A U.S. Securities and Exchange Commission (SEC) amendment, which will take effect on October 14, 2016, has important financial implications for retirement plan participants and individual investors that own nongovernment money market funds. The amendment made to the Investment Advisors Act of 1940 (IA 1940) replaces the stable net asset value (NAV) for money market funds with a “floating” NAV.
In this article, Milliman consultant Jeff Marzinsky explains the SEC’s reasons for amending IA 1940. He also discusses how the amendment affects investors and retirement plan sponsors and provides steps people should consider to prepare for the new regulation.
Recent market declines appear to be driven by a few primary factors: the purported North Korean hydrogen bomb test, tensions between Iran and Saudi Arabia, an oil glut causing the lowest price per barrel in a number of years, along with continuing concerns about growth in China, have all contributed to global market instability in recent days. Not to mention, we are entering into a presidential election year in the United States. While we have no way to predict the outcomes of these economic and geopolitical issues, we do view them with some historical perspective and insight.
We are seeing some positive aspects in domestic economics with the U.S. Labor Department indicating better job growth during the last three months and hourly pay rising 2.5%. The U.S. unemployment rate remains steady at 5% and is the lowest it’s been since 2008.
Since the end of December, the Dow Jones Industrial Average has dropped nearly 1,000 points and the S&P 500 has fallen nearly 121 points, amounting to percentage declines of around 6% in the first week of 2016. If you look back to January 2015 and January 2014, we began both years with declines in the U.S. equity markets early in the month, continuing into negative territory to finish off January. In both of those years, the market rebounded during February and ended the quarter with better results than January might have predicted.
This is not to say that we are expecting or predicting the same type of rebound during February 2016, but it shows that, from a historical perspective, the January effect doesn’t provide the full story. As you can see, rocky starts were followed by healthy rebounds as we moved into the mid part of the first quarter in each year.
More currently, during August 2015, the markets experienced a sharp correction of more than 11% over a period of six trading days from August 18 through August 25. During that period, market volatility rose significantly, as noted in the VIX Index (see chart below). The VIX, a market volatility indicator, jumped significantly during this time from the 10-to-15 level prior to the correction to over 40 during the first couple days of the decline, and remained moderately high through September.
During this time, we saw the market attempt a rebound on a couple of occasions, but ultimately it dipped again in the last week of September. The return of the market to pre-correction levels took the entire month of October, finally ending the first day of November with the S&P 500 hitting 2,100.
At this point, as an investor, you are most likely asking yourself what, if anything, should be done. Looking at historical market patterns and movements, there is a tendency for investors to be cautious when the market ventures into near-correction territory. Concerns associated with market declines often lead to unwarranted or ill-timed actions. Remember to look at the long-term aspects of your investment strategy. Market setbacks and corrections are always a part of long-term investing. Keep in mind your risk tolerance while thinking twice before making any significant portfolio adjustments.
During December 2014, U.S. equity markets peaked at all-time highs—over 18,000 for the Dow Jones Industrial Average and 2,090 for the S&P 500 Index. Then, in January, equity markets became more volatile and both indexes pulled back dramatically, as international economic uncertainty rose and oil prices fell. Some thought interest rates couldn’t go any lower during 2014 with the U.S. Federal Open Market Committee (FOMC) hinting at an upward adjustment. But interest rates on the longer end of the maturity spectrum dropped during 2014, which most likely had a detrimental effect on defined benefit (DB) pension plan liabilities.
Now, more than ever, plan sponsors should be reviewing their DB plan investments as we react to these market movements, which are critical in the asset allocation process. For more perspective on the shifting landscape, see my paper “Developing pension plan investment strategy: A variety of considerations,” published last year to help DB plan sponsors understand the range of considerations and how they interact in the development of a pension plan investment strategy.
Investment committees face a variety of considerations when managing pension plans. In the past, these committees focused mainly on strategies for investments, but now they need to consider multiple dimensions. Taken together, the multiple aspects affect the value of plan assets and liabilities when effectively managing a pension plan. They also affect the development of an investment strategy for the plan assets. As a pension plan sponsor, it is important to fully understand the various areas that will affect the volatility of assets, liabilities, and contributions on the pension plan and to develop a strategy that will lessen this impact. This paper authored by Jeff Marzinsky offers some perspective.
Retirement plan participants are often told that target date funds (TDFs) are a “set it and forget it” investment. Many sponsors have similar feelings when selecting a TDF series. Still, it is important for them to constantly monitor the fund series subsequent to its initial review. Sponsors need to focus on fees, asset allocation along the glide path, performance, and expenses. Looking at a combination of indexes and peer groups can offers sponsors better perspective on a suitable investment philosophy.
Plan Sponsor recently published an article focusing on four areas to revaluating TDFs. In the following excerpt from the article I discussed the importance of reviewing a fund’s investment strategy.
That sort of analysis is especially important because some target-date funds have made significant changes in recent years. Look for issues such as alterations to the glide path, a move from active management to enhanced index or indexing strategies, or switches in the underlying funds, suggests Jeff Marzinsky, a principal at consultant Milliman Inc. in Albany, New York. He has seen sponsors actually replace their target-date funds, mainly in cases of investment underperformance or changes in the funds’ underlying philosophy.
I also provided perspective regarding an increased interest in custom target date funds, which offer sponsors control over investment options and asset allocation changes.
…It may be less about many having an employee base different enough to warrant a custom glide path than sponsors seeing it as “a better way to pick the investments,” because sponsors have more control than with off-the-shelf funds.
In our recent article, “Developing an alpha beta pension plan portfolio,” we reviewed some of the basic concepts in developing allocations for pension plans. By using a combination of index and actively managed investments, known as an “core/satellite allocation,” a sponsor can diversify across a wide variety of asset classes and strategies while focusing on target return, volatility, and diversification.
The starting point, setting goals for the portfolio, allows for monitoring of the results, which include:
• Diversification: Overall allocation across classes, as well as correlation of returns
• Target return: The desired annualized return to meet retirement goal requirements
• Management expenses: The investment manager expense
Index investments represent the beta, or the market return that is the basis of the portfolio. Active managers can be used to generate the alpha, returns in excess of the market (or index) return. Also, active managers can be used to moderate downside risk in declining markets. The combination of the two approaches can be a prudent strategy in developing an alpha beta portfolio.