents total return for stated period. Past performance is not indicative of future returns. Data are as of 6.30.13, except for the CS/Tremont Equity Market Neutral Index, which reflects data through 2.28.13. “10-yrs” returns represent period of 1.1.03–12.31.12 showing both cumulative (Cum.) and annualized (Ann.) over the period. Data are as of 6.30.13.
corporate profits over time should lead to positive returns over inflation. Of course, recessions and other dynamics make stock returns anything but linear, but as long as an investor has an appropriate time horizon to endure stocks’ ebbs and flows, they can add value. Third, when properly deployed, asset allocation can provide a hedge against costs an investor endures. For example, while not appropriate for all investors, commodity investments fluctuate with prices of assets like oil, industrial metals, agriculture, and other goods. Often these goods are tied directly to inputs that surround an investor’s daily life, so having some offsetting portfolio exposure can help against price fluctuations, especially when input costs move higher.
Aggregating these three considerations, we strive to create portfolios that incorporate both protection against adverse events and long-term factor exposure. Asset classes can have overlapping factor exposure and the correlations or co-movements between asset classes can fluctuate, so by no means is the construction process a static exercise. Figure One, which provides a snapshot of nine different asset classes and one blended portfolio’s returns over the past decade, reveals why having a portfolio construction process with the three principles highlighted can be additive. If you notice where the broad-based asset allocation portfolio (which incorporates each of Figure One’s standalone asset classes) ranks year after year relative to the individual asset
continued on page 18
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classes, it is no worse than sixth place and no better than fourth place. This time period covers a considerably volatile and instructive period in the capital markets for this discussion. Of course, one cannot directly invest in an index, and these returns are gross of any fees or transaction costs, but many useful takeaways emanate from this illustration. Asset allocation portfolios seek to do what I imparted on Hailey before she began her round that sweltering June day: not allow the highs to get too high or the lows too low. It also shows how individual asset classes can be extremely volatile from year to year and, as a corollary, how fleeting first- and second-place finishes can be. While U.S. stocks as measured by the S&P 500 have had a great year thus far, note they have lagged the broad asset allocation portfolio over the past 10 years by almost 30 percent, and this is a period where U.S. stocks have hit two all-time highs (first in October 2007 and again this May). Note also, emerging market equities, which have had the best cumulative performance of any of these asset classes, have had poor performance so far this year and were sharply negative in 2011. For all the talk of a 30-year-plus bond bull market, broad fixed income returns as measured by the Barclays Capital Aggregate Bond Index are in seventh place out of nine asset classes, including cash. Behavioral finance, which studies the human mind’s proclivities related to investment choices, provides some clues as to why investors look at trending asset classes and extrapolate how those asset class trends relate to their situation. For example, some investors may look at recent U.S. stock strength and question why their portfolios are not at all-time highs, ignoring other asset class returns. According to psychologists Neal Roese and Kathleen Vohs, hindsight bias occurs when people “knew it all along” or deem an event more predictable after it occurs than before it happens.2 Similarly,
investors may deem that they themselves, their financial advisor, or money manager should have the prescience to know what asset classes will be in first and last place. So, when the financial media cheers all-time highs in a familiar index like the Dow Jones Industrial Average, investors take notice and make inferences about their portfolio performance, perhaps forgetting that other asset classes helped stabilize their portfolios during the dark days of 2000 and 2007. We continue to see the glass as half full with respect to global capital markets, and we see momentum for both global equities and potential value emerging as the bond market stabilizes. Despite a very experienced investment committee, independent investment research supplemented by outside services, and a deep team at our headquarters and regional offices, we do not have perfect foresight about the path forward. We do, however, strive to provide clients with durable portfolio strategies across market dynamics, remaining mindful of fees and our clients’ objectives. Different asset classes will contribute to those objectives over any given time period, despite their popularity or unpopularity at any given moment. While all investors would love to have all of their assets in the best-performing asset class at any given time, the market timing path is fraught with peril and usually, as the Wall Street adage goes, ends in tears. Hailey’s two-day tournament did not end in tears; she had memorable experiences in Williamsburg that furthered her love for the confounding game of golf. She took her grandfather’s words to heart, letting near birdies and near blowups roll off her back, as well as her old man’s pretournament foibles. My eyes get misty whenever I see that ponytail bob up and down as she marches down a tournament fairway sure to present her with challenges and rewards aplenty; I am hard-pressed to find a more beautiful sight.
Sources:
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1
For further reading, see Fama and French, 1993. “Common Risk Factors in the Returns of Stocks and Bonds.” Journal of Financial Economics, vol. 33, no. 1.
2
Roese, Neal and Kathleen Vohs. “Hindsight Bias.” Perspectives on Psychological Science. September 2012, vol. 7, no. 5, pp 411–426.
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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 ’13
Large Cap Growth
Fixed Income
Mid Cap Growth
Small Cap Growth
Fixed Income
Mid Cap Value
Small Cap Growth
26.86%
11.81%
5.08%
46.29%
29.09%
7.84%
18.51%
17.44%
Mid Cap Value
Small Cap Value
International Equities
Cash
Large Cap Growth
Mid Cap Growth
Large Cap Growth
Small Cap Value
Mid Cap Value
22.25%
12.65%
23.48%
11.63%
37.21%
26.38%
2.64%
18.05%
16.10%
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%
15.90%
Cash
Large Cap Value
Mid Cap Growth
17.51%
14.70%
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
Small Cap Value
-5.59%
-15.52%
38.07%
15.48%
5.26%
13.35%
7.05%
-38.44%
32.46%
16.71%
-1.38%
15.81%
14.39%
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%
11.80%
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%
4.47%
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%
4.71%
-1.42%
-43.06%
Small Cap Value
Mid Cap Growth
4.08%
-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 0.04%
Fixed Income -2.44%
Small-Cap Value Stocks (Russell 2000 Value)
Large-Cap Value Stocks (Russell 1000 Value)
International Equities (MSCI)
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 2ND QUARTER ASSET CLASS RETURNS
INDICES
Q2 ’13
YTD ’13
2012
2011
2010
2009
2008
1-YEAR
3-YEAR
5-YEAR
10-YEAR
S&P 500
2.91%
13.82%
16.00%
2.11%
15.06%
26.46%
-37.00%
20.60%
18.45%
7.01%
7.30%
Dow Jones Industrial Average
2.92%
15.20%
10.24%
8.38%
14.06%
22.68%
-31.93%
18.87%
18.23%
8.64%
7.92%
NASDAQ Composite
4.15%
12.71%
15.91%
-1.80%
16.91%
43.89%
-40.54%
15.95%
17.29%
8.22%
7.69%
Russell 1000
2.65%
13.91%
16.42%
1.50%
16.10%
28.43%
-37.60%
21.24%
18.63%
7.12%
7.67%
Russell 1000 Growth
2.06%
11.80%
15.26%
2.64%
16.71%
37.21%
-38.44%
17.07%
18.68%
7.47%
7.40%
Russell 1000 Value
3.20%
15.90%
17.51%
0.39%
15.51%
19.69%
-36.85%
25.32%
18.51%
6.67%
7.79%
2.21%
15.45%
17.28%
-1.55%
25.48%
40.48%
-41.46%
25.41%
19.53%
8.28%
10.65%
Russell 2000
3.08%
15.86%
16.35%
-4.18%
26.85%
27.17%
-33.79%
24.21%
18.67%
8.77%
9.53%
Russell 2000 Growth
3.74%
17.44%
14.59%
-2.91%
29.09%
34.47%
-38.54%
23.67%
19.97%
8.89%
9.62% 9.30%
Russell Mid-Cap Index
2.47%
14.39%
18.05%
-5.50%
24.50%
20.58%
-28.92%
24.76%
17.33%
8.59%
MSCI Europe, Australia, Far East
-0.73%
4.47%
17.90%
-11.73%
8.21%
32.46%
-43.06%
19.14%
10.55%
-0.16%
8.16%
Wilshire REIT Index
-1.39%
5.94%
17.59%
9.24%
28.60%
28.60%
-39.20%
8.41%
18.50%
7.20%
10.80% 3.70%
Russell 2000 Value
Barclays Govt Intermediate Bond
-1.37%
-1.23%
1.73%
6.08%
4.98%
-0.32%
10.43%
-0.59%
2.33%
3.80%
Barclays Corporate IG Bond
-3.31%
-3.41%
9.82%
8.15%
9.00%
18.68%
-4.94%
1.36%
5.73%
7.30%
5.18%
Barclays Aggregate Bond
-2.32%
-2.44%
4.22%
7.84%
6.54%
5.93%
5.24%
-0.69%
3.51%
5.19%
4.52%
Barclays Intermediate Govt/Credit
-1.70%
-1.45%
3.89%
5.80%
5.89%
5.24%
5.08%
0.28%
3.14%
4.57%
4.03%
Barclays High Yield
-1.44%
1.42%
15.81%
4.98%
15.12%
58.21%
-26.16%
9.49%
10.74%
10.94%
8.91%
90-Day U.S. Treasury
0.02%
0.04%
0.11%
0.10%
0.13%
0.21%
2.06%
0.11%
0.11%
0.29%
1.72%
Consumer Price Index (Inflation)
0.27%
1.66%
1.74%
2.96%
1.50%
2.72%
0.09%
1.71%
2.31%
1.30%
2.42%
Sources: Morningstar, Mobius, MPI
2013 2ND QUARTER INDEX PERFORMANCE
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, 2nd Quarter 2013
• U.S. stocks continued their ascent higher in the second quarter with the S&P 500 closing up 2.9% for the quarter Q2 ’13
2013
3.20%
15.90%
and 3.1% respectively for the quarter, bringing both of
2.91%
13.82%
them up over 15% for the year-to-date period.
2.06%
11.80%
Mid Value (Russell)
1.65%
16.10%
Mid Blend (Russell)
2.21%
15.45%
Mid Growth (Russell)
2.87%
14.70%
Small Value (R2000 Value)
2.47%
14.39%
Small Blend (R2000 Blend)
3.08%
15.86%
Small Growth (R2000 Growth)
3.74%
17.44%
Large Blend (S&P 500) Large Growth (R1000 Growth)
and 13.8% for the year. Mid- and small-caps were up 2.2%
• Seven out of the 10 major S&P 500 sectors were positive in the second quarter, and financials (the second largest sector) was the clear leader, up 7.3%, while consumer Source: MPI Stylus Pro
Large Value (R1000 Value)
discretionary stocks rose 6.8%. Interest-rate-sensitive utilities fell 2.7% to lead losing sectors. • Since the U.S. equity market touched its March 2009 low, large-caps, mid-caps, and small-caps are up 160%, 211%, and 202%, respectively, including reinvested dividends.
INTERNATIONAL EQUITIES Market Performance, 2nd Quarter 2013
• Developed and emerging international equities both fell in U.S. dollar terms in the second quarter, with the former 2013
-0.73%
4.47%
-10.88%
-4.60%
European Stocks (MSCI Europe Ex-UK)
0.92%
3.96%
Japanese Stocks (MSCI Japan)
4.42%
16.64%
UK Stocks (MSCI UK)
-2.15%
0.29%
Emerging Markets (MSCI EME)
-7.95%
-9.40%
International Equities (MSCI EAFE) Pacific Stocks (MSCI Pacific Ex-Japan)
still positive (+4.5%) and the latter more deeply negative (-9.4%) for the year-to-date period. The developed equity-focused MSCI EAFE Index has been higher 13 out Source: MPI Stylus Pro
Q2 ’13
of the last 17 quarters, while the MSCI Emerging Markets Index has been higher 12 out of the last 18 quarters. • Japan continued to rally in the second quarter, but not without considerable volatility. Japan has rallied 34% this year in local currency, but thanks to a sliding yen it has gained only half as much in dollar terms. • Emerging markets were noticeably weak within the quarter, with China (-6.5% following a -4.5% first quarter), Russia (-8.3%), India (-5.6%), and standout Brazil (-17.8%) all posting negative returns. Adverse currency movements and concerns about growth prospects hurt EM investors in the second quarter, especially from midMay through the end of June.
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PLAN SPONSOR | Q2 13
FIXED INCOME Market Performance, 2nd Quarter 2013
• The Barclays Aggregate Bond Index fell for only the third quarter out of the past 19, falling 2.3% in the second 2013
Broad Market (Barclays Capital U.S. Aggregate) -2.32%
-2.44%
Barclays Capital U.S. Treasurys
-1.92%
-2.11%
Barclays Capital Mortgage Backed Securities
-1.96%
-2.01%
Barclays Capital Municipals
-2.97%
-2.69%
Barclays Capital Intermediate Corporates
-2.38%
-1.82%
Barclays Capital High Yield
-1.44%
1.42%
quarter and 2.4% year-to-date, primarily due to concerns about the Federal Reserve’s potential bond-buying slowdown. Note that the index has not had a negative Source: MPI Stylus Pro
Q2 ’13
annual return in 13 years. • Within the broad fixed income space, historically riskier parts of the bond market were mixed this past quarter despite the run-up in global stocks, with emerging market debt falling 5.1% but high yield only off by 1.4%. Treasurys fell almost 2%, and Treasury inflation-protected securities (TIPS) fell 7% in the quarter as investors’ inflation expectations moved lower. • Research firm ICI’s mutual fund flow data in the second quarter reflected the sharpest outflow in bonds since October of 2008, perhaps a harbinger of things to come.
HEDGE FUNDS / PRIVATE EQUITY Market Performance, 2nd Quarter 2013
• Hedge fund strategies posted a solid start to 2013, with the HFRI Fund Weighted Composite Index posting a 3.6% 2013
HFRI Fund Weighted Composite Index
-0.01%
3.59%
HFRI Equity Hedge Index
0.40%
5.34%
HFRI Relative Value Index
0.17%
3.26%
-0.04%
3.28%
1.41%
4.25%
HFRI Fund of Funds Composite Index HFRI Fund of Funds Conservative Index
return through the end of June following a slight decline in the second quarter. • Global macro remained a challenging sub-strategy Source: HFRI
Q2 ’13
(-1.07% year-to-date) after losing 1% for 2012 and also registering weak 2010 and 2011 calendar years as global central bank policy and unstable trends continue to impact managers. Equity hedged strategies continued their streak of comparable returns to their global longonly peers. Event-driven strategies, particularly special situations, are standouts thus far in 2013. • Alternatives research firm Prequin highlights that private equity fundraising was strong for the second quarter, although heavily concentrated within the industry’s largest players. Only 154 funds received commitments in the second quarter, the fewest in a quarter since 2003.
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COMMODITIES Market Performance, 2nd Quarter 2013 Q2 ’13
2013
Dow Jones UBS Commodity Index
-9.45%
-10.47%
S&P GSCI Commodity Index
-5.93%
-5.41%
-22.78%
-26.31%
Natural Gas (U.S. Spot Henry Hub)
-11.38%
4.28%
Crude Oil (U.S. Spot, WTI Cushing)
-0.69%
5.16%
Gold (Spot, $/oz)
Sources: MPI Stylus Pro, Bloomberg
• The Dow Jones UBS Commodity Index fell 9.5% in the second quarter after falling 1.1% in the first quarter. Dollar strength has hurt so far this year, as has brent crude falling over 8%. • At the sub-index level, energy was weak across the board, as were industrial metals on global growth concerns, particularly regarding China, Latin America, and India. • Precious metals were also hit by dollar strength, with the index falling 5.5% after posting a 6% return in 2012. Individually, gold and silver fell 22.8% and 30.5%, respectively, in the quarter as some of the more popular commodity trades over the past few years fell out of favor.
Market Performance, 2nd Quarter 2013 Q2 ’13
2013
MSCI U.S. REIT Index
-1.58%
6.36%
Wilshire REIT Index
-1.39%
5.94%
Source: MPI Stylus Pro
REAL ESTATE • Public real estate, as measured by the MSCI U.S. REIT Index, fell 1.6% for the quarter. REITs underperformed U.S. equities for only the fourth quarter out of the last nine. REITs are still positive for the year (+5.94%) and are up a staggering 204.6% cumulative over the past 10 years ended December 31. • Higher interest rates hurt REIT performance as the 10-year U.S. Treasury yield rose from 1.8% to 2.5% in the second quarter, causing investors to revalue REIT distributions in light of higher interest rates. • Several REIT subsectors exhibit attractive fundamentals, and overall capital positioning is strong for REITs, but should interest rates continue to migrate higher, performance could again be vulnerable.
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PLAN SPONSOR | Q2 13
captrust news
CAPTRUST GROWTH CAPTRUST grew in the second quarter with the following new additions to the team
GIVING BACK We are honored to have supported these charities during the second quarter of 2013: • Junior Achievement of Central Virginia
Rush Benton joined CAPTRUST as a senior director of strategic wealth and is responsible for growing the firm’s private wealth assets both organically and through acquisition of independent, fee-based registered investment advisors. Prior to joining the firm, Rush served as cofounder and chairman of WealthTrust, one of the first consolidators of registered investment advisors. Rush received a Bachelor of Arts degree in economics from Vanderbilt University.
• The Salvation Army of Wake County • Youth Homes of MidAmerica • American Heart Association’s Heart Walk • Ronald McDonald House Iowa • John Owen’s Adventure • Big Brothers Big Sisters of the Triangle • Dallas Arthritis Walk • Angelman Syndrome Foundation • Hit it Farr for Kirby • Salvation Army — Raleigh (Youth Basketball sponsorship) • Upper Room Christian Academy • Hope Reins • St. Baldrick’s Foundation
Danny Lowe joined CAPTRUST as a senior manager, Nonqualified Executive Benefits, and oversees the firm’s nonqualified deferred compensation offering to include plan design, implementation, financing, integration, and administration. Prior to joining our firm, he worked at the Principal Financial Group as senior executive benefits consultant. Danny received a Bachelor of Arts degree in management and society from the University of North Carolina at Chapel Hill and a Master of Business Administration from East Carolina University.
• Pediatric Brain Tumor Foundation • Tisch Brain Tumor Center (at Duke University Children’s Hospital) • North Carolina Foundation for Public School Children • Wildwood Hills Ranch • Read & Feed • Raleigh Food Bank • Food Bank of Eastern Michigan
FAREWELL TO A DEAR FRIEND Just shy of her 105th birthday, we lost our dear friend Ruby Merritt of Chapel Hill, N.C. Ms. Merritt had known our CEO Fielding Miller since he was a rookie stock broker in 1987.
Richard Rush joined CAPTRUST as a senior manager, Investment Research, and manages the firm’s emerging market client relationships by providing investment management and consulting services. Prior to joining our firm, he worked at CIG Corporation as the director of Wealth Management. Richard received a Bachelor of Arts degree in political science from St. Mary’s College and a Master of Arts in mathematics from Wayne State University.
“I have never known a finer person than Ruby Merritt. For 26 years I have had the wonderful privilege of meeting with Ms. Merritt and her family in her home — and many times I brought home one of her priceless pearls of wisdom to share with my own family. I vividly remember our first encounter, sitting at her kitchen table. She had her mind made up that she wanted to invest in tax-free bonds — at the highest interest rate going. Ms. Merritt was 78 at the time so I reminded her that the highest interest rates would be with bonds that wouldn’t mature for 20 years or more. She just smiled and said, ‘I plan to be around for a while so let’s get those good rates.’ And that we did. Since then I have been blessed with a friendship that I will cherish for my lifetime.” — Fielding Miller
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UPCOMING INDUSTRY INVOLVEMENT The following is a list of topical discussions to be led by CAPTRUST at upcoming industry events in the third quarter of 2013. July 21, 2013 | San Diego Western Benefits Conference
PAPERLESS STRATEGIC RESEARCH REPORT We’ve added an electronic Strategic Research Report offering in response to our readers’ requests for an eco-friendly alternative. Going forward, you can access our publication on a desktop computer, a tablet, and mobile devices, while also enjoying a robust set of enhanced digital viewing and sharing features. It is our hope that your reading experience will be enhanced through this electronic medium. Please contact your financial advisor or client relationship manager if you would like to subscribe to our electronic Strategic Research Report.
QDIA Due Diligence, New Realities of Cash Equivalents in Plans Speaker: Mark Davis, Financial Advisor September 10, 2013 | New York
RECOGNITION
Global Alpha Forum Risk Debate: Long-Term Asset Allocation Trends–Risk Allocation vs. Strategic Asset Allocation Speaker: Ernest Liebre, Financial Advisor
CAPTRUST Honored by the Greater Raleigh Chamber of Commerce The Greater Raleigh Chamber of Commerce awarded CAPTRUST with an Entrepreneurial Company Award for companies with 101 or more employees at the 29th annual Pinnacle Business Awards event. The event honored local businesses that have showed courage, commitment, and conviction. Entrepreneurial businesses based in the Triangle such as CAPTRUST received awards for their staying power, business growth, community involvement, and innovation along with their steady growth and profitability.
September 15–18, 2013 | Las Vegas 2013 Las Vegas Mid-Sized Retirement & Healthcare Plan Management Conference Best Practices for Conducting an Advisor Request for Proposal Speaker: Greg Middleton, Senior Manager Enhancing Retirement Readiness through a Focus on Total Retirement Speaker: Pam Popp, Financial Advisor September 19, 2013 | New York Liability Driven Investing Conference Speaker: Grant Verhaeghe, Senior Manager Speaker: Ernest Liebre, Financial Advisor
CAPTRUST CEO Named as Regional Finalist for the 2013 E&Y Entrepreneur of the Year Award® J. Fielding Miller joined a list of esteemed visionaries nominated as a finalist for the coveted Ernst & Young Entrepreneur of the Year Award® for the Southeast region. The Entrepreneur of the Year Program recognizes business owners who demonstrate creativity, innovation, and personal commitment in turning an idea into a successful and sustainable enterprise.
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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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