Fall/Winter 2016

City of LA’s reinvention of retirement income security

DC MattersInvestment cornerThe role of commodities Page 14

Participant communicationsWomen, wisdom and wealth Page 18

An academic angleEngaging participantsPage 24

MyLoupe-UIG/Universal Images Group/Getty Images

Over the past decade, we’ve seen government and corporations launch a number of measures in pursuit of promoting retirement savings, from federal legislation to employee education. In this issue, we address two such measures.

Welcome to DC Matters magazine. Each issue contains insights and ideas we hope you find helpful in your role as a plan sponsor. The contributors in each issue share your passion for helping American workers achieve their goal of a secure and comfortable retirement.

Promote savings and strengthen retirement securityThough assets in retirement savings plans in the US have grown dramatically over the decades, too many Americans are still inadequately prepared. In this issue Jim Lockhart, former Director of the PBGC and Vice-Chairman, of WL Ross & Co., a subsidiary of Invesco, outlines these challenges and proposed solutions based on his work with the Bipartisan Policy Center’s Commission on Retirement Security and Personal Savings.

Embracing financial wellnessAs guest author Dr. Julie Agnew addresses in her article, “Financial Literacy in an Auto Features World,” plans with automatic features still need to keep employees engaged. Even though almost 70% of large plans have adopted automatic enrollment, more than half of those plans have a default savings rate of just 3% of pay.1 For most, that’s not enough. And as we address in “Women, Wisdom and Wealth,” women in particular are at greater financial risk.

Knowing that workers shouldn’t completely rely on automatic plan features to get them to retirement, an increasing number of employers are implementing holistic financial wellness programs to provide guidance not just on retirement savings, but in other areas including debt, mortgages, emergency funds and college savings.

Proponents of these programs contend that helping workers ease monetary burdens can help them become less stressed, happier and more productive — and more companies are coming on board. An estimated 40% to 60% of employers had some form of financial wellness plan in place in 2014, and 21% of organizations that didn’t offer financial education in 2014 had plans to do so in 2015.2

We all play an important role Addressing the retirement topic will be best achieved through the combined efforts of legislators, employers, employees and investment managers. At Invesco, we’re committed to partnering with you as we all work toward the same goal — ensuring a secure and comfortable retirement for all Americans.

Regards,

Marty Flanagan, President and CEO Invesco

Marty Flanagan at a recent client event

1 Source: PSCA 58th Annual Survey of Profit Sharing and 401(k) Plans, Reflecting 2014 Plan Experience 2 Source: Consumer Financial Protection Bureau (CFPB), “Financial Wellness at Work: A review of promising practices and policies,” 2014

Nikada/Vetta/Getty Images

DC Matters Fall/Winter 2016 1

DC digestLessons from abroad

What we can learn from Australia’s DC system Page 2

Food for thought Form 5500 gets a makeover

Key changes slated for 2019 Page 4

Facts and figuresDC trends

Page 5

Plan sponsor forumCity of Los Angeles

Challenging conventional wisdom Page 6

Hail to the chief (economist)Global economic outlook

Central banks continue to play a pivotal role in financial markets Page 10

Investment cornerUnder the hood

The role of commodities Page 14

Participant communicationsWomen, wisdom and wealth

Helping women to save more Page 18

What’s up on Capitol Hill?The Commission speaks

Retirement security and personal savings Page 20

An academic angleEngaging participants

Financial literacy in an auto features world

Read the full story on Page 24

Nuts & boltsFiduciary outsourcing

So you hired an ERISA 3(38) fiduciary, now what? Page 29

Table of contentsInvesco’s official magazine for defined contribution plan sponsors

2

DC digestLessons from abroad

Greg Jenkins, CFASenior Director, US Institutional Consultant Relations Team, Invesco

Greg Jenkins has more than 20 years of experience working in the DC industry. He’s a frequent speaker at industry conferences and webinar events, sharing his passion for educating plan sponsors and their participants. Mr. Jenkins earned a BA degree in economics from the University of Colorado and an MBA from the University of Texas at Dallas. He is a CFA charterholder and an active member of DCIIA, NAGDCA, Southwest Benefits Association and the Dallas Society of Financial Analysts.

Australia began the transition from traditional pensions to a DC system in the late 1980s.

To conclude our two-part “Lessons from abroad” series, we explore some of the positive attributes of the Australian system and, in particular, aspects we can learn from and potentially employ in the US.

Australia’s DC systemThe Australian DC system is smaller than the US DC system in absolute terms, but larger as a percentage of gross domestic product (104% versus 72.7% in the US).1 To understand the Aussie system of today, it is helpful to look at how it began. Australia began the transition from traditional pensions to a defined contribution system in the late 1980s. The Australian government very adeptly recognized the demographic writing on the wall and realized that its DB-based system was in jeopardy. Compulsory contributions were instituted in 1992, escalating over time to the 9.5% level of today.2 Most importantly; there was vision and a thoughtful plan behind it all.

By contrast, the DC system in the US arose from corporate managers taking advantage of an obscure provision in the tax code under section 401(k).

The Australian system is clearly a global leader on key fronts, the most obvious being the high ratio of savings to GDP. Additionally, Aussies benefit from viewing DC plans more like traditional pensions in several important areas such as access to accounts, investment diversification and the level of contributions required to achieve acceptable outcomes.

As we attempt to tackle retirement savings issues here in the US, we should not ignore the fact that there is an arguably more mature and accomplished DC system to study across the Pacific.

The Australian DC system is clearly a global leader on key fronts, the most obvious being the high ratio of savings to GDP.

Typical asset allocation for an Australian DC plan4

%

• Domestic equity 23

• International equity 21

• Domestic fixed income 14

• Cash 13

• Real estate 9

• International fixed income 7

• Unlisted infrastructure 5

• Private equity 5

• Hedge funds 2

• Other 2

1 Source: Towers Watson Global Pension Study 2016. US figures includes IRA assets.2 Source: Australian Taxation Office, 2016 3 Source: Financial Services Council and ING, Your Super Future report 20154 Source: Association of Superannuation Funds of Australia Statistics, May 20165 Source: Callan DC Index 2016

What we can learn from DC systems abroad

Part 2: Australia

This year, the US DC system is celebrating the 10-year anniversary of the Pension Protection Act of 2006 (PPA). Since its passage, significant progress has been made in areas like default funds and automatic features — and there is cause for commendation. However, most in the industry acknowledge there is much work to be done in order for DC plans to provide the level of retirement income participants need. To answer the question of where we go from here, it makes sense to study the most established and mature DC system on the planet – the Australian pension system.

DC Matters Fall/Winter 2016 3

Read Greg’s blog at blog.invesco.us.com

Key takeaways

Required contributions – The cornerstone of Australia’s system is compulsory contributions.– Employers must contribute 9.5% of each employee’s earnings, and employees may contribute up to an

additional 3%. MEP/superannuation structure

– Another important facet of the Australian system is the MEP (multiple employer plan). – The MEPs are called superannuation funds, or the “supers.” – The supers are generally organized by industry, but there are many options available for workers;

some large employers have their own super. – Employers typically have a default super for workers who do not make an election. – Every worker participates in a super, or workers can set up their own self-managed fund (SMSF).2

Employee coverage – Due to the system’s mandatory nature, coverage is close to 100%.

Economies of scale – A handful of large MEPs cover the vast majority of participants, creating advantages of scale.Heavy use of default funds – A large percentage of participants use default investment options.

– Only 31% of workers said they have taken advantage of investment choices beyond the default.3

Use of alternatives – Alternative and real assets investment strategies are commonly employed, with an average of 17% of DC plan assets in alternatives and 14% in real assets — similar to DB plans in the US.4

– Real estate is viewed as a standard asset class and is not considered an “alternative.” – The average real estate allocation: About 5% private real estate and 4% listed real estate (REITs).

This compares to a less than 1% aggregate allocation in US DC plans.4,5 – Other alternative investments such as private equity (5%) and infrastructure (5%) are also relatively common.4

Mandatory employee auto escalation

– Mandatory contribution escalation has been very successful. – Contribution levels started at 3% in 1992 and will increase from 9% in 2012 to an eventual 12% in 2019.

Key challenges

Compulsory contributions and multi-employer structure

– Since mandatory contributions are the same across employers, DC plans have become less of a recruiting tool and employee benefit, and more of a centrally run, non-voluntary system (similar to social security taxes in the US).

– Most employers have little say in how most supers are managed and are unable to customize the benefit for workers.

Lack of participant engagement

– This is evidenced by relatively large numbers of orphan accounts owned by participants who apparently “didn’t know the accounts existed.”2

Super-sized – As many of the supers become titanic in size, there is a growing level of concern around transparency and governance.3

Bottom lineEvery DC system has strengths and weaknesses, but it is clear that some aspects of the Australian system are worthy of further study in the US. The bottom line is that US employees must save more, and Australia — with a high savings-to-GDP ratio — serves as a model for what DC systems should strive to achieve.

Access and coverage – Mandatory contributions make coverage exceptional at nearly 100%. – This may not be feasible or desired in the US, but a mandatory contribution with opt-out, similar to the UK,

is closer to what might be acceptable in the US. More investment diversification

– In most cases, diversification is much better than that in the US, due to a more institutional approach and the inclusion of asset classes like infrastructure, private equity and private real estate.4

More difficult to take money out early

– Loans are not allowed, and hardship withdrawals have stricter standards than in the US.

Lower plan costs – One benefit of the multi-employer aggregation is lower costs, particularly for workers at small employers.

Higher participant savings rates

– While it’s unlikely that the US would ever adopt a mandatory contribution system like Australia, one must admire the vision the Aussies had when they decided long ago that 3% contributions would not lead to prosperity.

4

Food for thoughtForm 5500 gets a makeover

Read Jeff’s blog at blog.invesco.us.com

On July 21, 2016, the Department of Labor (DOL) issued proposed amendments to the 5500 series forms in a “Notice of Proposed Forms Revisions,” prepared jointly by three agencies: the DOL, the Internal Revenue Service and the Pension Benefit Guaranty Corporation, collectively referred to as “the agencies.”

Historically, Form 5500 has served primarily as an information source, but the agencies are increasingly relying on information reported as a key component of their compliance and enforcement initiatives.

Jeffrey Hemker National Manager, Retirement DivisionInvesco

With more than 30 years of experience in the industry, Jeff Hemker has been a featured speaker at educational seminars and industry events throughout his career. He is a frequent blogger and shares his passion for helping improve participant retirement readiness. Mr. Hemker graduated from the University of Wisconsin-La Crosse and Roosevelt University. He is a Certified Investment Management AnalystSM (CIMA®) professional.

Form 5500 is the primary source of information about the operations, funding and investments of private-sector, employment-based pension and welfare benefit plans in the US. The proposed revisions would add a number of new reporting requirements designed to aid the agencies in assessing whether a retirement plan is being operated and maintained in compliance with the Internal Revenue Code and the Employment Retirement Security Act of 1974 (ERISA).

The agencies believe the revisions are necessary because existing forms have not kept pace with industry changes that have occurred since the form’s initial rollout in 1975. This has led to outdated and missing information that the agencies believe adversely affect their ability to protect employee retirement and health benefits.

The proposed revisions to Form 5500 would result in a number of changes to existing reporting obligations for retirement plans. These proposed changes expand Form 5500’s financial and compliance reporting, analytics capability and service provider information, including:

1. Financial information. The proposal modifies the asset breakouts on the balance sheet component of Schedule H (Financial Information), adding new sub-categories of assets. The agencies are pursuing increased granularity of reporting to enable them to have a more accurate and detailed view of the types of assets held by a plan, including alternative investments, derivatives, hard-

to-value assets and underlying holdings of collective investment vehicles.

2. Service provider fee information. The proposed revisions to Form 5500 are also aimed at harmonizing the disclosure requirements on Schedule C (Service Provider Information) with the DOL’s service provider fee disclosure requirements under Section 408(b)(2) of ERISA. Updated fee reporting will include those covered service providers who receive less than $5,000 per year, especially in “indirect” compensation. The proposal would require plans to file separate Schedule C’s for each covered service provider.

Plan sponsors should consider whether they currently have systems in place to capture the new data required by the proposed revisions.

3. Compliance information. Select new questions will target issues concerning plan operations, service provider relationships and financial management of plans. The new questions are intended to compel fiduciaries to evaluate plan compliance with important requirements mandated by ERISA and the Code, and to provide the agencies with improved tools for oversight and enforcement and possible future regulation.

Although many of the proposed changes, if adopted, are targeted for 2019 plan year filings, plan sponsors should consider whether they currently have systems in place to capture the new data required by the proposed revisions. The DOL extended the comment period from Oct. 4 to Dec. 5, 2016, so it will be interesting to see where the agencies take us at the end of the year.

For more details, the proposals and a fact sheet are available at www.dol.gov/ebsa.

Key changes slated for 2019

DC Matters Fall/Winter 2016 5

Facts and figuresDC trends

For more information, visit invesco.com/dc

Matchmaking1

Best places outside the US to retire6

1. Algarve region of Portugal 2. Valletta, Malta 3. Puerto Vallarta, Mexico 4. Cayo, Belize 5. Ljubljana, Slovenia

DC plans offering a company match

46.2%True-up provisions

78%Large plans

$ $ $$ $ $

78% of large DC plans offer a company match, with a majority matching 51% to 99% of the first 6% of salary.

46.2% of plans have a true-up matching provision (allowing participants to receive the maximum match).

Unengaged employees2

33.9%of plan sponsors say that they are somewhat or very likely to reduce or eliminate the use of revenue sharing to pay for plan expenses.5

28% have never rebalanced their 401(k) account

31% have never made a change to their initial investment options

18% have never increased their contribution amount

18%Never increased

28%Never rebalanced

31%Neverchanged

College or retirement3

Collective vehicles

70.8%of plans offered collective trusts within their fund lineup in 2015. That’s up from 60% in 2014.5

Parents with children aged 8–14

75% postpone

69% college

75% of parents with children aged 8 to 14 are willing to postpone retirement to pay for their children’s college tuition.

69% said they favor putting aside money for their kids’ college before their own retirement.

Financial Achilles heel: Workers’ biggest financial concerns4

66%

60%

51%

48%

36%Medical expenses

Basic living expenses

Children's education

Retirement savings

Debt

1 Source: 2015 PLANSPONSOR Defined Contribution Survey of plans with assets >$500mm to $1b 2 Source: J.P. Morgan, 2016 Defined Contribution Plan Participant Survey3 Source: Employee Benefits News, “Parents say they’d sacrifice retirement to send kids to college,” Aug. 15, 20164 Source: International foundation of employee benefit plans5 Source: Callan DC Survey 20166 Source: Live and Invest Overseas, 2016 Annual Retire Overseas Index

6

Retirement income security: Challenging conventional wisdom

DC Matters interviewed Steven Montagna, Executive Director of the City of Los Angeles Deferred Compensation Program. Under his guidance, the program has implemented strategies and tools to boost employee engagement and help achieve retirement income security for city employees.

DC Matters Fall/Winter 2016 7

Plan sponsor forumCity of Los Angeles

Steven Montagna Executive Director, City of Los Angeles Deferred Compensation Plan

Steven Montagna is a Chief Personnel Analyst with the City of Los Angeles Personnel Department/Employee Benefits Division, where he serves as the Executive Director of the City’s $5 billion, 42,000-member Deferred Compensation Plan. He is also responsible for the City’s Civilian Benefits Program, which serves 25,000 employees. He has worked for the City of Los Angeles for 27 years, and been in a leadership role with the Deferred Compensation Plan since 1995. Mr. Montagna is also the 2016/2017 President of the Board of Directors for the National Association of Government Defined Contribution Administrators (NAGDCA), an organization of state and local government agencies administering supplemental retirement programs.

First, can you discuss your overall philosophy and core mission of the City’s Deferred Compensation Plan?Our mission is to create retirement income security for our plan participants, and we’ve spent considerable time creating a theory and a specific methodology for what that looks like. This all happened as part of creating our retirement income projection calculator and really engaging with our participants and getting feedback from them that helped inform our views.

You mentioned the retirement income calculator that the City of Los Angeles provides to participants. How did you develop it from concept to finished product, and how have participants embraced the tool? It actually all started with a spreadsheet that I created about 15 years ago for my personal use. I was interested in figuring out what my own income needs were going to be when I retire, and I wanted it to be very specific. At some point, I realized that this could make a great web tool for all of our plan participants.

We have three different defined benefit plans within the City of L.A., each with different rules and multiple tiers. We wanted to build those rules into the calculator and make sure that it was customized to our workforce. Importantly, we wanted it to be interactive — we didn’t want to just give people information

without giving them the ability to play with choices and assumptions to see how that might affect their results. We worked hard to strike the right balance between including enough of the variables that are essential to coming up with customized results without overdoing it and trying to address every single contingency. If we made it too complicated, people would disengage. So we were going back and forth with our plan participants and focus groups and asking them for feedback to find that right balance.

When we rolled out the calculator in October 2013, we really tried to put it front and center. For example, after people log in to the Plan website, this is one of the first things they see. We’ve done a number of different campaigns to promote it and create incentives for participants to use it. We track the number of times that people go into it, and our participants have gone in and used the calculator over 45,000 times. We also did a survey last year, and one of the questions we asked was about awareness of the calculator — do participants know that it’s out there? We found that 83% of the survey respondents said that they were aware of the calculator. We consider that a huge success.

We’ve done a number of different campaigns to promote the retirement income calculator and create incentives for participants to use it.

Retirement income calculator utilization by participantsCumulative number of sessions from inception date of Oct. 30, 2013 to June 30, 2016

10,000

20,000

30,000

40,000

50,000

2Q/161Q/164Q/153Q/152Q/151Q/154Q/143Q/142Q/141Q/144Q/13

45,847

36,278

24,360

7,602

Karen Desjardin/Photographer’s Choice/Getty Images

8

Plan sponsor forumCity of Los Angeles Continued

Retirement income security is a hot topic for DC plan sponsors. From your perspective, what is it and how do you define it? As I mentioned earlier, we do have a very specific theory and methodology for how we approach this question. In simple terms, the target that we’ve articulated to our participants is 100% replacement of what we call “lifestyle income.” So we look at the nominal annual salary that somebody is projected to have when they retire — let’s say it’s $100,000, for example. And let’s say that in this example, they’re contributing roughly 10% to the DB plan and 10% toward the DC plan. So that comes out to $80,000 in what we would call lifestyle income — an employee’s gross nominal annual salary at retirement less their primary reductions for retirement savings.

There are a lot of different interpretations as to what retirement income security means. We would make the case that what makes the most sense as not just a methodology, but more importantly, as effective language and communication, is to frame the objective as 100% replacement of lifestyle income. We think that’s important because people understand conceptually what 100% of anything means. It’s a more difficult concept if you’re saying, “You need 80% of this or so many times final salary, etc.” Making them do the math may intimidate them and cause them to turn away from the issue, and leaving it too vague is also not helpful. 100% as a concept means there’s no reduction to your standard of living at the time that you retire. People get that concept.

That means you don’t have to think about retirement as a time to cut back and reduce your expectations and your needs. That’s actually what I regard as the most empowering aspect of this approach. Most of our participants were assuming they were headed to leaner times in retirement, and that this was out of their control. Once they used the calculator, they found either that they were on track to a better outcome or there were steps they could take to reach a better outcome. I can’t even begin to tell you how gratifying it’s been to witness that.

The target we’ve articulated to participants is 100% replacement of what we call “lifestyle income,” which is nominal annual salary upon retirement less primary salary reductions for retirement savings (i.e., maintaining one’s working years’ standard of living)

What is your approach to participant education? What programs do you offer employees, and do you take a segmented approach based on either gender or age group? We are interested in being able to target audiences, and I think that’s kind of the next frontier for us. As an example, we did a campaign in which we were trying to increase enrollment with an under-enrolled population within the Department of Transportation. We had traffic officers and crossing guards who have historically contributed at very low levels. And we were able to, with a lot of work, data mine and find out exactly who wasn’t enrolled and reach out to them. We did so via mail, in person and at workshops. And it worked. It was very successful. Given the size of our workforce, however, that kind of approach isn’t something that we can replicate with the entire workforce. So we need to come up with more efficient ways to be able to reach the members. We regard that as a central but exciting challenge.

On the topic of challenges — what would you consider your top two to three challenges? At the end of the day it all comes down to engagement, communications and impacting behavioral choices. Everything else we do is certainly important, but it really is secondary because if you’re not

successful with those three things, then at the end of the day we’re not going to be able to meet our core mission or achieve more successful participant outcomes.

So, the first job is to be able to get your participants to pay attention to you, to listen to you. That’s the engagement piece. The next challenge is to be able to communicate to them in a language that they understand and that works with their own world view. And even if you’re successful at the first two, it’s that last piece that’s the most challenging: How can you support the behavioral changes and actions that they need to make in order to be able to create and maintain retirement security for themselves?

We’ve conducted many focus groups over the years, and there’s never been one in which I didn’t learn that participants were actually interpreting information in a way that was very different from what we intended.

City of LA is an adopter of white label funds. How have participants embraced white label funds versus brand name funds? The only pushback came at the moment of change, and it was relatively modest because we did the best job we could before we made the changes to explain why we were making them. We realized there needed to be a communication process where we had to really explain what the rationale was for getting rid of branded funds and replacing them with funds that would be labeled by asset class. We told our participants what we were thinking of doing and asked them what they thought about it. We were able to do this via a survey. A clear majority replied that the idea sounded reasonable.

A simple, versatile theory of retirement income security

30+ year career

DB and/or social security

income

DC plan income

30+ year retirement

income security

For illustrative purposes only

DC Matters Fall/Winter 2016 9

Visit cityofla457.com to learn more

We ended up making the change very incrementally, so from the participants’ point of view, they didn’t see everything change all at once. The only time that we had a real moment of resistance came with large-cap funds, and that’s only because so much of their assets were in those large-cap funds. But even then, it was really only a handful of participants that expressed major concerns. When you’re talking about 40,000 participants, that’s not a huge number. Still, we engaged with them proactively to assist with the changes. So, the process went very well, and participants are used to the investment menu. It’s very rare that people come forward to us and ask to add a fund to the lineup because we have a full brokerage window that provides access to the broad universe of investment choices.

I might also add that we wanted to keep the white label funds asset class specific in support of our broader objective — to help participants manage their personal and unique relationships with risk. When you introduce too many concepts and make them too complicated, you can undermine the participant’s ability to effectively engage with risk. Understanding the difference between major market segments — stocks versus bonds, large companies versus small companies — are all part of the risk management equation. And risk management, of course, is the number one topic when our participants come to see us.

What would you say are leading attributes to retirement readiness?I think it’s important that a distinction be made between “retirement income security” and “retirement expense security” as actually two different concepts. It’s dawned on me recently that they’ve been kind of muddled together, and we need to separate them. So as an example, there’s a lot of talk about retirees facing higher health care costs and this is a retirement income security risk. But that’s not a retirement income problem, that’s a retirement expense problem. Think about it this way: if a bunch of our workers were behind on their mortgages or facing emergency expenses, we wouldn’t say the way to solve those problems is to increase their pay. We might offer financial counseling, for example, through an

employee assistance program, or before someone even reaches that point we’d talk to them about insurance programs.

When we talk about managing retirement expenses, a lot of it is risk management and people lining up the insurance they may need to be able to deal with unanticipated outcomes, or to put money away to save for particular types of foreseeable expenses such as long-term care. We probably need to do a better job of separating out those conversations with our participants so they’re not trying to solve two things with one program. From a communications perspective, this adds a new dimension to communicating to our participants, and I’m really interested in exploring tools and resources that we can build to help our members engage with that retirement expense risk issue without necessarily marrying it to the retirement income challenge.

At the end of the day it all comes down to engagement, communication and impacting behavioral choices.

What is your vision for the plan in the future? What other areas would you still like to pursue? From my perspective, I think the next big phase is really shifting to more of a rigorous goals and metrics approach — trying to actually move the data versus just absorbing the data. It’s a mind shift. For example, we may notice that the participation rate is X this year and it was X last year. That’s one way to look at it. The other way is to say, “We were at this rate this year, and next year we want to increase that up to some new rate.” Then, as you look at that more closely, you begin to see how many factors influence the participation rate and your strategies for creating the desired behavioral outcome begin to broaden and become more experimental. For example, maybe one focus needs to be increasing the gross numbers of new enrollments, and that requires multiple strategies: for new hires, existing employees, etc. The more you do that, the more you start seeing the relationship between your strategies and outcomes. Once you truly start settling into that mindset, the process is

really never-ending. You’re always in that constant process of data mining, shifting the goal-setting, testing out and changing up strategies, whatever it takes to move the needle. I think that’s the mind shift that has yet to institutionalize itself. The reason I think that’s so important is because it actually creates accountability to a much greater extent than the mere observation of data and trends.

So often I hear things like, “People don’t understand something because they didn’t read the material.” Or, “This result is because this group is really hard to reach.” It’s a thought process of “Well, it’s beyond our control.” In fact, though, we simply have more difficult challenges in some areas, but our job is to continually evolve our strategies for addressing those challenges.

What advice would you offer other plan sponsors that have faced similar challenges?First is to really focus on communication, goals and outcomes – to find as many ways as you can to tap into the minds of your participants. Find out what they’re thinking rather than presume what they’re thinking. The focus group concept is great. I’ve done so many of them over the years, and there’s never been one in which I didn’t learn that participants were actually interpreting information in a way that was very different from what we intended.

Another thing that I think is crucial is having the willingness to think outside the box and to really challenge conventional wisdom. There is a lot of thinking in our world that’s been around for a very long time, and yet we live in a time when the pace of change is really speeding up and the things that worked in the past may not any more. We’re in a process of relentless reinvention. I would really encourage all plan sponsors and everybody that’s involved in the industry to always be looking through that lens. I think that’s also the part that makes our work the most fun and rewarding — creating something new and seeing people connect with it.

10

Central banks continue to play a pivotal role in financial markets

Hail to the chief (economist)Global economic outlook

Read John’s blog at blog.invesco.us.com

US 1.5%

Eurozone 1.5%

UK 1.7%

For the world as a whole, 2017 will be another year of only moderate growth, with inf lation below target in many economies. While the business cycle upswing in the US should continue, its beneficial effects could be undermined from time to time by de-leveraging in the largest EM economies or by instabilities arising from the Eurozone or from Brexit.

John GreenwoodChief Economist Invesco

Based in London, John Greenwood is Chief Economist of Invesco Ltd. with responsibility for providing economic analysis and forecasts to Invesco portfolio managers and clients.

Summary• Brexit – All meaningful outcomes are in suspense until the British government declares its hand by triggering Article 50 of the Lisbon Treaty which initiates the procedure for a country to leave the EU. Recently, UK Prime Minister Theresa May has said that this would happen by the end of March 2017.

– My view is that, irrespective of the start date, the process is likely to be long and painful. Volatility in financial markets — at least for sterling assets — is therefore likely to be the hallmark of the next few years.

• Central banks – On Aug. 4, the Bank of England (BoE) cut Bank Rate to a record low 0.25%, renewed quantitative easing (QE) with a further planned purchase of 70 billion pounds sterling, and added a new “Term Funding Scheme” to encourage banks to make more loans to businesses.

– Despite active speculation that the European Central Bank (ECB) would ultimately need to extend its QE purchase program, the Governing Council decided to take no actions on either July 21 or Sept. 8.

– The US Federal Reserve’s (Fed) Federal Open Market Committee (FOMC) decided at its July 26–27 and Sept. 20–21 meetings to take no action. Anxiety about relatively weak growth at home and subdued inflation, plus concern about weakness abroad again induced postponements of any interest rate rise. The market now expects a 0.25% interest rate hike in December.

– In the US, and to a lesser degree other developed economies, the long bond market appears to be finally approaching a major turning point after some 35 years of consistently falling yields. If so, this could have a major impact on a whole range of asset classes.

DC Matters Fall/Winter 2016 11

Central banks continue to play a pivotal role in financial markets

Invesco’s CPI forecast

CPIUS 2016 CPI inflation forecast

1.1%CPI

Eurozone 2016 CPI inflation forecast

0.2%Source: Invesco as of Sept. 12, 2016

Eurozone 1.5%

Japan 0.6%

2015 inflation and growth

• Consensus real GDP• Consensus CPI inflation

US

%

2.6

0.1

1.9 2.2

0.00.6

0.8

2.4

1.51.1 1.1

6.9

1.4

7.4

4.9

0.0

IndiaChinaCanadaAustraliaJapanUKEurozone US

1

2

3

4

5

6

7

8

2016 inflation and growth forecasts

• Consensus real GDP • Invesco real GDP• Consensus CPI inflation • Invesco CPI inflation

US

%

1.5

1.5

1.2

1.1

1.5 1.7

1.7 0.

70.

70.

6

-0.2

-0.1

2.9

2.7

1.3

1.3

1.2

1.0

1.6 1.

16.

66.

62.

01.

67.

67.

55.

25.

1

1.6

0.2

0.2 0.

8

IndiaChinaCanadaAustraliaJapanUKEurozone US

0

2

4

6

8

Source: Consensus Economics, survey date: Sept. 12, 2016

2016 consensus real GDP forecast

With the exception of sterling, global financial markets have recovered from the initial shock of the UK’s Brexit decision.

12

Hail to the chief (economist)Global economic outlook Continued

– The overall picture for developed economies is therefore one in which both growth and inflation will remain subdued. While central banks maintain or expand their assets, other financial institutions, firms and households outside the central banks continue to experience low money and credit growth.

– Beyond that, emerging market (EM) commodity producers are likely to continue to suffer further commodity price weakness and currency depreciation, while EM manufacturers should start to benefit from the steady recovery in the US.

The US consumer has higher savings, less debt, and stronger real take-home pay than in several years. This has been the basis for the US economy continuing to make steady progress while other economies have faltered.

United StatesUS real GDP improved in Q2 2016 only slightly to 1.1%. However, on Sept. 30, the Atlanta Fed’s “Nowcast” estimate of real GDP for the third quarter was 2.4%. Although still too early to be reliable, this estimate is more consistent with recent nonfarm payroll data which recorded firm increases averaging 232,000 per month in the June-August period. Although personal consumption spending has been reasonably buoyant, there are areas of the economy, such as corporate capital equipment spending, that are still running at well below past norms, implying that the overall outlook for the economy remains subdued.

The US consumer has higher savings, less debt, and stronger real take-home pay than in several years. This has been the basis for the US economy continuing to make steady progress while other economies have faltered. Hourly wage growth remained firm in August at 3.3%, according to the Atlanta Fed’s median wage growth tracker. Reflecting these tailwinds, real consumer spending was up 2.7% over the year to the end of the second quarter.

However, the main area of concern in the US economy continues to be the health of the corporate sector. Following the steep cutbacks in capital spending by the energy sector in 2015, there has been little recovery in this sector, while the combination of a strong dollar and weak world trade have eroded the growth of overall corporate revenue which has slowed to 2.1% year-on-year in Q2 2016. Although interest rates and energy prices remain low, slowing profits, political uncertainties ahead of the election, and weakening growth abroad have lowered business confidence. One striking consequence has been the persistent weakness of capital spending by businesses.

The EurozoneIn the eighteen months since the ECB started its QE purchases of government bonds in March 2015, the economies of the Eurozone had gradually started to see some signs of improvement, but in Q2 2016 GDP slowed to 0.3% from 0.5% in Q1 2016. This translated into a growth of 1.6% year-on-year in Q2 2016, slightly down on the 1.7% seen in the previous quarter. The slowdown occurred despite fiscal spending restraints becoming less of a drag on overall GDP.

While the long-term consequences of the Brexit decision should favor the rest of the EU at the expense of the UK (particularly in the financial sector and foreign direct investment), in the short term, the shocks to Eurozone activity that will flow from weaker sterling and some slowdown in the UK will adversely affect the other EU economies. For 2016 as a whole, I therefore expect real GDP growth of 1.6% and CPI inflation of 0.2% for the Eurozone.

United KingdomSince the referendum, there have been numerous surveys suggesting that consumer spending has remained buoyant, while business investment has slowed. Consumers are temporarily benefiting from improved wages and higher employment, and have not yet been affected by the decline in sterling, but it is widely expected that the price increases from the weaker currency will start to undermine real take-home pay over the winter months.

Similarly in the business arena, there have been offsetting forces at work. On the one hand the cheaper pound has given a temporary competitive boost to exporters, but on the other hand numerous projects involving foreign direct investment (FDI) have been put on hold.

With all these changes flowing from the Brexit decision, I now expect the economy to grow at 1.7% for the year as a whole, and about 1% in 2017.

JapanRevised GDP data now show that Japan’s real GDP increased by 2.1% (at an annualized rate) in Q1 2016, slowing to 0.7% annualized in Q2. The erratic pattern of Japan’s GDP estimates is reflected in the fact that these figures translated into year-on-year growth rates of 0.2% and 0.8% only.

The continuing sense of underlying economic weakness and the persistent failure to achieve the Bank of Japan’s (BoJ) inflation target of 2% were the main reasons why the central bank undertook a major “assessment” of its quantitative and qualitative easing (QQE) policy.

DC Matters Fall/Winter 2016 13

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Against this weak growth background, inflation has again returned to negative territory. In August, the headline and core national CPI rates recorded -0.5% and -0.4% year-on-year, respectively. The headline figure has now been in negative territory on a year-on-year basis for five months, while the CPI ex food prices has been falling for eight successive months. Three factors have affected the CPI data in the past two years: an upward spike from the consumption tax in April 2014; downward effects from the roughly 20% strengthening of the yen since mid-2015; and lower oil prices.

China and non-Japan AsiaWhile China continues to slow, the India economy has been gradually improving its performance. Indian growth now regularly surpasses that of China. Even so, China’s economy is in many ways much more open, having a much larger trade sector than India. Thus, while China exported over US$2.2 trillion worth of goods in 2015, India exported only US$355 billion. The differences on the import sides are similar, implying China will continue to have a far bigger regional (and global) impact than India.

The slowdown in China and in world trade has hit the smaller East Asian economies especially hard. Asian emerging markets are heavily reliant on exports. Therefore, declines in exports are having a sustained effect on East Asian economies’ reported GDP figures, many of which have slowed to low single-digit growth rates. In addition, these economies have experienced a depreciation of their currencies against the US dollar, coinciding with the fall in exports that began in early 2015 and has persisted since. This has affected almost all the smaller East Asian economies.

Until global demand strengthens — especially in the Euro-area and Japan — and China succeeds in stabilizing its growth rate, it seems likely that the smaller East Asian economies will not regain their past vigor. They may benefit marginally from cheaper commodity

prices, but those price declines are hurting some of their key export markets such as Brazil and Indonesia.

While China continues to slow, the India economy has been gradually improving its performance. Indian growth now regularly surpasses that of China.

CommoditiesDuring the past several years commodity prices have consistently collapsed during the final calendar quarter. This year that trend looks likely to be broken. At the end of September the S&P GSCI spot index was up over 23% since the start of the year, although it is still 53% below its average over the last 5 years. Three factors explain this outcome: stronger growth in Asia outside of China; some reduction in supply; and the fading of the effects of the strong US dollar. Together these have led to commodity price indices rising from their nadir in January 2016, but a positive outlook for commodities is by no means guaranteed.

Unquestionably, the major driver of commodity markets in the last decade was the rapid growth of China, which is also the dominant end-user for a whole range of commodities. Therefore, the sustained slowdown in the Chinese economy, the emergence of massive excess capacity in key industrial sectors in China, as well as structural changes in the energy sector brought about by new supplies from unconventional sources such as shale, solar and wind, have inevitably led to substantial falls in commodity prices.

The US has continued to grow at a moderate rate, and it seems likely that this trajectory will enable the Fed to raise interest rates in December, and then again once or twice in 2017.

ConclusionWith the exception of sterling, global financial markets have recovered from the initial shock of the UK’s Brexit decision. Europe has been largely pre-occupied with the continuing problems of its banking system, most recently in Italy and Germany, a consequence of two factors: the failure to recapitalize banks on a systemic basis (as was done in the US); and the failure to re-liquefy the economy by means of a well-designed QE program or other measures. The result has been a prolonged, sub-par recovery.

The US has continued to grow at a moderate rate, and it seems likely that this trajectory will enable the Fed to raise interest rates in December, and then again once or twice in 2017. In other words, the business cycle will continue to expand, irrespective of the political cycle.

In Japan the economy continues to struggle to generate positive growth or inflation. As in Europe, there has been inadequate focus on balance sheet repair and the re-liquefication of the economy by means of QE or banking sector expansion.

Finally, some of the large EM economies are now in urgent need of an extended period of de-leveraging, which seems almost certain to undermine their growth rates going forward, thus keeping commodity prices subdued. In the wake of China’s debt explosion, the only large EM economy that is capable of growing vigorously is India, but the government appears hesitant to implement the radical reforms necessary to expand its foreign trade sector.

For the world as a whole, 2017 will be another year of only moderate growth, with inflation below target in many economies. While the business cycle upswing in the US should continue, its beneficial effects could be undermined from time to time by de-leveraging in the largest EM economies or by instabilities arising from the Eurozone or from Brexit.

All data provided by Invesco unless otherwise noted. Where John Greenwood has expressed opinions, they are based on current market conditions as of Oct. 3, 2016 and are subject to change without notice. Unless otherwise specified, data was supplied by Mr. Greenwood.

14

Investment cornerUnder the hood

Scott Wolle, CFA®

Chief Investment Officer and Portfolio ManagerInvesco Global Asset Allocation

Scott Wolle is the Chief Investment Officer and a Portfolio Manager for the Invesco Global Asset Allocation team, which invests in stock, bond and commodity markets worldwide. Mr. Wolle joined Invesco in 1999 as an analyst and portfolio manager, and became a member of the Global Asset Allocation team in 2001. He assumed his current role in 2005. Mr. Wolle graduated magna cum laude from Virginia Tech with a degree in finance. He earned an MBA from the Fuqua School of Business at Duke University, with the distinction of Fuqua Scholar. He is a CFA charterholder.

In this article, we’ll examine how commodities have historically served as an inflation hedge, and discuss how they may be implemented in a DC plan as part of a larger, diversified strategy.

Equities and fixed income are both well-understood asset classes with clear roles in a portfolio. Commodities do not enjoy these same benefits and have spawned debate about how plan sponsors should use them.

Key benefitsThere are two key benefits of adding commodity exposure portfolios such as target date, target risk or real asset strategies: 1. Potential inflation hedge 2. Portfolio diversification

In addition, there is the question of whether an allocation to commodities has generated a risk premium over time. In our experience, this has been one of the greatest obstacles for plan sponsors when considering an allocation to the asset class. Finally, we look at the recent environment and how the decline in prices could indicate an attractive opportunity for future returns.

Potential inflation hedge Investors commonly argue that stocks offer an effective hedge against inflation. The simplest version of this argument is that earnings will rise along with inflation, and therefore investors will be protected. This claim rests on the following equation:

The role of commoditiesParticipants are likely to face different economic environments throughout the accumulation and distribution phases of their investing life cycle. Inf lationary growth is one economic environment that poses a significant risk to participants’ assets if their portfolio is not constructed appropriately to hedge inflation. For those in or near retirement, one of their top concerns is losing the purchasing power of their assets. For younger investors, reducing inflationary risk is important to achieving real growth, wealth accumulation and a comfortable retirement. Sapna Reddy Photography/Moment/Getty Images

DC Matters Fall/Winter 2016 15

Stock Price = Price/Earnings Ratio x Earnings

This assumes that the price/earnings (P/E) ratio remains constant and that earnings will grow in real terms. Unfortunately, the first assumption has not been validated in periods when inflation rises substantially.

Exhibit 1 considers the behavior of US companies’ P/E ratios during inflationary environments. Using a cyclically adjusted P/E ratio to eliminate the effect of the business cycle, it suggests that the current level of inflation may be ideal for equities. As inflation has risen, the average P/E ratio has fallen.

Earnings do indeed grow along with inflation; however, real earnings growth was roughly zero during the 1970s and 1980s when inflation was high. Conversely, real earnings growth has been much higher over the last 25 years when inflation was low.

In contrast, commodities have had a distinctly positive relationship with inflation. Two primary reasons for this include the clear flow-through effects of commodity prices as well as monetary impacts when countries attempt to reduce the value of their currencies.

Inflation is often separated into expected and unexpected inflation. Commodity strategies have historically provided a hedge against both. Exhibit 2 shows the one-year excess return of commodities and one-year unexpected inflation.

These findings are also consistent with prior studies including Bhardwaj, Gorton and Rouwenhorst, who found a 0.47 correlation between commodities and inflation on a five-year horizon from 1957 to 2014, and a 0.65 correlation for the 2005-2014 period.2

Exhibit 1: P/E has decreased as inflation has risenS&P 500 cyclically adjusted P/E

• YoY inflation

21.3

14.3

9.3

>10%4–10%<4%

5

10

15

20

25

AdjustedP/E %

Sources: DataStream and Invesco analysis. Period represented: Dec. 31, 1950, through Dec. 31, 2015.

Exhibit 2: Commodities correlated to unexpected inflation1

High correlation with unexpected inflation

• Unexpected inflation • Commodity excess return

-60-40-20

020406080

100120

-6-4-202468

1012

Unexpectedinflation %

Commodityexcess

return %

12/1512/1012/0512/0012/9512/9012/8512/8012/7512/70

Sources: Bloomberg L.P., DataStream and Invesco analysis. For illustrative purposes only. Commodity excess return above the US 30-day Treasury Bill. Data from Dec. 31, 1970 through Dec. 31, 2015. Unexpected inflation is defined as year-over-year inflation relative to its 5-year moving average. Commodity excess return is the rolling 12-month excess return index are represented by the S&P GSCI Light Energy Index from Dec. 31, 1970 through Dec. 1, 1998 and the Deutsche Bank Liquid Commodity Index from Dec. 1, 1988 through Dec. 31, 2015. Inception dates for the S&P GSCI Light Energy Index and Deutsche Bank Liquid Commodity Index are May 1, 1991 and Feb. 28, 2003, respectively. All information presented prior to the inception dates is back-tested. Back-tested performance is not actual performance, but is hypothetical. Although back-tested data may be prepared with the benefit of hindsight, these calculations are based on the same methodology that was in effect when the index was officially launched. Index returns do not reflect payment of any sales charges or fees. Past performance cannot guarantee future results. An investment cannot be made in an index.

16

Investment cornerUnder the hood Continued

Exhibit 3: Stocks, bonds and commodities have responded differently to the economic environment1

Asset Performance as growth rises Performance as inflation rises

Bonds

Stocks

Commodities

Source: Invesco analysis and DataStream. For illustrative purposes only. Data from Jan 1, 1973 through Dec. 31, 2015. Bonds represented by Barclays US Treasury Index, commodities by the S&P GSCI and equities by the S&P 500 Index. Inception date for the S&P GSCI is May 7, 2007. All information presented prior to the inception dates is back-tested. Back-tested performance is not actual performance, but is hypothetical. Although back-tested data may be prepared with the benefit of hindsight, these calculations are based on the same methodology that was in effect when the index was officially launched. Index returns do not reflect payment of any sales charges or fees. Past performance cannot guarantee future results. An investment cannot be made in an index.

The relationship between equities and commodities is more ambiguous, but investors still would not expect a high correlation between the asset classes.

Portfolio diversification There is a straightforward framework to consider how various assets react to different market environments. Looking at Exhibit 3, one would expect government bonds to benefit when growth and inflation fall. This implies a low or negative correlation with commodities, which tend to benefit when growth and inflation rise. The relationship between equities and commodities is more ambiguous, but investors still would not expect a high correlation between the asset classes.

As it turns out, this simple framework fits well with the historical record. Exhibit 4 compares correlations across stocks, government bonds and commodities. Two observations stand out: 1. There is a low correlation among the

commodity complexes, especially compared with stocks and bonds.

2. Equities, bonds and commodities have historically had low or negative correlation with each other.

These observations have implications for the value of investing in commodities. The potentially low correlation of commodities with traditional asset classes should allow investors to create diversified portfolios with a higher expected return per unit of risk. Low correlations among the commodity complexes can provide opportunity for high return simply through rebalancing.

Potential for excess return The potential inflation hedge characteristics and diversification benefits of an allocation to commodities are supported by the historical performance of the asset class. However, many investors remain skeptical that commodities deserve a strategic allocation and believe they will likely be a drag on portfolio performance in the absence of inflation. Most long-term studies of commodities refute this skepticism. Indeed, most indicate Robbie George/National Geographic/Getty Images

DC Matters Fall/Winter 2016 17

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Exhibit 4: Low correlation can create an opportunity to build a better portfolio1

30-year correlation within asset classes 30-year correlation across asset classes

0.2

0.4

0.6

0.8

0.60

Stocks Bonds Commodities

0.50

0.20

Correlationswithin thecommodity asset class are low

-0.3

0.0

0.3

0.04

-0.05

0.02

CommoditiesBondsStocks

None of the asset classes are highlycorrelated with one another

Sources: Datastream, Invesco analysis. Data from Dec. 31, 1986, through Dec. 31, 2015. The FTSE 100 Index inception is Jan 3, 1984. The EuroStoxx50 Index inception is Feb. 26, 1998. The Tokyo Stock Price Index inception is July 1, 1969. All information presented prior to the inception dates is back-tested. Back-tested performance is not actual performance, but is hypothetical. Although back-tested data may be prepared with the benefit of hindsight, these calculations are based on the same methodology that was in effect when the index was officially launched. Index returns do not reflect payment of any sales charges or fees. Past performance cannot guarantee future results. An investment cannot be made in an index. In the left chart, stocks represented by the S&P 500, FTSE 100, EuroStoxx50 and Tokyo Stock Price Index. Bonds represented by US Treasuries, UK Gilts, German Bunds and Japanese Government Bonds. Commodities represented by S&P GSCI sub-indexes for Agriculture, Energy, Precious Metals and Industrial Metals. This compares correlations within each asset class. The right chart uses the same asset class proxies to compare correlations across the asset classes. Data begins at first common inception date of all indices using a correlation matrix to represent asset class correlation.

Exhibit 5: Major commodity corrections1

The experience since 2008 has been as bad as any in modern history

• 1974 • 1980 • 1997 • 2008

11/7

4

10/8

0

05/9

7-4

1% -55%

12/1

5-6

6%

-51%

-46%

06/0

8

Commodity excess return index2

100

400

700

1,000

12/1012/0012/9012/8012/70 Index value100=peak

120100806040201

20

40

60

80

100

120

Months from peak

Sources: DataStream and Invesco analysis. For illustrative purposes only. Data from Jan. 31, 1970 through Dec. 31, 2015. The four periods of loss are named for the year in which commodities reached a major local peak. The recovery is considered complete when the index exceeds the prior local peak. Prior to Jan. 1 1991, commodities are represented by the S&P GSCI Light Energy Index. Starting Jan. 1, 1991, commodities are represented by the Bloomberg Commodity Index. Inception dates for the S&P GSCI Light Energy Index and Bloomberg Commodity Index are May 1, 1991 and Jul. 14, 1998, respectively. All information presented prior to the inception dates is back-tested. Back-tested performance is not actual performance, but is hypothetical. Although back-tested data may be prepared with the benefit of hindsight, these calculations are based on the same methodology that was in effect when the index was officially launched. Index returns do not reflect payment of any sales charges or fees. Past performance cannot guarantee future results. An investment cannot be made in an index.

the asset class has return and risk characteristics similar to equities.

Commodity corrections Of course, the weak performance of commodities from 2011 through early 2016 makes some people question whether this reflects an inability to produce attractive returns in the future. On the contrary, like most assets, the decline in price can create an attractive opportunity for future returns.

The severity of the current commodity correction is striking. There have been four major commodity bear markets in modern times — starting in 1974, 1980, 1997 and 2008 — as depicted in Exhibit 5. In particular, the most recent bear market — starting at the end of 2008 — has been the worst experience in modern history.

The weak performance of commodities from 2011 through early 2016 makes some people question whether this reflects an inability to produce attractive returns in the future.

For more familiar assets like stocks and bonds, a decline in price makes it less expensive to buy the cash flows that the asset will produce in the future. In commodities, the decline in price puts pressure on commodity producers to reduce capital spending, reduce production and, sometimes, go out of business.

Summary Commodities can play a very important role as an inflation hedge and diversifier within a portfolio while still offering reasonable return expectations. While plans may be concerned that many participants wouldn’t know how to properly allocate to a standalone commodities option, we believe commodities can play an important role in a plan as part of a professionally managed, diversified strategy such as a target date or risk-based option.

1 Includes back-tested data. 2 ”Facts and Fantasies about Commodity Futures Ten Years Later,” May 25, 2015, by Bhardwaj, Gorton and Rouwenhorst. 3 Excess return above Treasury bills.

18

Participant communicationsWomen, wisdom and wealth

To learn more, visit the participant communication page at invesco.com/dc

Facts and figures

Social Security benefits are not enough to live on

$1,500 Men

$1,182 Women

The average monthly benefit for retired workers in 20151

Longer life expectancies = longer retirements

86.6 yearsWomen’s average life expectancy in 20152

Did you know?Of the 63 million US female workers (age 21 to 64), just

44%participated in a retirement plan.3

As a plan sponsor, you want all of your participants to be educated on the importance of retirement planning. But research has shown that a one-size-fits-all approach to communication isn’t the most effective tactic. And while it’s impossible to customize messages person by person, it turns out that it’s quite easy to customize them by one big factor: gender. It’s widely accepted that there are differing preferences in communication styles and learning techniques between most men and most women.

The question is: How can you adjust your message in a way that’s enlightening, not alienating for your female participants?

Lisa KuengDirector, Creative CampaignsInvesco Consulting

Lisa Kueng is a national speaker and the developer of many of Invesco’s consulting programs, including the “Your Prosperity Picture” workshop for women investors and “The New Retirementality,” and is co-author of “Picture Your Prosperity: Smart Money Moves to Turn Your Vision into Reality.” Ms. Kueng has been a keynote presenter at hundreds of industry conferences and has been featured in Business Week, The New York Times, NPR’s “Marketplace Weekend” and Fund Marketing Alert. Ms. Kueng holds a BS degree in journalism with a concentration in speech communications from the University of Illinois and has earned her Registered Corporate Coach designation. She is currently a member of the Invesco Women’s Network, a volunteer for One Million Degrees and a regular guest speaker at Loyola University in Chicago.

The risks of not being preparedBefore I answer that question, I want to reinforce why this topic is so important.

Women have longer average lifespans than men, yet tend to underestimate how much they need to save for retirement. The chart below shows that women generally expect they’ll need less in retirement savings than men. But the truth is that they will likely need more. For example, a 2012 study reported that a healthy 65-year old woman can expect cumulative health care expenses, including premiums, to top $417,000, nearly 13% higher than those for men.4

How much savings do you think is needed for retirement?

% Men Women

Less than $250,000 28 32

$250,000–$499,999 19 22

$500,000–$999,999 22 21

$1M–$1.49M 10 7

$1.5M+ 12 8

Don’t know or remember 5 8

Source: ebri.org, 2013 Retirement Confidence Survey Fact Sheet #5, “Gender Comparisons Among Workers”

Helping women

Savemore

DC Matters Fall/Winter 2016 19

Clearly, we need to make sure that our participant communications are being heard by women.

Avoiding labelsAt this point, you may be thinking that I’m going to suggest a series of women-branded workshops or educational flyers stamped in pink.

But I’m not.

When Invesco Consulting began the process of creating a workshop for women investors, we tested numerous options for titles with specific references to women, and one of the first things we heard from women investors is that they do not want to be singled out by their gender. In fact, any title that included a gender reference — such as “What Women Know About Money” or “The Female Financial Advantage” — consistently scored in the bottom 20% of our dial session research.

Why? Because women often view these approaches as carrying a subtle suggestion of inferiority, as if the “women’s version” was created for those who don’t qualify for the regular workshop. We found that a better approach is to create educational workshops and materials with the preferences of women in mind, but which don’t highlight them as “special” or “different.” In other words, simply work to meet the needs of your women participants — without labeling them.

Simply work to meet the needs of your women participants — without labeling them.

Three key principlesThis is the approach Invesco Consulting took when creating our investor education workshop “Your Prosperity Picture” (notice the lack of women-specific labels in the title). We found that there are three key principles that resonate with many women investors, and we incorporated these in our program:1. Provide experience before explanation2. Align life goals with financial goals3. Be positive

Principle No. 1: Provide experience before explanation. According to the College Student Journal, women tend to be “Relational Learners” while men are usually more “Independent Learners.” We found that beginning a workshop with an interactive activity (instead of just launching into a presentation) can be a great way to tap into that learning preference for many women.

But what kind of activity? In my last column for DC Matters — “What will retirement look like?” — I discussed the power of visualization exercises. Science has shown us that if you visualize a particular goal that requires financial resources, such as traveling or pursing a hobby, it helps to condition the brain to look for information and resources that might help in achieving that goal. Walking investors through a visualization exercise that focuses on their goals can be a great way to begin a financial workshop.

Principle No. 2: Align life goals with financial goals. One study has shown that women who feel their financial advisors have successfully helped them align their investment goals with their life goals are 41% more likely to be satisfied.5 In “Your Prosperity Picture” workshops, we do this by walking investors through the process of creating a visual financial plan that illustrates their short-term and

long-term goals, and organizes them by the amount of financial resources that will be necessary to make those goals happen.

Once investors are talking and thinking about their vision for their retirement, the next logical step is to connect that vision with your retirement plan benefits. You’ve set the stage to talk about practical strategies geared toward making their goals happen.

Principle No. 3: Be positive. I started this column with some fairly sobering statistics about women and longevity risk. I did that to set the stage for you, the plan sponsor, but I would not include these in an investor workshop. Our research has clearly shown that negative spin doesn’t sit well with most women investors, and trying to scare them into action can backfire. In fact, the principle of being positive is so powerful that it actually transcends gender. It’s proven to be one of the most important and consistent language trends that Invesco Consulting has seen since we began doing our language research in 2007.

What does this mean for plan sponsors? Rather than focusing on the possibility of negative outcomes and how to avoid them, focus on achieving what’s possible. Position your benefits plan as a way to help investors reach their goals, rather than taking a gloom-and-doom approach.

Bottom lineIn general, women and men have different learning styles and communication preferences, but women don’t want to be singled out. A workshop designed for these needs won’t include “women” in the title, but will follow three key principles: providing experience before explanation, aligning life goals with financial goals, and maintaining a positive message.

1 Source: Social Security Administration, “About Social Security: Fast Facts & Figures,” Aug. 20162 Source: Social Security Administration, “Social Security is Important to Women,” June 20153 Source: Employee Benefits Security Administration and US Department of Labor, Women and Retirement Savings, Sept. 20154 Source: Insured Retirement Institute, “IRI Exclusive: Escalating Health Care Costs Threaten to Erode American’s Retirement Savings,” Jan. 10, 20125 Source: “Harnessing the Power of the Purse: Female Investors and Global Opportunities for Growth” by Sylvia Ann Hewlett and Andrea Turner Moffitt with

Melinda Marshall. ©2014 Center for Talent Innovation. All rights reserved.

20

What’s up on Capitol Hill?The Commission speaks

Securing our financial future: Report of the Commission on retirement security and personal savings

James B. Lockhart IIIVice Chairman, WL Ross & Co. LLC, an Invesco company; Co-Chairman, Commission on Retirement Security and Personal Savings

James B. Lockhart III is the Vice Chairman of WL Ross & Co. LLC where he is a member of the management committee, oversees the financial services investment team and serves on investment committees including two mortgage funds. Prior to joining WL Ross & Co., Mr. Lockhart served as the director of the Federal Housing Finance Agency and chairman of its Oversight Board, and was the director of its predecessor agency, the Office of Federal Housing Enterprise Oversight. He also served on the Financial Stability Oversight Board, overseeing the Troubled Asset Relief Program (TARP). Mr. Lockhart was the deputy commissioner and chief operating officer of the Social Security Administration and executive director of the Pension Benefit Guaranty Corporation. He also served as a lieutenant (j.g.) in the US Navy aboard a nuclear submarine. Mr. Lockhart earned an MBA from Harvard University and a BA from Yale University. He is a director of Virgin Money in the UK, Bank of the Cascades, Capital Markets Cooperative, Shellpoint Partners, Situs Holdings and the Bruce Museum. In 2009, he received The American Financial Leadership Award from the Financial Services Roundtable. He is a fellow of the Association of Corporate Treasurers in the UK.

A large segment of Americans struggle to save for any purpose. Millions are anxious about their preparation for retirement as well as their difficulty accumulating a savings cushion for short-term, unexpected needs.

Policymakers are concerned about the consequences of insufficient retirement savings for individuals, families and the nation. Recent economic headwinds — stagnating wages and weak economic growth — have heightened these anxieties.

DC Matters Fall/Winter 2016 21

Visit the BPC web site at bipartisanpolicy.org

IntroductionThe nation’s retirement system has many strengths, but it is also experiencing challenges. Retirement and savings policies have evolved over the decades into a true public-private partnership. Assets in workplace retirement savings plans and Individual Retirement Accounts (IRAs) have grown dramatically over the last four decades, but too many Americans are still not preparing adequately. Social Security remains the base of financial support in old age for most Americans, yet the program faces substantial financing problems. A long history of bipartisanship built these systems to promote savings and improve retirement security, but much work lies ahead.

To address these challenges, the Bipartisan Policy Center (BPC) launched the Commission on Retirement Security and Personal Savings in 2014. Over the last two years, our 19-member commission has carefully reviewed the issues and explored many potential approaches to boost savings and strengthen retirement security.

We are encouraged that the issues of savings and retirement security have attracted bipartisan interest among

business leaders, the media, elected officials in Congress, the administration, and the states, as well as from candidates seeking public office. We hope that the commission’s recommendations will contribute to meaningful action by individuals, businesses and government to achieve a secure retirement future for all Americans.

Workers have found themselves part of a great experiment — one that has given individuals and families far more control and responsibility for financing their own retirement, and simultaneously exposed them to greater risk.

BackgroundTectonic shifts in demographics, policy, and the marketplace have transformed the US retirement landscape. The most profound change has been an ongoing shift by many employers from defined benefit pensions to defined contribution plans. As a result, the 401(k) — previously an obscure section of the tax code — has become a household name.

Workers have found themselves part of a great experiment — one that has given individuals and families far more control and responsibility for financing their own retirement, and simultaneously exposed them to greater risk.

Today, more than in the past, personal responsibility is of central importance in retirement preparedness — individuals and families can’t afford to take a passive approach to retirement savings — but that doesn’t mean everyone should be or can be on their own. People need the assistance of a well-designed system as they accumulate, invest and spend down their retirement savings. Public policy has a critical role to play in facilitating savings and a secure retirement.

The commission addressed six key challenges:

1. Many Americans’ inability to access workplace retirement savings plans

2. Insufficient personal savings for short-term needs, which too often leads individuals to raid their retirement savings

3. Risk of outliving retirement savings4. Failure to build and use home equity

to support retirement security

Orhan Cam/shutterstock.com

22

What’s up on Capitol Hill?The Commission speaks Continued

5. Lack of basic knowledge about personal finance

6. Problems with Social Security, including unsustainable finances, an outdated program structure and failure to provide adequate benefits for some retirees

RecommendationsTaken together, the Commission’s recommendations aim to establish a better savings culture and renew the promise of an adequate retirement — across the income spectrum — for current and future generations of Americans.

1. Improve access to workplace retirement savings plans

Too many Americans, especially those who work for small businesses, lack access to a payroll-deduction workplace retirement savings plan.

We recommend the creation of a new, streamlined option called Retirement Security Plans that would allow small employers to transfer most responsibilities for operating a retirement savings plan to a third-party expert, while still maintaining strong employee protections. We would also enhance the existing myRA program to provide a base of coverage for those workers, such as part-time, seasonal and low-earning workers, who are least likely to be offered a retirement savings plan.

Other workers have access to retirement savings plans but do not contribute. We also propose an alternative to non-discrimination testing, along with new tax incentives to encourage employers to adopt automatic enrollment and escalate their employees’ contributions over time. Once these reforms are in place, we recommend establishing a nationwide minimum-coverage standard to pre-empt the patchwork of state-by-state regulation that is already developing.

A variety of additional reforms could support greater access to retirement savings plans and improve the experience of plan participants. We would encourage lower-earning individuals to save for retirement by improving the existing Saver’s Credit for younger workers and by exempting some retirement savings from asset tests to qualify individuals for certain federal and state assistance programs.

We also recommend several additional actions, including the creation of a Retirement Security Clearinghouse to help Americans consolidate their retirement savings, steps to limit over-exposure to company stock, and modest adjustments to retirement tax expenditures.

Establish a nationwide minimum coverage standard to expand access to workplace retirement savings.

2. Promote personal savings for short-term needs and preserve retirement savings for older age

Americans need to increase their personal savings so that they are better positioned to handle emergencies and major purchases. Insufficient short-term savings can lead workers to draw down their retirement accounts, incurring taxes and (often) penalties. This “leakage” of retirement savings — while it might address an immediate financial squeeze — jeopardizes many Americans’ long-term retirement security. To address this issue, we recommend clearing barriers that discourage employers from automatically enrolling their employees in multiple savings accounts, one for short-term needs and another for retirement.

Some leakage of retirement savings results from system complexity and poorly designed regulation. We propose to ease the process for transferring savings from plan to plan, because many pre-retirement withdrawals occur upon job separation. In addition, early-withdrawal rules and penalties for workplace plans and IRAs should be harmonized by raising IRA standards.

Simplify the process to move assets from plan to plan.

Old Job 401k Simplified 401k

NewJob 401k

3. Reduce the risk of outliving savings

While Social Security provides a form of lifetime income, Social Security benefits alone will not be adequate to meet all income needs for most retirees. For those who have accumulated sufficient savings, other lifetime-income solutions offer the security of additional, regular retirement income that they cannot outlive.

We recommend that plan sponsors integrate sophisticated, but easy-to-use, lifetime-income features within retirement savings plans. Plan sponsors could establish a default lifetime-income option or offer an active-choice framework in which participants are asked to choose options from a customized menu.

In-plan tools could also help participants make an informed decision about when to claim Social Security benefits and then to schedule withdrawals from their retirement plan to facilitate later claiming of Social Security benefits. We believe employers need safe harbors to limit their legal risk as they offer these features and attempt to educate workers about longevity risk and lifetime income.

Additionally, we recommend clearing barriers to offering a wider array of choices for lifetime income in both retirement savings and pension plans. Workers with defined benefit pensions should be able to receive part of their benefit as a lump sum and the rest as monthly income for life, rather than the all-or-nothing choice most have today. To encourage participants to work longer and provide more consistent work incentives, we recommend allowing employer-sponsored retirement plans to align plan retirement ages with Social Security.

DC Matters Fall/Winter 2016 23

Encourage plan sponsors to integrate easy-to-use, sophisticated lifetime-income features.

$ $ $$ $ $

4. Facilitate the use of home equity for retirement consumption

Housing is an important form of savings. Americans own more than $12.5 trillion in home equity — a sum that rivals the $14 trillion that Americans hold in retirement savings.1,2 For individuals or couples who lack substantial savings in a retirement plan but who own their residence, homeownership can be a major source of retirement security. A variety of mechanisms exist for tapping home equity to fund regular consumption needs in retirement; for example, homeowners can downsize, use a reverse mortgage, or sell their home and rent instead.

Federal and state tax policy, however, actually subsidizes the use of home equity for pre-retirement consumption, leaving many retired homeowners burdened with debt and with less equity to support retirement security. We recommend ending these subsidies by eliminating tax benefits for borrowing that reduces home equity.

We also propose to strengthen programs that support and advise consumers on reverse mortgages, which can be a good option for some older Americans. Establishing a low-dollar, reverse-mortgage option would facilitate smaller loans while reducing fees for borrowers and risk for taxpayers.

5. Improve financial capability among all Americans

Financial capability — defined as having the knowledge, ability and opportunity to manage one’s own finances — is lacking among too many Americans.3,4 This is a troubling fact at a time when the nation’s retirement system has transitioned toward greater individual control and responsibility.

Exposure to financial knowledge and planning should begin early in life, with schools, communities, employers, and federal and state governments all working to foster a culture of savings and to position individuals to make prudent financial choices. We support a variety of approaches, including implementing recommendations from the President’s Advisory Council on Financial Capability, providing improved personal financial education through K-12 and higher-education curricula, and better communicating the consequences of claiming Social Security early.

Better communicate the advantages of claiming social security benefits later.

$ $ $

Age62

Age67

Age70

Benefits increase

6. Strengthen Social Security’s finances and modernize the program

Social Security provides the income foundation for many older Americans, but to maintain that legacy, prompt adjustments to the program are needed. For decades, the program’s trustees have affirmed the need for changes, noting that Social Security faces significant financial challenges.

We recommend adjustments to Social Security’s tax and benefit levels to 1) reflect changing demographics; 2) better target benefits on those who are most vulnerable in old age, including surviving spouses and workers in low-earning occupations; 3) preserve reasonable intra- and inter-generational equity; and 4) more fairly reward work.

Financial capability — defined as having the knowledge, ability and opportunity to manage one’s own finances — is lacking among too many Americans. This is a troubling fact at a time when the nation’s retirement system has transitioned toward greater individual control and responsibility.

ConclusionOur recommendations aim to bring peace of mind to Americans preparing for retirement by assuring the financial sustainability of the Social Security program and by significantly expanding access to workplace retirement savings plans. Together, these changes would help many more workers take charge of their financial futures.

1 Source: Board of Governors of the Federal Reserve System, Financial Accounts of the United States: Fourth Quarter 20152 Source: Investment Company Institute, The U.S. Retirement Market, Fourth Quarter 20153 Source: Investor Education Foundation, 2012 National Financial Capability Study4 Source: Center for Social Development, “Financial Capability: What is It, and How Can It be Created?”The Bipartisan Policy Center (BPC) is a non-profit organization that combines the best ideas from both parties to promote health, security, and opportunity for all Americans. BPC drives principled and politically viable policy solutions through the power of rigorous analysis, painstaking negotiation, and aggressive advocacy.

This content is a product of BPC’s Commission on Retirement Security and Personal Savings. The findings expressed herein are those solely of the commission, though no member may be satisfied with every formulation in the report. The findings and recommendations expressed herein do not necessarily represent the views or opinions of the BPC’s founders or its board of directors.

24

An academic angleEngaging participants

Financial literacy in an auto features world

Plan sponsors know all too well that individuals in retirement systems face difficult decisions. Deciding how much to save and how to allocate assets is hard enough, not to mention tackling distribution decisions and managing longevity risk. Layer on top of that the “aging brain,” and it is not surprising that people are overwhelmed.

Julie R. Agnew, Ph.D.Associate Professor of Finance and Economics, Raymond A. Mason School of Business

Dr. Julie Agnew is the Class of 2018 Associate Professor of Finance and Economics at the Raymond A. Mason School of Business at the College of William & Mary. Her research and consulting activities focus on behavioral finance and its relationship to financial decisions made by individuals in their retirement plans. Dr. Agnew serves on the Advisory Board of the Wharton School’s Pension Research Council, is a Wall Street Journal Expert Panelist and is a Research Associate for the Center for Retirement Research at Boston College.

Dr. Agnew frequently presents her research all over the world and has testified as an invited expert witness in front of the Senate’s Committee on Health, Education, Labor and Pensions. Her work has been published in journals including the American Economic Review, the Journal of Financial and Quantitative Analysis, and Management Science (forthcoming). Prior to pursuing her doctorate, Dr. Agnew worked as an analyst in investment banking for Salomon Brothers and as an equity research associate for Vector Securities International. A former Fulbright Scholar to Singapore, Dr. Agnew co-authored a book examining strategic business opportunities in Indonesia, Singapore and Malaysia. Dr. Agnew graduated magna cum laude from the College of William and Mary with a BA in economics and earned a PhD in finance from Boston College.

What we knowFinancial decisions associated with retirement can be emotionally taxing on individuals. This was abundantly clear to my coauthors and me during a series of focus groups we held.1 As a warm-up exercise, we asked our focus group participants to look at several pictures and pick one image that best captured how they felt when they thought of retirement planning. The pictures ranged from beautiful sunsets on a beach to more alarming pictures similar to the one below. Notably, this type of disturbing image was the one selected most often from all the options.

Examining the image that was chosen, participants clearly felt stressed about retirement decisions. Participants remarked that the picture captured their feelings of being out of control and exemplified the weighty consequences of making a mistake. Feeling overwhelmed like this can lead individuals to rely on simple heuristics or to succumb to behavioral biases when making financial decisions. This often will not result in an optimal outcome.

It is a difficult state of affairs where individuals face hard, emotionally charged financial choices that they must consider, often without the necessary financial literacy skills to effectively address them.

James W. Porter/Corbis/Getty Images

DC Matters Fall/Winter 2016 25

On top of the emotion, we know that many individuals around the world lack sufficient working knowledge of financial concepts2 and, unfortunately, the outcomes of financial education efforts to correct this are mixed at best.3 Taken all together, it leaves us facing a difficult state of affairs where individuals face hard, emotionally charged financial choices that they must consider, often without the necessary financial literacy skills to effectively address them.

Why does financial literacy matter in an auto feature world?Given these facts, I’m often asked: Why are we still talking about financial literacy and not simply relying on automatic features to guide participants? I believe this commonly asked question is flawed

in how it is framed. Offering automatic features and building financial literacy is not an “either/or” choice. In fact, I am a strong proponent of automatic features, but I assert that new research findings suggest that the presence of defaults provides a compelling reason in itself for building financial literacy among individuals — not a reason to abandon educational efforts.

While defaults help individuals start to save and allocate correctly, we also need to consider the possible long-term consequences of participants being placed into an investment option that they do not understand. This concern is supported by associations found in the literature between individuals with low financial literacy and their likelihood of default.

While defaults help individuals start to save and allocate correctly, we also need to consider the possible long-term consequences of participants being placed into an investment option that they do not understand.

For example, several years ago, Lisa Szykman and I worked on an experimental study in which we asked participants to choose an asset allocation for a hypothetical portfolio. The participants could choose among many funds or accept the default. We found that 20% of those with low financial literacy defaulted compared to only 2% of those with above-average financial literacy.4

Bertlmann/E+/Getty Images

26

An academic angleEngaging participants Continued

Low financial literacy leads to higher default rates

20%of participants with below-average financial literacy defaulted

2%of participants with above-average financial literacy defaulted

Source: Agnew and Szykman (2005)

Why literacy should also include plan knowledgeBut financial literacy should not be measured based solely on knowledge of broad financial concepts; knowledge of specifics related to common investment vehicles and financial offerings, like features offered in retirement plans, are important, too. Highlighting this is a 2015 study by Jeff Brown, Anne Farrell and Scott Weisbenner.5 They examined pension choices of public university employees in the state of Illinois. In this study, employees were defaulted into a traditional defined benefit plan if they did not make a decision about their plan choice within the first six months. The researchers found that those without a basic awareness of their plan choices were more likely to default than those who had some knowledge.

These findings are supported by other research suggesting that when participants understand their plan features, they react appropriately to their incentives.6 However, while individuals make sensible decisions based on what they believe is true, research also shows that their beliefs are not always accurate.7

Our research found some voluntarily enrolled participants who were 100% invested in target date funds still reported that they had never heard of target date funds.

More evidence that participants may not understand their plans’ features or even their own decisionsWhile it is easy to understand why individuals defaulted into their allocations may not understand their investments, I have also found in my joint research evidence of people’s misunderstanding of their own active choices. In a study of US 401(k) investors that combined survey results with administrative data, we found many people were not aware of their own specific 401(k) allocations even when they made the choice. In fact, we found some voluntarily enrolled participants who were 100% invested in target date funds still reported that they had never heard of target date funds, let alone invested in them.1

Similarly, a 2013 Australian study I completed with Susan Thorp and Hazel Bateman found only 40% of those we surveyed knew that the balanced investment option was not exclusively invested in safe assets.8 This is a concern because the balanced investment option tends to be the default option in Australian retirement plans. Clearly, this lack of understanding could lead to long-term dissatisfaction for those who are invested in this option and lose money. Thus, plan education can be valuable and it should never be assumed that individuals understand the investments

they are defaulted into or even the ones they actively chose.

Long-term regret is a concern for defaultersWith the emerging evidence that people do not always understand their plan choices and that low financial literacy is often linked to those who default, plan sponsors should consider the possible long-run effects of defaulting on the satisfaction levels of these participants. This is an area of research that needs more attention, but preliminary work suggests it should be a priority.

For example, the study of plan choice discussed earlier asked participants this question: “If you could go back in time and re-do your original pension choice, which plan would you choose?” Participants also rated the strength of their desire to choose a different plan.

What researchers found of those in the defined benefit plan was that the percentage that would strongly desire a different retirement plan was much higher for those who defaulted into that plan than for those who actively chose that plan. Furthermore, the desire to change for the defaulters was much higher than it was for participants who made other active plan choices.

Participants invested in target date funds are often unaware of their own allocations

Only 40% of participants surveyed realized they could lose money in a balanced fund

28%

True False Don’t know

40%

32%

10

30

50

%True or false: A ‘balanced’ investment option means that it is invested exclusively in safe assets such as savings accounts, cash management accounts and term deposits.

• Correct allocation reported 45

• Incorrect allocation reported 25

• Never heard of target date funds 20

• Not sure of allocation 10

Source: Agnew, Szykman, Utkus and Young (2013) Source: Agnew, Bateman and Thorp (2013)

DC Matters Fall/Winter 2016 27

Visit drjulieagnew.com to read more of Dr. Agnew’s research

In a large-scale experiment, we found lower financial literacy related to greater feelings of information overload, and those individuals were 30% less likely to feel confident about their choice.

While more research is needed to confirm these findings, we should also keep in mind that those with lower financial literacy often report greater feelings of information overload. These feelings could be one reason that some individuals avoid making active choices and default. In an experiment about annuity choice, my co-authors and I found that the high levels of information overload participants experienced related to a reported lack of confidence at the time the participants made their investment decisions.9

Furthermore, those who reported high information overload ultimately reported less satisfaction at the end of the experiment once the financial outcomes were known, even when controlling for these outcomes.

Therefore, more research is needed to determine whether improvements in financial literacy can reduce feelings of information overload when individuals make choices. Could these efforts help individuals understand their choices better, including their default options, and improve their satisfaction in the future?

Those who reported high information overload ultimately reported less satisfaction.

Bottom lineEven in an auto features world, financial literacy remains important. Plan sponsors should consider the long-term consequences of disengaged and/or uninformed participants. The possibility of future regret and dissatisfaction

exists even in a plan with well-designed defaults if participants at the onset do not understand their choices.

1 Source: Agnew, Julie, Lisa Szykman, Stephen Utkus and Jean Young (2013), “Target Date Funds: Survey and Administrative Evidence,” Working paper2 Source: Lusardi, Annamaria and Olivia Mitchell (2011), “Financial Literacy Around the World: An Overview,” Journal of Pension Economics and Finance,

10: 497–5083 Source: Fernandes, Daniel, John G. Lynch, Jr., and Richard G. Netemeyer (2014), “Financial Literacy, Financial Education, and Downstream Financial

Behaviors,” Management Science, 60 (8), 1861–1883 4 Source: Agnew, Julie and Lisa Szykman (2005), “Asset Allocation and Information Overload: The Influence of Information Display, Asset Choice and Investor

Experience,” Journal of Behavioral Finance, 2005, 6 (2), 57–705 Source: Brown, Jeffrey, Anne M. Farrell and Scott J. Weisbenner (2015), “Decision-Making Approaches and the Propensity to Default: Evidence and

Implications,” NBER Working Paper6 Source: Chan, Sewin and, Anne Huff Stevens (2008), “What You Don’t Know Can’t Help You: Pension Knowledge and Retirement Decision-making,” The Review

of Economics and Statistics, 90, 253–66 7 Source: Brown, Jeffrey and Scott J. Weisbenner (2014), “Why Do Individuals Choose Defined Contribution Plans? Evidence from Participants in a Large Public

Plan,” Journal of Public Economics, 116, 35–468 Source: Agnew, Julie, Hazel Bateman, and Susan Thorp (2013), “Superannuation Knowledge and Plan Behaviour,” JASSA: The Finsia Journal of Applied

Finance, 1, 45–509 Source: Agnew, Julie and Lisa Szykman (2011), “Annuities, Financial Literacy and Information Overload,” in Financial Literacy: Implications for Retirement

Security and the Financial Marketplace (eds.) Olivia S. Mitchell and Annamaria Lusardi, 260–297, Oxford, UK: Oxford University Press

Lessons from research

Lesson 1 Takeaway 1

– Consider the long-term consequences of unengaged participants.

– Those with low financial literacy or who experience information problems may be more susceptible to behavioral biases.

– Participants must understand their choices, or later on they may regret their action (or inaction).

– Effective communication is critically needed as a result.

Lesson 2 Takeaway 2

– Too much information can cause participants to disengage from decision-making and be less satisfied in the future.

– Focus on the quality of the communication.

– Keep the message simple to understand.

Lesson 3 Takeaway 3

– Do not assume participants understand their plan features or general finance.

– Tailor your communications to your participant base and their knowledge.

– Test your communication material for understanding.

– Use survey assessments and focus groups to understand what your participants know and do not know.

Lesson 4 Takeaway 4

– Understanding how groups view communications differently should inform design. For example, younger people may react differently to communications from older people.

– Communications should be tailored to specific groups.

– A “one-size-fits-all” approach will not suffice.

DC Matters Fall/Winter 2016 28

DC Matters Fall/Winter 2016 29

So you hired an ERISA 3(38) fiduciary … now what?

Nuts & boltsFiduciary outsourcing

Scott Matheson, CFA, CPA Senior Director, Defined Contribution Practice Leader, Consulting Research Group CAPTRUST

Scott Matheson joined CAPTRUST in 2007 and is currently a Senior Director and Practice Leader, responsible for leading the development of defined contribution services. Prior to joining the firm, he served as an institutional sales person on a fixed income trading desk for Citigroup’s Global Investment Bank in New York, New York. Mr. Matheson has worked in the industry since 1999, earned a BS in Business Administration degree in finance from Appalachian State University and an MBA from the University of North Carolina at Chapel Hill.

Organizations are doing more with the same amount of people, including the oversight and management of their retirement plans. Faced with financial market volatility, rising interest rates, regulatory scrutiny and rising plan-related litigation activity, plan sponsors are looking for help managing their plans. In some cases, they are turning to their plan advisors, asking them to do more on their behalf. The result is an increase in plan sponsors engaging advisors in a discretionary capacity to select and monitor plan investments.

Faced with financial market volatility, rising interest rates, regulatory scrutiny and rising plan-related litigation activity, plan sponsors are looking for help managing their plans.

Decoding the numbers When creating a custom asset allocation, engaging a professional to provide investment advice has been common for some time among plans subject to the Employee Retirement Income Security Act of 1974 (ERISA). These advisory arrangements are referenced and contracted as ERISA 3(21) engagements, or, as some call them, co-fiduciary arrangements. This naming convention comes from the section numbers within ERISA itself; Section 3 of ERISA provides term definitions. The 21st item in the list defines a fiduciary.

The 2008 and 2009 financial crisis forced many plan sponsors to streamline and, in many cases, reduce the headcount in their finance and human resources departments. These departments are usually the most involved in the ongoing management and oversight of employee retirement plans. While the economy has improved, we have not yet seen plan sponsors add back these positions to a great extent. Further, human resources and finance professionals have had other things, such as the Patient Protection and Affordable Care Act of 2010, occupying their time.

3(38) investment manager

Investment monitoring

Investment selection

Investment replacement

Investment removal

Plan sponsors looking for help

Hiring a 3(38) investment manager can help off load some of the responsibility, but not all.

Thierry Dosogne/Iconica/Getty Images

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When sponsors engage investment advisors as 3(21) fiduciaries, they hire them to provide investment advice. These advisors are responsible for the analysis, tools and advice they provide. Although plan sponsors may rely on the advice of their 3(21) investment advisors, they’re still responsible for any decisions made.

A more recent trend for DC plan sponsors is to engage advisors for discretionary investment management. Doing this requires the investment advisor to contract as an ERISA 3(38) fiduciary. As you may have guessed, this refers to ERISA Section 3’s 38th definition. Note that ERISA 3(38) does not define “investment advisors with discretion,” nor does it say “here’s a way to transfer more risk to your investment advisor.” Rather, it defines investment managers as distinct fiduciaries contracted with full discretionary authority over plan investments and plan investment decisions.

In a DC plan, this means the investment manager may select, monitor, remove, and replace investment options offered to plan participants. An appropriately contracted and executed 3(38) arrangement frees the plan sponsor from the time involved in selecting and monitoring plan investment options and the liability associated with these decisions. As explained in ERISA 405(d), “The plan sponsor and/or trustees of the plan are not liable for acts or omissions of the 3(38) investment manager, and are under no obligation to invest or otherwise manage any asset of the plan which is subject to the management of that investment manager.” The fact that ERISA outlines this protection makes engaging a 3(38) investment manager an appealing prospect for many plan sponsors.

So what’s left to do?An ERISA 3(38) arrangement represents the highest level of investment liability transfer possible under ERISA, but that doesn’t mean a plan sponsor has eliminated all investment-related fiduciary duties. As attorney Michael Abbott, an employee benefits partner at Gardere Wynne Sewell LLP, reminds us, “ERISA 3(21) covers plan fiduciaries — including plan sponsors — to the extent

such fiduciaries have any discretionary authority or discretionary responsibility relating to plan management or administration.”

But hiring a 3(38) investment manager is not a panacea. Abbott continues: “While engaging a 3(38) lessens your investment-related responsibilities and risk, it doesn’t absolve you completely or allow you to abdicate all investment fiduciary responsibilities.” The process of selecting and engaging a 3(38) itself is a fiduciary responsibility.

An ERISA 3(38) arrangement represents the highest level of investment liability transfer possible under ERISA, but that doesn’t mean a plan sponsor has eliminated all investment-related fiduciary duties.

Engaging a 3(38) investment manager transfers the responsibility and risk associated with the selection and monitoring of the plan’s investment options. It is critical, however, that plan sponsors realize that even with an appropriately structured 3(38) arrangement, such sponsors “still have the responsibility to monitor their 3(38) and be aware of the ERISA-related liability

Nuts & boltsFiduciary outsourcing Continued

DC Matters Fall/Winter 2016 31

Visit captrustadvisors.com to read more of Scott’s commentary

associated with hiring, monitoring and, if needed, replacing them,” according to Abbott.

An analogy may help clarify roles. Let’s say you bought a new home and are trying to decide how best to move your belongings. Your cheapest option would be to do the move yourself. In doing so, you perform all the work. If anything breaks during the move, there is no one to blame but yourself. You have retained all of the move’s liability.

Another option would be to pay someone to help you load the moving truck. In this scenario, that worker would be responsible for his role in the move. If he dropped a box of your fine china,

he would be on the hook for what he damaged. Meanwhile, assuming he didn’t poorly pack the china, if the china cracked as you drove the rental truck across town, you would own the liability. Driving the truck was outside the scope of the worker’s role.

Finally, you could completely outsource the move by hiring a full-service moving company. Your mover’s contract includes an insurance policy to protect your items and removes your liability for broken items. Yet, even in this scenario, you will want to be on site, ensuring the movers do what you instructed them to do, placing boxes in the correct rooms and furniture against the right walls.

Hiring a 3(38) investment manager is like outsourcing your move. While you have outsourced the work and liability, you cannot step away from the process. You must still monitor the investment manager to make sure it is fulfilling its contractual obligations.

Building a monitoring frameworkWhen plan sponsors hire a 3(38) investment manager, sponsors often ask how they should monitor the manager. We have a unique perspective in answering this question because, in the course of business, we evaluate and monitor the investment managers whose products are present in our clients’ investment lineups.

Feifei Cui-Paoluzzo/Moment Open/Getty Images

32

Nuts & boltsFiduciary outsourcing Continued

For more information, visit invesco.com/dc

Important information This article is intended to be informational only. CAPTRUST does not render legal, accounting, or tax advice. Please consult the appropriate legal, accounting, or tax advisor if you require such advice. The opinions expressed in this report are subject to change without notice. This material has been prepared or is distributed solely for informational purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The 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.

Questions plan sponsors should consider when creating a framework to monitor a 3(38) investment manager:

Fulfillment of duties – Has the investment manager acknowledged in writing that it is acting as a plan fiduciary?– Is the investment manager adhering to the plan’s investment policy statement (IPS)?– Is the investment manager selecting plan investment options consistent with the plan’s IPS?– Is the investment manager monitoring (and replacing, if needed) investment options consistent

with the plan’s IPS?– Does the investment manager report performance compared with each strategy’s objective,

appropriate benchmarks, and peer groups?– Does the investment manager provide adequate rationale and documentation for investment

changes made?– Does the investment manager work with your provider to execute fund changes on your behalf?– We also suggest that you periodically ask your investment manager questions about its

organization, perhaps annually, to ensure the firm you hired has not changed in a way that could impact its ability to fulfill its duties.

Organizational due diligence

– Have there been any organizational changes to the firm that may impact plan management? – Has there been a change to the firm’s status under the Investment Advisers Act of 1940? – Has the firm been the subject of an investigation by any regulatory or government agency? – Has the firm been routinely examined by regulators or independent auditors? – Has the firm been the subject of any litigation (settled, pending, or threatened)? – Have there been any material changes to the firm’s fidelity bond or errors and omissions insurance?– Have there been any changes to the firm’s written fiduciary status related to the plan? – Have there been any changes to the firm’s roles and responsibilities related to the plan? – Has the firm disclosed all sources of compensation?– Does the firm have any conflicts of interest with any of the plan’s investment managers or

other providers? – What are the investment manager’s 3(38) assets and number of plans under advisement?

Unless staffing trends reverse, the demands on human resources and finance departments lessen, or the complexity of managing retirement plans decreases, demand for defined contribution 3(38) investment manager services will continue to grow.

Putting a bow on itA 3(38) arrangement is not a means to absolve all your investment fiduciary responsibilities. Any move, whether it is across town or to a new fiduciary framework, requires a clear understanding of roles and responsibilities before making an informed decision.

Unless staffing trends reverse, the demands on human resources and finance departments lessen, or the complexity of managing retirement plans decreases,

demand for defined contribution 3(38) investment manager services will continue to grow. If you are among the growing number of plan sponsors who find the structure of a 3(38) arrangement optimal for your plan’s management, establishing a framework for evaluation is an important step to fulfilling the new, though lessened, responsibilities introduced by this arrangement.

DC Matters Fall/Winter 2016 33

About us

As one of the world’s leading independent global investment management firms, we are uniquely positioned to help plan sponsors achieve their investment objectives.

Invesco offers a wide range of investment capabilities across equity, fixed income and alternative asset classes, delivered through a diverse set of investment vehicles.

By the numbers

Providing investment solutions to DC plan sponsors

36 yearsGlobal assets under management

$779.6 billionDC assets under management

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>6,500Cities worldwide where Invesco has on-the-ground presence

27Countries where Invesco serves clients

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The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. The comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions, there can be no assurance that actual results will not differ materially from expectations. Past performance is no guarantee of future results.

This magazine is not intended to be legal or tax advice or to offer a comprehensive resource for tax-qualified retirement plans. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation. The information presented is based on current interpretation of pending retirement legislation and regulations. State laws may differ. Always consult your own legal or tax professional for information concerning your individual situation. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed.

This magazine is for informational purposes only and is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. Please obtain and review all financial material carefully before investing.

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About riskCommodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Diversification does not guarantee profit or eliminate the risk of loss

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