SPRING / SUMMER 2010 Journey - J.P. Morgan · SPRING / SUMMER 2010 PLUS > Executive Perspective...

JourneyRetirement Insights and Solutions from J.P. Morgan

ISSUE 4SPRING / SUMMER

2010

PLUS> Executive Perspective

J.P. Morgan Funds’ George Gatch

> Speaking InvestmentsGoing global and BRICs

> Building BlocksDirect real estate in DC Plans

> Ask BobThe answer from

our man in Washington

> Stable ValueNew thinking on a

traditional strategy

11 Plan Sponsor RoundtableThree professionals tackle DC fund selection

24 DC: The Next ChapterDavid Musto on trendsand opportunities

15 DC Fund Line-ups in FocusDay in the Life of an Investment Strategist

19 Dr. David Kelly: Retirement Insights

EDITOR-IN-CHIEF Daniel R. Darst

MANAGING EDITORS Chester C. Dawson Mark L. Sobolak Kirk L. Isenhour

SENIOR EDITOR Maria Cassisi

ART DIRECTOR

Rachel Liu

GRAPHIC DESIGNERS

Courtney A. Ayers Victoria Khalatyan

Naomi L. Rosenberg

CONTRIBUTORS

Jason I. Brown I Margaret E. Cox Connie Fish I Barbara M. Heubel

Diane M. Gallagher I Bob A. Holcomb

This document is intended solely to report on various investment views held by J.P. Morgan Asset Management. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable but should not be assumed to be accurate or complete. The views and strategies described may not be suitable for all investors. References to asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. In-dices do not include fees or operating expenses and are not available for actual investment. The information contained herein may employ proprietary projections of expected returns as well as estimates of their future volatility. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. Discussions presented should not be construed as legal opinions or advice. You should consult your own attorney, accountant, financial or tax advisor or other planner or consultant with regard to your own situ-ation or that of any entity which you represent or advise. Past performance is no guarantee of future results.

J.P. Morgan Asset Management is the marketing name for the asset management business of JPMorgan Chase & Co., and its affiliates world wide.

IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, market-ing or recommendation by anyone unaffiliated with JPMor-gan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

© 2010 JPMorgan Chase & Co. All rights reserved.

rchitects say that “God is in the details.”* And anyone who has indulged in discount Swedish design at IKEA or a Lego kit knows the value of detailed instructions and the importance of adhering to them without exception.

Fund line-ups, too, require a careful precision. Style drift, securities overlap, underperformance, manager changes and objectives resetting, plus a handful of additional criteria, can gang up on a plan sponsor to render the investment offering much less than an Investment Policy Statement would propose.

For many employers, the challenge of maintaining a laser-like focus on the fund offering is a matter of time. The popular term of ‘not enough bandwidth’ reminds us of the need to prioritize. “Investments are integral to the plan,” explains CEO of J.P. Morgan Retirement Plan Services, Pam Popp, in the following pages. We underscore the importance of this sentiment; indeed, the investment line-up is the plan, certainly its heart and soul. Making sure that participants have a range of appropriate choices in terms of asset classes, styles and capitalizations is how a diversified and long-term DC portfolio is birthed.

In this issue of Journey, we focus on investments and fund line-ups in particular. First and foremost, we talked with clients. Their insights and experiences in the investment space come across in a roundtable discussion featured on page 11. Complementing the client discussion is our center spread, “Day in the Life,” in which we shadowed a J.P. Morgan investment strategist as she worked with clients to review fund line-ups and consider adjustments and met with fund managers offering their investment services.

We sat with Dr. David Kelly, Chief Market Strategist at J.P. Morgan Funds and frequent CNBC guest, to discuss prospects for the U.S. economy and America’s shifting demographics and retirement savings plans. To develop the conversation around investments, we examined global investing and profiled the BRICs. We are pleased to share the executive perspective of George Gatch, CEO of J.P. Morgan Funds, and as with previous issues, we include statistics, letters from the field, and our legislative anchor, Bob Holcomb.

While there is no detailed instruction manual, we hope the topics and insights in this magazine help guide you toward a better solution.

Daniel Darst Editor-In-Chief [email protected]

* Ludwig Mies van der Rohe, German-born architect and designer

J.P. Morgan JOURNEY 1

8 Executive PerspectiveA conversation with George Gatch, CEO of J.P. Morgan Funds, on the defined contribution and retirement landscape from a mutual fund perspective

10 Ask BobBob Holcomb answers your questions about legislative issues

11 Plan Sponsor RoundtableSit table-side as several plan sponsors discuss investment line-ups and the critical issues in building a plan that help create successful outcomes for their employees

15 Day in the LifeJourney follows investment strategist Diane Minardi-Stone as she works with plan sponsors and fund companies to identify, build and monitor optimal fund choices and line-ups

19 Guide to RetirementDr. David Kelly shares his insights and outlook on the state of the economy and the financial implications for retirement

22 Building BlocksA longer look at the ways in which DC plans can offer commercial real estate—directly—in the fund line-up

24 DC: The Next ChapterDavid Musto, head of Defined Contribution Investment Solutions at J.P. Morgan, discusses key business issues in the investment only arena

25 Outside the (Stable Value) BoxAn in-depth discussion of new thinking for Stable Value investing, fresh from J.P. Morgan Asset Management

IN THIS ISSUE

the ContentI S S U E 4 S P R I N G / S U M M E R 2 0 1 0

2 JOURNEY Spring / Summer 2010

...they’re part of the plan. And the plan, well, that is the cul-mination of a coordinated and integrated approach to cre-ating positive outcomes for the participant. At least, that is how it should be.

Investment strategies don’t exist in a vacuum...

Too often, I’ve found myself dis-cussing investment strategies with the client’s corporate treasurer or CFO and then discussing plan design benefits and communications with a separate group in HR. Everyone has the best of intentions. Each side has insights into their particu-lar area of experience and knowledge, but the sum of the two parts is not greater than the whole. In fact, it often can be less.

I would suggest that it’s the over-arch-ing synthesis of plan benefits, commu-nications and investments, supported by administration that are the critical dimensions of the plan, and if they’re not aligned, balanced and coordinated, the plan is under-optimized. Investments are an integral part of the plan, not a distinct appendage. A carefully researched and evaluated fund line-up designed with the best intentions according to a well reasoned

a Word

28 Corporate Pension PlansA look at DB funding ratios and their critical drivers

VALUE-ADD & COLUMNS

4 Stat LifeAuto-enrollment, auto-escalation...a look at the numbers

5 Speaking InvestmentsMore plans are widening their lens to capture global opportunities—plus a primer on BRICs

9 Legislative CornerA look ahead at DB and DC legislation from our man in DC (Washington, that is)

27 Dear JourneyEverything you always wanted to know about retirement (but were afraid to ask)

32 Fast ForwardAn editorial perspective on the dilemma of building a balanced reward/risk investment program in an atmosphere of short-term gratification

33 Did You KnowA round-up of data points from our recent Ready! Fire! Aim? 2009 and defaulted participant research


Investment Policy Statement may fall short of the mark if the plan is constructed in a manner that limits participant action. Individual funds, while attractive on the merits of their risk-adjusted returns, may not complement other offerings in the line-up due to correlated beta risk. A well-reasoned approach to a balanced fund or a target date fund may be constrained by a Spartan communications program. Helping the participant make the right decisions is paramount to delivering the value of the plan. If the participant is not able to make an informed decision, the fund selection may be for naught. What distinguishes the defined con-tribution plan from the traditional de-fined benefit plan is the central role of the participant. A simple translation of this statement is that the focus of the sponsor’s investment decision cannot solely be based on price or fees, but rather how that individual investment option will align with the rest of the line-up, how it will be communicated and how it will be made available through the critical features of the plan’s design. When we work with plan sponsors to help build effective programs, we try to keep a steady focus on the implications of any and all decisions on the partici-pant and the type of outcomes we seek to achieve for the participant, namely, wage replacement. One of the basic requirements for any investment in a defined contribution plan is that it be easily available to and easily understood by the participant. In order to accomplish this, the provider needs to grasp the buying behavior of the individual. In our profiling lexicon of buying behaviors, we refer to doers, delegators and sophisticates (which is to say, ac-tive, involved investors), across a con-tinuum of time, talent and interest. Time—will the participant take

the time needed to consider and evaluate what he or she needs from their investments? Talent—do the participants have the ability and skill to grasp the implica-tions and trade-offs as they construct their investment selections? Interest—does the participant have the needed level of interest to take seri-ously the opportunities and challenges inherent in the decision? And how does that interest wax and wane through key life-phases? While the stated desire is to prioritize all three of these variables to the best

extent possible, an overwhelming set of data points underscores just how chal-lenging it is to find participants at the higher end of this continuum.1 Despite everyone’s desire to do the right thing, few make the time available to truly manage their investments. Consider that so many of those polled are just will-ing to spend ten minutes a year on their investment strategy for their own retirement!2 As for talent, we live in an era whenthe marriage of data and technol-ogy makes accessing information easier than ever. It is not for a lack of

information, data or understanding of behavior, but rather it’s when the stars of time, talent and interest align, we get desired participant behavior in the remaining minutes of the year. We must make sure we are focused on the message—this is why the alignment of HR and treasury is key. Benefits directors need to recog-nize the way that investments, plan structure and communications work together. Investment executives need to understand participant behavior so that their decisions about fund line-ups and target date funds reflect the reality of the plan participants. Reach the participant. Reach them in a personalized manner. Talk their language. Show them the pertinent data. At J.P. Morgan we call it ‘Audience of One’, a comprehensive package of customized communication driven by the individual’s profile, demographics and holdings. We take a holistic view, capturing as much information as possible to deliver the personalized recommendations and ongoing commu-nications at a pace, rate and pitch that is as well aligned with the participant’s preference as can be. Consider an investment strategy that contemplates the participants’ behav-ior. Create a communication program that addresses the time, talent and in-terest continuum. Craft a suite of ben-efits and plan features that enables the participants to engage fully. Let’s keep our lens open wide so that investments are integrated fully with the plan and not left on the sideline.

Pamela A. PoppCEO, Retirement Plan Services

1 ‘Anything But Certain’, J.P. Morgan, 2009. p. 312 Ibid

What distinguishes the defined

contribution plan from the

traditional defined benefit

plan is the central role of

the participant.


Stat life

Automatic to the People

Automatic enrollment first began to catch on in the late 1990s. But, it didn’t grow beyond niche status until the Pension Protection Act of 2006 cleared the way for more employers to offer it, with the caveat that employees have the right to opt out. Since then, plan sponsors increasingly have turned to automatic enrollment as a way to boost their participation rates. As seen below, the use of automatic enrollment among plan sponsors has climbed from just 8% in 2004 to over 40% in 2009, according to J.P. Morgan’s proprietary research.

Automatic Escalation Of course, as many plans sponsors are

aware, just having automatic enrollment

doesn’t necessarily mean that most

participants will take full advantage of

their DC benefits. To help boost retire-

ment savings, a growing number of

plans are instituting automatic increase

provisions. Our in-house data show that

the number of plans opting for auto-

Drilling down deeper into the

data, we found that of those plans with

the automatic enrollment feature, some

89% use it only for new hires—and 11%

of those also incorporate retro auto-

matic enrollment. What’s more, 56% of

plans using automatic enrollment have

a 3% deferral default rate. Only 15% set

their deferral default rate below 3%, and

29% of the total set it at 4% or higher.

increase has jumped from just 4% in

2006 to 38% in 2009.

04 05 06 07 08 09Year end: 12/30

A u t o m a t i c E n r o l l m e n t

% of qualified plans with

J.P. Morgan

Of those plans using automatic in-

crease, fully 64% offer it on an “opt in”

basis, whereas the remaining 36% offer

it on an “opt out” basis, according to our

data. With more plan sponsors wonder-

ing how to cope with inertia among non-

participants and inactive participants,

automatic enrollment and automatic

increase are two catalysts that may be

worth a second look.06 07 08 09Year end: 12/30

A u t o m a t i c I n c r e a s e% of

plans


Stat lifespeaking Investments

mean GDP growth in Brazil is forecast to reach 6.2% in 2010, according to J.P. Morgan Asset Management.

CAUTIONARY NOTE: The MSCI Brazil Index is skewed towards commodity pro-ducers and exporters, and is dominated by the two largest companies listed on the exchange, which together account for around 40% of the market. Investors who stick to the benchmark index may have less than optimal diversification in their exposure to Brazil.

Going GlobalPlan sponsors tend to think of

domestic funds and foreign funds as separate categories, but global

funds seek out the sweet spot where those two worlds converge.

The world’s largest, fastest growing emerging markets are Brazil, Russia, India and China, also known as the BRICs. Some economists have predicted the combined GDP of these four powerhouses will overtake the developed world as soon as 2050. Today, they account for nearly half the world’s population and about 20% of the global economy. Here’s a primer on who the BRICs are and why they matter…

THE FACTOR: The biggest South Ameri-can economy, Brazil is defined by its competi-tive agricultural, mining, manufacturing, and service sectors. In the past decade, Brazil has promoted fiscal and monetary stability, turning the page on years of excess debt and hyperinflation. The twin domestic trends of rising investment and consumer demand

GDP: $2.025 trillionGlobal GDP Rank: 10

WHEN IT coMES to buying things we use ev-ery day—like a car, coffee maker or even the shoes on our feet—most Americans look for attributes like price, quality and overall value regardless of the country of origin. While a Japanese car, Chinese-made percolator or pair of Italian shoes hardly qualify as exotic these days, it’s still un-usual to find fund line-ups with any more than a handful of investment options out-side the U.S. Of course, domestic equity


speaking Investments

THE FACTOR: Since the collapse of the Soviet Union, Russia has rapidly evolved into a more market-based and globally-integrated economy. Its growth is largely fueled by global demand for commodities as Russia is one of the world's largest exporters of natural gas, oil, aluminum and steel. The Russian economy grew at an average rate of

about 7% from the end of a 1998 financial cri-sis through the start of the global credit crisis in 2008. Its recent economic slump appears to have bottomed out in mid-2009.

CAUTIONARY NOTE: Russia’s depen-dence on basic materials exports makes it vulnerable to high volatility in the prices of global commodities. Also, a legacy of highly concentrated ownership in major industries persists following the transformation of many formerly state-owned firms into business units of politically-connected "oligarchs."

THE FACTOR: India’s economy has grown an average of more than 7% per year since 1997, just a few years after the country began to implement policies designed to liberalize its economy by dismantling many regulations on foreign trade and investment. Although just over half of all Indians work in agriculture, the biggest growth engine is a

and fixed income funds are the top choice of many inves-tors—and for good reason. Too much of a good thing, how-ever, may unwittingly over-expose participants to single market risk—even if that market is as deep and mature as that of the U.S. So does it make sense to “overweight” American bonds and stocks in a retirement savings plan even as the investment universe grows increasingly global and diverse? The good ‘ole U.S. of A. boasts some of the most stable and transparent markets—not to mention being the world’s largest economy. So ‘buy America’ may make sense for long-term investors in the U.S., be it through stocks, bonds or real estate. But it’s worth keeping in mind that some foreign companies actually do more business in the U.S. than their American-based rivals. And some American firms do more business in certain foreign markets than their locally-based rivals do. In fact, it’s very hard to generalize about which mul-tinationals are best poised to capture growth in the U.S. and other markets. Just as British retailers and Canadian financial companies are a major presence in the U.S., American fast food chains and software firms are big players overseas. That’s the thinking behind global funds—a category of-ten confused with purely international strategies—to pro-vide exposure to both U.S. and foreign securities in a “best of class” search for attractive companies, no matter where they happen to be headquartered around the globe. “Where a company is domiciled doesn’t necessarily reflect where it does the bulk of its business,” says Nigel Emmett, Manag-ing Director at J.P. Morgan in New York. “Truly global firms often get most of their revenue from markets outside of their home country.” Consider the case for auto makers, energy companies or household toiletry manufacturers. Many brand names we’re familiar with in the U.S. are actually owned by

conglomerates based in Western Europe or Japan. So the only way to invest in, say, a company that makes a favorite brand of toothpaste or a popular video game console may be to increase “international” exposure. That is also an important consideration for another reason: economic expansion in most emerging markets is expected to outpace growth in the developed world over the next decade. While GDP growth doesn’t necessarily translate into higher corporate profits per se, the balance sheets of globally-oriented companies—both those based in the U.S. and those based overseas—stand to benefit from higher demand in the developing world. Those companies able to best access high-growth markets are likely to be long-term winners. “The real argument for going global is that you want the fund manager to be able to buy the best company in an industry irrespective of where that company may be based,” says Emmett. So what is the right share to allocate to a global strategy? It’s not a one-size-fits-all answer. As with other investment decisions, calibrating exposure in a fund line-up to foreign



1 Source: J.P. Morgan Asset Management, FactSet. As of December 31, 2009.

2 Based on IMP current estimates, subject to change. The above charts are for illustrative purposes only.

U.S. market share as a percentage of Global GDP2

Europe 19%

U.K. 9%

U.S. 25%

Non-U.S. 75%

EM 13%

Japan 8%

Pacific 5%

Canada 4%

United States

42%

EM countries (%)

China 2Brazil 2Korea 2Taiwan 1India 1South Africa 1Russia 1Mexico 1Other 2

MSCI ACWI country breakdown1



vibrant service sector—which accounts for over half of India’s GDP. With a conservative banking system and relatively low depen-dence on exports, India escaped the 2008-2009 financial crisis largely unscathed.

CAUTIONARY NOTE: Bureaucratic interfer-ence in the economy coupled with over-taxed infrastructure may create a bottleneck to economic growth. Also, the valuations on Indian stocks have risen to—and stayed at—relatively elevated levels compared to other emerging markets.

THE FACTOR: China’s road to becoming the “world’s factory” began with a crash course in industrialization and modernization in the late 1970s. Since then, its gross domestic prod-uct has increased tenfold. The pace of growth picked up amid a wave of liberalization un-leashed in 1993. In recent years, Chinese GDP growth has hit a fever pitch at or near double

digits. Measured on a purchasing power parity (PPP) basis adjusted for price differences, China became the second-largest economy after the U.S. in 2009 (although its per capita GDP ranking is much lower due in part to its large population). Growth slowed amid the financial crisis, but rebounded quickly.

CAUTIONARY NOTE: China faces a number of challenges including a still immature finan-cial system, dependence on low value-added exports and graft. Chinese mainland stock indices have been subject to extreme volatility.

Source: J.P. Morgan, C.I.A. World Factbook

A World of Opportunity The typical advice given to many long-term investors has been to allocate roughly 20% of their equity exposure to international stocks. Yet today the U.S. represents less than half of the world’s stock market capitalization and growth rates globally have outpaced those in the U.S. every year over the past decade.

The principle rationale for lower allocations to international equity funds has been to limit exposure to potential volatility in overseas stock markets. But does this argument sacrifice too much return for the long-term investor? Perhaps. For most of the past 40 years, the U.S. and international economies grew at about the same pace. But over the past decade, the rest of the world has outpaced the U.S. in growth by a margin of more than two to one. Those higher growth rates appear to have translated into rising stock markets. In seven out of the last eight years, both the MSCI EAFE index and the MSCI Emerging Markets index have beaten the S&P 500 in total return.

So should investors consider increasing allocations to non-U.S. equity? Plan sponsors mulling that question might consider the following four possibilities based on J.P. Morgan projections:

The rest of the world is likely to grow faster than the U.S. over the next decade

The U.S. dollar could fall over the next few years if domestic inflation rates pick up

Many international stocks remain relatively cheap compared to U.S. stocks

Some investors still have sub-20% exposure to international equity

Given that emerging and developing countries now represent almost 60% of global GDP and are expected to continue to grow faster than the U.S., it may be prudent to provide participants with further options to take advantage of the potential in international equity.

Excerpted from “A World of Opportunity: Allocating to International Equities” by J.P. Morgan Funds, 2010


markets depends on a number of vari-ables. Another way to look at the issue is to flip the question around: how much is too much when it comes to U.S.-only investments? Most Americans have a higher exposure to “U.S. dollar-denomi-nated assets” in their nest egg than they might realize. Not only are the major-ity of 401(k) investments earmarked for domestic bonds and stocks, but most other retirement-oriented assets are also valued in dollars. These include the value of homes, bank savings or pension benefits and, of course, Social Security payments. That is potentially a great reason to put a little more money to work overseas, if only to reduce ex-posure to assets in one currency. At the same time, global funds can work to complement purely interna-tional strategies. After all, if it doesn’t make sense to limit investment hori-zons to the U.S., then does it make any more sense to restrict a skilled fund manager to only look at non-U.S. com-panies? Probably no more so than it does to shop around for the best value in a new car, but then limit the search to “only U.S.” or “only foreign” models. Similarly, financial professionals who look at a wide array of U.S. and foreign markets may be able to select the best mix of stocks continued on p. 30


What are the big trends affecting mu-tual funds? We have seen a continued trend toward asset allocation funds and more “packaged” mutual fund suites such as TDFs. We expect to see even more risk-based asset allocation funds, and options that help participants po-sition themselves for retirement such as managed account programs. Plan sponsors and participants are increas-ingly looking for solutions that allevi-ate some of their worry by, for instance, turning responsibility over to a profes-sional manager. Another trend we see involves the heightened focus by plan sponsors and the general public on fees and overall transparency. We expect to continue to see an unbundling of fees attached to mutual funds.

What is the latest pattern you are seeing in DC plan fund line-ups? It’s not limited to DC plans, but broad-ly, investors are reassessing their fund line-ups as a result of what has trans-pired over the past two years in the financial markets.

What are the key legislative initiatives you are keeping an eye on? Our main concern on the regulatory side is that Congress might seek to mandate certain investments such as an annuity or in-dex fund option within all 401(k) plans. We think those decisions should be left up to plan sponsors. On the other hand, it seems that some of the pressure that had been brought to bear by legislators on things like TDFs—in terms of nam-

ing conventions and glide path require-ments—has dimin-ished as markets have recovered.

What is some of the newest think-ing in terms of

fund strategies? One of the big-gest lessons learned from the financial crisis is that investors were not diversified enough. We at J.P. Mor-gan have been strong advocates for in-creasing diversification through access to strategies that have low correlations to U.S. stocks and bonds. These alter-natives could include market neutral funds, inflation hedges, exposure to non-traditional asset classes through exten-sion strategies like international REITs, convertible bonds, commodities and absolute return fixed income strategies.

Isn’t the TDF structure one way to ac-cess these extension strategies? Yes, as it’s unlikely that any of these would be available as stand alone DC options. That doesn’t mean they won’t be one day, but many plans already have too many funds. Instead, we’re seeing plan spon-sors start to tap alternative strategies via TDFs which incorporate them. Some larger plans are developing customized TDFs with extension strategies.

continued on p. 30

Do funds have more fun? We sat down with George C. W. Gatch, CEO of J.P. Morgan Funds, who discussed the evolving landscape for mutual funds.

In the excerpts below, George weighs in on what’s new for fund line-ups both within DC plans and in the

broader marketplace.

The Feeling is MutualE x E C U T I V E P E R S P E C T I V E

Curious, though, as much of the re-search seems to indicate that investors in DC plans spend hardly any time on their investments... True, but there is a growing sense of urgency among plan sponsors. Many are taking a fresh look to make sure that they’re properly aligned in terms of risk and return. For example, some people who thought they had invested in a low-risk fixed in-come strategy woke up amid the credit crisis to find out that wasn’t necessarily the case.

Is there a difference in the DC/DCIO approach to fund selection? Essentially, we see it is being one in the same as far as decision-making goes for both channels. When a plan sponsor is thinking of changing the record keeper, then that’s an obvious juncture to con-sider changes in the fund line-up. But it’s probably prudent for DC plans to periodically—at least annually—review their funds’ performance and consider adding or streamlining.


DC Legislative Round-up

THIS yEaR’S dEbaTES on health care reform, financial reform, and the upcoming consideration of energy and jobs bills have left little time or appetite for a focus on retirement plans, but as always there are a few notable exceptions.

Roth ConversionsWhen the Senate passed its tax extend-ers bill in March of this year it included a floor amendment that would allow, sub-ject to certain limitations, conversions of non-Roth monies to Roth accounts within 401(k) plans. Participants who are eligible to receive a distribution would be able to convert pre-tax “distributions” from DC plans, such as a traditional 401(k), to Roth 401(k) contributions. The legislation would appear to be primarily aimed at providing this opportunity to participants eligible to take in-service distributions (i.e. age 59 ½ or older). While the Senate bill would need to be reconciled with the House version which passed late last year and did not include a Roth conversion provision, the legislation could move quickly. The conversion to Roth accounts would raise tax revenues, and

if the bill starts moving forward, there would be pressure on Congress to allow participants to make these conversions in

2010 and avoid the possibility of higher marginal tax rates in 2011.

Fee DisclosureFee disclosure remains an important is-sue for George Miller (D-CA), Chairman of the House Education and Labor Com-mittee. He attached language to the House tax extenders bill, which passed on Friday, May 28th, that did not include some of the language from the original Education and Labor bill, specifically the index fund mandate and the investment advice provi-sions. In addition, the disclosures may be presented in either dollar or formula form. The bill will still need to be reconciled with the Senate version which did not include

any fee disclosure provisions. If passed in its current form, it would be effective for plan years beginning after December 31, 2011, but plans could rely on a good faith interpretation of the legislation until 12 months after final regulations are published by the DOL.

Legislative corner

Fee DisclosureIt is anticipated that regulations will be issued under section 408 (b)(2) of ERISA in June 2010, although the consideration or passage of fee disclosure legisla-tion could delay or cause EBSA to withdraw any regulations. These regulations would cover disclosure from plan providers to plan spon-sors. Participant disclosure regula-tions will follow, although we would not anticipate seeing those until late summer or early fall.

Qualified Default Investment AlternativesEBSA is considering a “surgi-cal” reopening of the QDIA regulations. The changes will likely focus on what additional information must be disclosed to plan participants with respect to QDIA designated TDFs.

Investment AdviceIn February, regulations were re-proposed interpreting the investment advice provisions under the PPA. The proposed regulations focus on the PPA’s prohibited transaction exemption, a practice that sees little use in the industry. Most advice models are based on the “SunAmerica letter” which the proposed regulations affirm as still valid, though it asks to what extent EBSA should define

“generally accepted investment theory.” Early this year, the DOL and the Department of the Treasury issued a joint request for information (RFI) on lifetime income options for participants in retirement plans. The RFI reflects both the DOL and Treasury’s keen interest in annuities and lifetime income options. We would anticipate hearings on this topic at some point in the future.

I n A p r i l t h e D e p a r t m e n t o f L a b o r i s s u e d i t s r e g u l a t o r y a g e n d a . T h e E m p l o y e e B e n e f i t S e c u r i t y A d m i n i s t r a t i o n ’ s ( E B S A ) p o r t i o n o f t h e a g e n d a i n c l u d e d :

While the legislative agenda may be modest for 2010, we do expect to see the foundation laid for future pension reform. As the new Congress begins in 2011, we would anticipate pension reform being one of the key issues up for consideration.

In February of this year, the Department of Labor (DOL) issued new proposed regulations for investment advice under the Pension Protection Act (PPA) of 2006, essentially a re-proposal of the investment advice regulations. PPA created a prohibited transac-tion exemption for investment advice offerings allowing entities that pro-vided investment funds to a plan to also provide advice directly to participants as long as the advice was offered either through a computer model certified as unbiased by an independent party, or by an advisor whose compensation did not vary based upon the advice given. The proposed regulation issued in February of 2010 represents the efforts

of the Obama adminis-tration to provide

guidance on the certification procedures

Ask Bob A conversation with Bob Holcomb on federal matters large and small

Each issue, Bob answers a question he receives from readers. Please send your questions to: [email protected]

needed to ensure that the computer model is unbiased, and the rules regard-ing the level fees for investment advisors. It should be noted that there was little interest within the retirement plan industry in providing investment advice under the PPA prohibited transaction exemption. Most service providers were already offering advice under what’s known as the SunAmerica letter. The SunAmerica letter, or as it’s offi-cially known, Advisory Opinion 2001-09A, provided the above mentioned guidance, that is, confirming that the investment advisor was completely independent and their compensation did not vary based upon the investments made in accor-dance with the advice. This has become the preeminent investment advice model in the industry. As for the new proposed regula-tions, they state that the regulation does not invalidate or otherwise affect prior regulations, exemptions, interpre-tive or other guidance previously issued by the DOL. This was very welcome news. There had been some concern, particularly given certain legislative initiatives in 2009, that the SunAmerica letter might be in jeopardy. However, the proposed regulations state that computer models should be de-signed to avoid advice that would “distin-guish among investment options within a single asset class on the basis of a factor

that cannot confidently be expected to

persist in the fu-ture.” This would seem to clearly indicate that the DOL does not

believe that a computer model should favor an investment within an asset class over another investment in the same class based on historical performance. Hence, the key differentiator would be the investment management fees, and this would seem to create a bias in favor of passively man-aged over actively managed investments. To further heighten concerns, the preamble to the regulations asks wheth-er the DOL should define “generally ac-cepted investment theory,” how a model should “take into account investment management style” and “all else being equal, should a model ascribe different levels of risk to passively and actively managed investment options.” The DOL has traditionally avoided endorsing one style of investment management over another. Currently, plan fiduciaries exer-cise their prudent judgment in determin-ing what investment management style is best suited to their employees’ needs. Now to be clear, the proposed regula-tions only address computer models under the PPA prohibited transaction ex-emption, but we recognize that this may set a dangerous precedent that could lead to the application of these principles to other models, including SunAmerica. So in answer to your question, nothing in the proposed regulations, on their face, would change current investment advice offerings, but we need to be cautious and monitor DOL actions to ensure that this interpretation does not grow beyond the PPA model.

I saw that the Department of Labor recently issued proposed regulations on investment advice. What impact will that have on our advice offering, and will it change how advice is presented in the future?


ASpart of our ongoing series of plan sponsor roundtables, on April 20 Journey hosted a panel at J.P. Morgan’s Retirement Plan

Services headquarters in Kansas City, MO. Hosted by RPS marketing chief Kirk Isenhour, the round-table featured three plan sponsor representatives: Ed Gleason, Retirement Strategy Senior Specialist at American Airlines; Kate Stewart, Vice President at commercial printer Henry Wurst Inc.; and Melissa Conger, Corporate Compensation & Benefits Manag-er at specialty packaging producer Huhtamaki, Inc. In the hour-long discussion, the three panelists dis-cussed a number of issues centering on fund line-ups, including the optimal number of funds, monitoring processes, employee input and QDIAs. What follows are excerpts from our conversation...


ISENHOUR: With everything going on in the industry and on Capitol Hill, what’s been your latest action on investments? CONGER: At Huhtamaki, we added a TIPS fund on the advice of our consultant. It was a pretty seamless process from start to finish and we’ve seen several hundred thousand dollars flow in already. GLEASON: How many funds does your company’s DC plan have? CONGER: We have 16 in total.

ISENHOUR: How involved was the outside consultant in your decision process to add the TIPS fund? CONGER: We’ve already had a relationship with this con-sultant for about four years. So it only took six months from beginning to end—from review through implementation. That was much faster than in the past, when nine or even 12 months was typical. Part of the reason it has taken so long previously is that our investment committee only meets four times a year and we split our time between DC and DB plans. We still do that, but the consultant helped pave the way to our decision.

ISENHOUR: What’s new with Henry Wurst’s plan, Kate? STEWART: We have about a dozen funds in our plan’s

line-up, plus TDFs. Right now, we’re looking at the possi-bility of adding managed accounts. We’re constantly asking ourselves: ‘Do we have the right number of funds?’ We’re satisfied with each specific fund, but we’re not so sure about the total number in the line-up. The pendulum swings back and forth on the optimal line-up. We used to think: ‘Are there segments of the market we’re missing?’ Now, we think it’s time to sit down and ask: ‘Do we belong in all of these funds?’ It comes down to properly connecting with our employees about their objectives.

ISENHOUR: What has been driving that process of rethink-ing the line-up?

STEWART: We have some new blood replacing some mem-bers of our investment committee, so we’re in the process of educating them about our plan’s offerings. We ask ourselves: ‘Is a dozen a good number?’ We deliberately choose the line-up, but is it more than the participants can absorb? I’m not sure, but we need to have that conversation. GLEASON: We have about 30 funds—two of them are frozen from accepting new investments, one of which is the company stock. Our main consideration is the diversity of our work force. Some of our participants are more experi-enced investors than others, they know the markets well and are eager for a brokerage window. These participants are the ones who typically ask when the plan is going to offer a gold fund! So by the end of the year, we should be putting in some type of brokerage window, understanding that maybe only 1-3% of our total number of participants will actually use it. Once that’s in place, we may look at reducing our core fund line-up down to a much more manageable number. STEWART: Does Huhtamaki have a brokerage window? CONGER: No, we don’t. STEWART: Actually, we find that our brokerage window helps mollify the ‘vocal’ participant. Some of our people used to say: ‘Gee, if I only had a brokerage window, then I’d be happy.’ Yet we’ve found that most don’t take advantage of the option now that we have it.

ISENHOUR: How willing are participants to get help? GLEASON: At American, we do a lot of retirement educa-tion for active employees—either through general financial advice or managed accounts. There are those who don’t know how to plan financially for the future at age 25 or 45. What makes us think they know what to do at 65 when their access to resources isn’t quite as robust? I’m always amazed when I see a participant equally invested in all 30 of our funds, three of which are risk-based. They just checked off every box! We may need to carry the education process and messages through even after retirement. CONGER: I think there may be a shift underway. While there are some people who can’t grasp the core concepts, there are plenty of others who do—but just don’t have the time to spend on mastering it. STEWART: I think the industry is moving that way be-cause of a lot more concern about volatility due to the finan-cial market’s gyrations over the past couple of years. I agree with Melissa that it’s not so much that people aren’t smart

Ed Gleason, Retirement Strategy Senior Specialist, American Airlines

Melissa Conger, Corporate Compensation & Benefits Manager, Huhtamaki, Inc.

Kate Stewart, Vice President, Henry Wurst, Inc.

I’M ALWAYS AMAzED WHEN I SEE A PARTICIPANT EQUALLY INVESTED IN ALL 30 OF OUR FUNDS, THREE OF WHICH ARE RISK-BASED.—GLEASON


enough or don’t have the interest in their own retirement savings. It’s more about not having enough hours in the day and a high enough comfort level to make big decisions that could affect the future of their entire family. You see the relief on their faces when these people hear about TDFs. ISENHOUR: Are you offering TDFs at American Airlines? GLEASON: We looked at TDFs, but because 75% of our DC participants are in a DB fund, it changes the landscape. Our DB plan is essentially like a TDF, so we’re sticking with a selection of risk-based pre-mixed portfolios instead of TDFs. Of course, that may change as our demographics change.

ISENHOUR: So, with older employees comes the topic of annuitization and after-retirement income. What are you thinking in terms of that topic? GLEASON: One idea would be a guaranteed income product for retirement. We’re waiting for the marketplace to develop those products. Right now, a lot of the options like annuities are too expensive. There’s some talk of federal legislation to help shape that development. But what a DB plan gives you is an annuity. A DC plan puts all the risk on the employee. As we get older—and people are living longer—the concern is that ten years into retire-ment the money runs out. It’s even a big concern for people who have invested wisely and saved a lot. So you’ll see more annuities to serve that need, but there has to be better regula-tion of the market. STEWART: We don’t have a DB plan. We want to counsel our people, but we’re not their investment advisors. We have employees leaving after 30 years with a sizeable nest egg and we can only hope that they’ll make wise choices from here on out. After all, they gave their all to the company during their working years. As they walk out the door, we’d like to be able to say: ‘Here are some options to consider.’ But in the post-AIG world you have to be concerned about annuities. And anytime you suggest something in a corpo-rate capacity, it becomes a tacit endorsement. So I’m very reluctant to go down that path. We won’t feel comfortable recommending annuities until the cost structures change and we see what regulatory changes are coming. CONGER: We have chosen not to pursue annuitization strategies right now because we already have too many other

things on our plate. Also, we have a DB plan that addresses that issue for most of our employees. And like Ed says, we are waiting for more legislative guidance to see how things develop along those lines.

ISENHOUR: Back to fund line-ups. What are your preferred ways to monitor and evaluate specific funds? STEWART: Our investment committee meets on a quar-terly basis. We also solicit feedback from our diverse group of employees. Sometimes our savviest investors can be found where some might least expect it: shop floor guys that in-vest as a hobby. And some of our highest paid employees are the least savvy when it comes to their own investments.

In the past, we’d had employees come to us and say: ‘Hey, you’re really missing the boat on real estate. We need a dedi-cated fund.’ Maybe we’ve heard that a bit less in the past two years, but our employees do pay a lot of attention to their accounts online.

ISENHOUR: How does Wurst seek employee input? STEWART: Our employee population is used to speaking up. They’re pretty engaged in the whole benefits picture in general. CONGER: It used to come in automatically, mostly by ‘drive-by’ venting at HR. [laughs] But in the past two years, I’d say things have been pretty quiet on that front. So we’re working with J.P. Morgan to send out a survey to our employ-ees to better understand their thinking. GLEASON: We don’t have to actively seek out employee feedback since our employees are very vocal. Our pension asset administration committee meets on a quarterly basis. The advisor to our committee on all of our plans—DB and DC—is American Beacon Advisors, Inc., which was spun-out of corporate treasury department in the late 1980s.They actually manage the DB investments and help us review our 401(k) line-up. Our committee is pretty well educated on the markets, but we do rely heavily on this ‘in-house consultant’ for advice. CONGER: We also rely on our consultants. They make it easy for us to spot issues. But we also work very closely with J.P. Morgan in that regard. STEWART: We don’t use a consultant. We work with J.P. Morgan in our quarterly reviews.

WHEN WE STARTED HAVING EMPLOYEE MEETINGS, WE MADE SURE TO PUT A QUICK ENROLL FORM AND A PEN ON EVERY CHAIR—STEWART


ISENHOUR: Are there issues where the administrative and investment halves of your plans butt heads? GLEASON: We have three committees. A Pension Asset Committee, a Pension Benefit Committee and a Pension Strategy Committee which oversees the other two. But all of our members serve on both the asset and strategy com-mittees—with exception of one member. So we don’t fight among ourselves! CONGER: We have only one committee. STEWART: That’s never been an issue for us. Our main challenge is communicating plan changes. We address that at the investment committee level and then go to HR to discuss communication. GLEASON: We just mapped. Communication is the key. STEWART: Yes, particularly when mapping.

ISENHOUR: Where do your plans stand when it comes to global, international or emerging market funds? GLEASON: We have an emerging markets fund. It’s very popular, not surprisingly if you look at performance. We consider it a high risk strategy so that’s why we capped it at 10% years ago. But times have changed. We still have a fiduciary responsibility, but loosening the cap to 15% was the right decision. We have two international funds, too, which aren’t capped. CONGER: We have an international fund. But our concern was more with having too much concentration in our stable value funds. We haven’t seen over-investing in international. STEWART: We also have some global/emerging market exposure. We don’t have a cap—that’s an interesting idea.

We may have one or two participants that may be “over invested” in these funds, but we assume that’s their choice.

ISENHOUR: What about stable value funds? CONGER: For us, trying to get participants to diversify out of stable value has been difficult. Actually, overexposure

I THINK THERE MAY BE A SHIFT UNDERWAY. WHILE THERE ARE SOME PEOPLE WHO CAN’T GRASP THE CORE CONCEPTS, THERE ARE PLENTY OF OTHERS WHO DO—BUT JUST DON’T HAVE THE TIME TO SPEND ON MASTERING IT.—CONGER

COMPANY PROFILESAmerican AirlinesThe world’s second largest airline in passenger miles transported, passenger fleet size, and in operating revenues; third largest, in aircraft operated. A subsidiary of the AMR Corporation, the airline is headquartered in Fort Worth, Texas, adjacent to the Dallas/Fort Worth International Airport.

Henry WurstFounded in 1937, Kansas City based Henry Wurst, Inc. provides targeted, integrated solutions managed by an experienced team that delivers from concept to print with complete production management capabilities.

HuhtamakiHuhtamaki is one of the world’s largest packaging companies with solutions such as smooth and rough molded fiber products, release films, flexible packaging, foodservice paper cups and other products based on paper forming technology.

in stable value may not have been a bad thing over the past two years, but it’s not a long-term strategy to grow retirement savings. One legacy plan we had mandated a 100% allocation in stable value for five years until the money vested, but we removed that in 2002. We have been educating our partici-pants about this, but we find that one-on-ones work best. Of course, not every employee wants to spend their own time sitting down with us.

ISENHOUR: Is active vs. passive an issue for your plans?ALL: No.

ISENHOUR: What is your QDIA? GLEASON: We use a moderate pre-mix portfolio of risk-based options. Based on our demographics, we felt that was most appropriate. Our prior default option was the company credit union money market plan and that didn’t qualify un-der the terms of a QDIA. When a person signs up for our DC plan, we require them to select an investment. We very rarely default someone into it. But it’s there if we were to do so in the future. For example, we’re getting ready to do a quick enroll that would put new participants into that fund. Our participation rate is in the 60% range. We attribute that to our DB plan. CONGER: We use managed accounts. A balanced fund had been our default. But we put participants in managed accounts and sent them a survey to ask them about their preferred investment style. STEWART: We use TDFs for our QDIA. continued on p. 30


D A Y I N T H E L I F E

When it comes to monitoring DC fund line-ups, retirement committees at many plan sponsors rely on their plan administrator’s

dedicated troubleshooter for key analytics and perspective.

W ITH A WARM SMILE, firm handshake and a win-ning way, Diane Minardi-Stone is an investment strategist in J.P. Morgan’s Investment Services

Group who works closely with plan sponsors to set up, moni-tor and fine tune their investment fund offerings. In other words, she’s a troubleshooter armed with an inch-thick brief-ing book, a trove of in-house and Lipper data at her finger tips and a limited tolerance for chronic underperformers in

her client’s fund line-ups. Whether darting into yellow taxi cabs for face-to-face meet-ings with client retirement committees or speed dialing into multi-party conference calls with external portfolio manag-ers, Diane tackles each of her tasks with an “only-in-New York” combination of grit and élan (plus a steady stream of Diet Coke).


Diane rises early and celebrates the sunrise with a regular coffee (note: “regular” in NYC means with cream and two sugar packets). After making breakfast for her two chil-dren and a bagged lunch for the eldest, she briefly scrolls through work and personal e-mail by logging onto her home PC.

A quick shower and visit to her wardrobe takes a half an hour. That’s when her nanny arrives and by 07:40 she’s out the door for a 10-minute drive to the train station.

Diane catches the Metro North express from her bedroom community in suburban Westchester County. An hour later she arrives at busy Grand Central Terminal in the heart of Midtown Manhattan and grabs a Starbucks skinny vanilla latte and yogurt parfait en route to her office.

Her first order of business at work is checking new e-mails, voice mail and calendar items. Then she dials a Kan-sas City-based analyst on her team to discuss what needs to be prepared for an upcoming client meeting. He is in a meet-ing, so she leaves a voice mail and begins writing up a pre-liminary memo on the client’s fund line-up focused on its international and mid-cap strategies.

Diane joins several of her colleagues, including su-pervisor Hal Bjornson, on a conference call with TIAA-CREF Asset Management, a division of Teachers Advi-

sors Inc. The registered investment advisor is a wholly owned subsidiary of Teachers Insurance and Annuity Association, which is part of the larger TIAA-CREF organization with over $426 billion in assets under management (AUM). The pur-pose of the meeting is to vet TIAA-CREF’s Mid Cap Value Fund for possible inclusion on the J.P. Morgan fund platform. While dozens of funds compete in the Lipper mid cap value peer universe, the idea is to hear why TIAA-CREF thinks it deserves a shot in J.P. Morgan client line-ups. This is an im-portant part of the “gatekeeper” role at J.P. Morgan to make sure only the most worthy funds stay in the mix. It’s one of the things that keep Diane and her colleagues busy when they aren’t meeting with plan sponsors. The call starts out with a few general questions about the size of TIAA-CREF’s mutual fund business and its Mid Cap Value team. The company boasts about $22 billion AUM in mutual funds and a bench of 36 research analysts with an average of 13 years experience, says the fund’s lead portfo-lio manager, Tom Kolefas. Next, Diane tees up a question about the hiring and training of the fund’s analysts. “Who is your typical hire and what do you look for?” she asks. Tom answers: “We like buy-side people who have been in the trenches and learned to survive.” Diane and her colleagues then fire off a number of que-ries about average tenures among TIAA-CREF’s investment professionals (“About 8-10 years”), its rotation of analysts (“Not a lot, but some”), information sharing processes (“I interact with the analysts throughout the day and we also have weekly meetings on topical issues, along with daily

NDEED, FOR DIANE AND HER five fellow regional IS’s, breaking down complex investment philosophies into simple action plans and vetting investment strategies for the J.P. Morgan fund platform are all in a hard day’s work. We recently caught up with her between internal and outside appointments near J.P. Morgan’s offices on bustling Park Avenue in New York City. What follows is a compilation of a ‘typical’ day for an IS based on actual itineraries. Some of the dates, locations and times have been modified.

Her agenda: Balance input on the “big picture” targeting dozens of funds on the firm’s platform with highly customized reviews of her 25 clients’ individual fund line-ups. Our objective: Shadow Diane to experience how she goes about kicking the tires of third party funds and doling out her pearls of wisdom to plan sponsors.

FULL NAME: Diane Minardi-Stone

JOB TITLE: Investment Strategist

HOME OFFICE: New York, NY

Years with company: 21 years, last 10 as an Investment Strategist

HOW SHE BECAME AN INVESTMENT STRATEGIST: Colleague recruited her internally from an account management role servicing mutual and pension funds

EDUCATION: B.A. in International Studies, minor in French at Iona College

FAMILY: Husband and two children (kindergarten and pre-K)

HOME TOWN: Sleepy Hollow, NY

HOBBIES: Chaperoning kids, entertaining friends and family, learning to play golf

BOOK CURRENTLY READING: “Siblings Without Rivalry” and “Kitchen Confidential” (for herself) and “Strega Nonna” and “Fancy Nancy” (for kids)

Being Diane Minardi-Stone


after-market briefings”) and Tom’s background (“I have a chemical engineering B.S. degree, a MBA in finance and worked in the chemical industry for five years before spend-ing the past 22 years in the financial industry, the last five with TIAA-CREF,” he says.) Next, the J.P. Morgan team goes into a deep dive asking about Tom’s methodology, which he replies is centered on fundamental, bottom-up analysis.

AFTER BROACHING A NUMBER of other topics— including the average number of stocks held in the fund, target prices for the fund’s stock picks, the

fund’s performance over the past 18 months and whether tracking error trumps conviction (“Not often,” says Tom) —Diane thanks Tom and the TIAA-CREF team for their time. She and her colleagues will continue to monitor the perfor-mance of that mid cap value fund with an eye to potentially adding it as an alternative to show clients. Next up, more phone work.

Diane returns a call from the Kansas City-based ana-lyst and gets an update on the client’s fund line-up. They then discuss putting together a quarterly ‘book’ containing all the relevant data on the plan’s fund performance, asset allocation mix and any outstanding issues, such as style drift concerns.

A Strategic Relationship Manager (SRM) asks Diane to hop onto a call with another of her client’s Treasurer in order to priori-tize the agenda for a planned retire-ment committee meeting. The Trea-surer asks for an update at that meeting on options for replacing their U.S. large cap growth fund. Diane makes a note to include that in the briefing book.

Lunch is a take-out sand-wich (hold the pickle) or salad at a nearby deli known for its Jewish rye.

Diane grabs a taxi for a trip uptown to the headquarters of a For-tune 500 plan sponsor. Taking an elevator (max. cap.: 14 persons) up to the 43rd floor, she is escorted into an elegant conference room with a

panoramic view of Central Park. A half dozen members of the company’s retirement committee sit across from one an-other at a large, black table with a glossy shine—some of those in attendance are compensation and benefits profes-sionals and the others are from the finance and legal depart-ments. Greetings are exchanged and then Diane gets down to business, handing out hard copies of a Plan Investment Review an analyst on her team has prepared. These bound, 80-to-100 page quarterly reports contain the latest capital markets review from J.P. Morgan economists along with a dedicated fund analysis (covering fees, performance and style, etc.) of the client’s plan using data from Lipper, plus supplemental analytics from Morningstar and Zephyr. “The funds are all performing as we would expect in this environ-ment,” she says. “Overall, we see very few hot spots.” Then Diane spends the next 20 minutes walking the client through a fund-by-fund analysis. After that review, Diane broaches the topic of TDFs in re-sponse to the client’s interest in possibly moving out of risk-based funds. While the committee is focused on performance, Diane points out that the Lipper peer review of about 45 funds is “not the end-all, be-all” because it covers such an unwieldy number of TDF managers. “Not all TDFs are the same,” she says. “There’s a wide variety of philosophies from conservative


to aggressive.” She suggests that TDFs can be evaluated in a more concrete way if a plan sponsor first decides whether its role is to get participants to or through retirement.

“Not all TDFs are the same... There’s a wide variety of philosophies from

conservative to aggressive.”

ONCE THE COMMITTEE HAS HAD a moment to chew on that, Diane shifts gears and reminds her client that their fund line-up contains two U.S. large cap

growth funds which overlap in terms of style box, but are miles apart in performance. The issue: the underperformer is a “brand name” legacy fund from the company’s old plan. For the past three years, the committee has grandfathered it into their new plan, but Diane recommends that they consider cutting the cord. “It becomes difficult to make these hard decisions, especially when so many participants are invested in a fund,” she explains. Then one of the client’s retirement committee members asks Diane about inflation protection strategies. Diane an-swers by stating that to one degree or another history has shown that a diversified portfolio, including commodity funds and real estate, has demonstrated resistance to infla-tion—and that TIPS are designed to do the same. But she adds that while a minority of sophisticated participants may

be comfortable with all or some of those options, the com-plexity may simply confuse a lot of other plan participants. Instead, Diane suggests adding a brokerage window option so that those who want to explore niche funds can do so without the risk of “clogging up” the core choices. Finally, Diane mentions that the client might want to con-sider adopting an Investment Policy Statement which sets forth well-articulated and transparent criteria for choosing, monitoring and removing funds. Should they decide to pur-sue that option, she offers to lend a hand. With that, she thanks the committee for their time and promises to follow-up next week by e-mail with the latest batch of data on their participants’ retirement planning behavior in the year-to-date. Ninety minutes after arriving, she takes the elevator back down to the Gilded Age lobby.

Back in her office, Diane pops in to Hal’s office to debrief him on the client meeting. Hal asks her to stick

around for an internal conference call for fund analysts and IS’s. This regular no-holds-barred meeting is an in-house forum for exchanging the latest information about funds on the J.P. Morgan platform. Over the next hour and a half, about a dozen analysts and IS’s discuss 30-40 funds spot-lighted for significant outperformance, underperformance or so-so performance. One fund drastically cut its portfolio holdings over the past quarter and was therefore deemed too highly concentrated for DC plans. Another fund underwent stealth “style drift” from value to growth, prompting one analyst to say jocularly: “It’s neither fish nor fowl now.” A third fund lost one of its two co-portfolio managers during the quarter and was im-mediately dropped by several big consultants. The verdict? It will remain, but be subject to close monitoring. On the positive side, several value funds that had tough stretches in 2009 earn plaudits for appearing to have turned the corner in 2010, reverting to the outperformance of their three- and five-year averages. The consensus: they will be removed from the spotlight for the time being.

Diane spends her last hour at work preparing for the day ahead and touching base with colleagues. She’s out

the door by 17:30 to catch the express for the hour-long train trip back to Westchester (if she’s lucky, she’ll get a seat).

As her five-year old asks ‘What’s for dinner, Mom-my?’, Diane is busy thawing out frozen chicken breasts and preparing a light salad. An hour later, she may play a game of Wii with her kids and husband before reading each child a favorite bedtime story. Then she splits “tuck in” duty with her husband and heads back downstairs to tidy up the kitchen.

As the day winds down, Diane take a few minutes to check her e-mails one last time on her home PC, followed by an hour or so of escapist TV show viewing (“Grey’s Anat-omy” is a favorite.)

After she spends a few minutes preparing for bed, it’s lights out in the Minardi-Stone household. Another busy day beckons tomorrow...


On the Mend:

Older, but Wiser?

Reading the tea leaves on the prospects for the U.S. economy, America’s shifting

demographics and retirement savings plans with David Kelly, Chief Market

Strategist at J.P. Morgan Funds.

FOR DC PARTICIPANTS, there’s no going back to the halcyon days of a seemingly limitless bull market and the ever-expand-ing nest eggs that accompanied that run-up in equity prices. But while a grim new era of lowered expectations has set in, the outlook for a sustained recovery may be better than many recession-shocked


Percent of People Working Over 65 Currently in the

Civilian Labor Force

10%

12%

14%

16%

18%

1989 1992 1995 1998 2001 2004 2007

0

2

4

6

8

10

12

14

45 50 55 60 65 70 75 80 85 90 95 00 05 10

Level (%)

Source: Bureau of Economic Analysis, J.P. Morgan. Data as of Q409.

U.S. Personal Saving Rate

Source: Bureau of Labor Statistics. Data as of 12/31/08.

Americans might suspect. The U.S. economy is grow-ing again at a decent—if not record—clip and, so far, has avoided the dreaded double dip recessionary sce-nario. Against the backdrop of a stealth recovery, par-ticipants in retirement savings plans face the challenge of aligning today’s investments with long-term goals. Of course, whether the pace of growth picks up from here on out—or slows precipitously—remains an open question. But the very worst of the slump appears to be over. The nationwide unemployment rate peaked last October, retail sales and industrial production continue to march upward, consumer confidence rose for a third consecutive month in May and the stock market has rebounded since hitting its recessionary nadir in March of 2009. Gross domestic product (GDP) climbed 4% in the second half of 2009, well above a long-term average of 3% over the past 40 years. That “above trend” growth may extend into the next five years, predicts J.P. Morgan Funds’ Chief Market Strategist David Kelly, who says that pent-up demand in four key areas—autos, home building, business equipment and inventories—re-ignited the economy’s engines and will likely continue to fuel growth. “I call them the ‘Four Horsemen of the Economy’ because they always lead us in and out of recessions,” he quips.

No Rose-Tinted GlassesNeedless to say, that doesn’t mean everything will be coming up roses this summer. History tells us post-recession unem-ployment improves very slowly—traditionally about 1% per year. At that rate, assuming the economy grows 4% annu-ally, the U.S. won’t get back to pre-crisis levels of employ-ment until 2015. Says economist Kelly: “The GDP outlook is pretty good, but it will take a long time before we feel the economy is ‘normal’ again.” There is evidence that Ameri-can consumers are—gingerly—loosening their purse strings, which is important since consumption is responsible for about 70% of U.S. economic activity. Indeed, the U.S. Com-merce Department announced in early May that consumer spending increased for a sixth straight month in March, coming on the heels of nearly two years of retrenchment.

But that silver lining bordered a cloud: most of the spend-ing came from lower savings instead of higher incomes. The Commerce Department data showed the savings rate dipped to 2.7%—the lowest level since September of 2008. That is a troubling sign that Americans are reverting back to some stubbornly spendthrift ways. U.S. savings rates

climbed over the past two years after steadily declining for nearly 20 years—from about 12% in the early 1980s to less than 2% in the mid-2000s (See below). It doesn’t take a PhD in economics to understand that less money for saving = less money for investments, which is a troubling omen for plan sponsors anxious to boost contributions into retirement sav-ings plans. What’s more, this comes at a time when the whole concept of retirement is be-ing redefined. More and more Americans who are aged 65 and older are stay-ing in—or re- entering—the la-bor force because they are either fi-nancially unable or mentally un-willing to stop working. “The single greatest demographic challenge of our time will be the disappearance of the idea of a gold watch at age 65,” says Kelly, who adds that isn’t necessarily a bad thing. “We live longer than ever before, so it makes sense that we have to save more and work longer too.” Employers are more receptive to a grayer workforce than ever before. That’s especially true in the knowledge-intensive service industry, which has overtaken the manufac-turing sector as the chief economic growth engine. The days when the U.S. economy rested on the brute muscle power of manual laborers are long gone as the most highly sought after workers are those with intellectual smarts. Indeed, the percentage of those 65+ in the labor force has shot up from

11% in 1993 to almost 17% in 2008, ac-cording to U.S. Bureau of Labor Statis-tics data cited in the 2010 edition of the J.P. Morgan Guide to Retirement (See p.21 Insert).

The ‘Buddy System’In some ways, the shift in workplace demographics mirrors the widespread entry of women into the full-time workforce beginning in the 1960s and 1970s. As more women left the role of homemaker, it became more socially acceptable to


In your view, what is the single biggest mistake a DC plan

participant can make? “Being too short-term focused and deviating from a long-term plan. It’s too easy to get caught up in the emotion of markets. When someone does that, they wind up selling at the bottom and getting back in too late—at the market’s very top. It’s much better to have a disciplined strategy and stick to it. Participants also need to do some thinking and planning. They can’t assume some bureaucrat in Washington, DC has found the magic number and can set a one size-fits-all retirement savings goal for everyone. Everybody needs to sit down and figure out what’s needed and how to get there.”

What keeps you up at night? “A few things. I worry about

shocks such as geopolitical problems which could, for example, affect oil

prices. I also worry about too much government interference in a free enterprise economy. The American economy works best when it is allowed to do its thing, so to speak. But the thing I worry most is the federal deficit and

debt. A recent CBO report predicted that our current national debt of $8.2 trillion would expand to over $20 trillion by the year 2020. That represents a colossal amount of borrowing and it’s still an open question as to whether the federal government can even get away with that. What that suggests is over the next decade, we’ll see higher interest rates, higher taxes and, eventually, government spending cuts. Who’s the government

most likely to tax? Wealthier Americans. Where is the government going to cut back? Areas supporting older Americans, most likely. So if you’re a wealthier, older American—and especially if you’re over-invested in the long end of the Treasury market—you have a big, fat bulls-eye on your back. It’s a wake up call. The federal government will not be their friend in the next decade.”

How did you become an economist? “I grew up the son of an Irish politician. I also

wanted to go into Irish politics, but wanted to know something about the economy beforehand. So I did a PhD at Michigan State University. As it turned out, my interest in Irish politics wasn’t as great as my interest in a girl I met in Grand Rapids. You can’t forecast everything!”

take up a career—as well as a means of becoming more upwardly mobile as double income families proliferated. The same may hold true for older Americans thinking about re-entering the workforce. “If all of your buddies are working past 65, then chances are that you will want to do so too,” says Kelly. “The key is to make that a choice for those over 65 instead of a necessity due to depleted retirement savings.” Many DC plan participants were shaken by the gyrations in the financial markets during the height of the credit crisis in late 2008 and early 2009. But the rebound in the equity market since then has not been accompanied by increased flows into equity funds by individual investors. That iner-tia is evident despite record low returns on cash deposits and the looming possibility of a bond market correction if interest rates start to rise (something that typically accom-panies economic recoveries). Participants who sat out the stock market rally in late 2009 and are spooked by recent volatility might wonder if there’s anymore upside potential now. For J.P. Morgan’s Kelly, the answer is “yes”—as long as the economy continues to improve. While some plan sponsors have viewed financial market turmoil as detrimental to their efforts to engage more par-ticipants, others have used the increased attention being paid to personal finance issues in order to drive home the message that it’s important to plan ahead for retirement. In fact, the credit crisis may have scared many Americans out

of complacency. Even though many participants’ immediate reaction to the upheaval in their portfolios was to do noth-ing—either out of fear or uncertainty—plan sponsors can use the markets’ recovery as an opportunity to encourage increased contributions, rebalancing of portfolios and greater diversity of investments. Says Kelly: “A plan sponsor can do more in terms of education because participants are much more fo-cused on retirement savings than they were pre-crisis.” With increasing signs the worst of the recession—if not the recession itself—is over, it’s a good time to remember that while economic cycles come and go, investing well is a long-term project.

INTRODUCING

THE GUIDE TO RETIREMENT The Guide to Retirement (GTR) is a compendium of data, markets information and trend indicators to help plan sponsors navigate the retirement landscape. If you are interested in receiving a copy of the GTR, please contact your J.P. Morgan representative. 25

25

RETIREMENT

INSIGHTS

10-yrs

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 '00 - '09

Real Estate

Real Estate

DJ UBSCmdty

MSCIEME

Real Estate

MSCIEME

Real Estate

MSCIEME

Barclays Agg

MSCIEME

Real Estate

26.4% 13.9% 23.9% 56.3% 31.6% 34.5% 35.1% 39.8% 5.2% 79.0% 174.5%

DJ UBSCmdty

Market Neutral

Barclays Agg

Russell 2000

MSCIEME

DJ UBSCmdty

MSCIEME

MSCI EAFE

Market Neutral

MSCI EAFE

MSCIEME

24.2% 9.3% 10.3% 47.3% 26.0% 17.6% 32.6% 11.6% 1.1%* 32.5% 162.0%

Market Neutral

Barclays Agg

Market Neutral

MSCI EAFE

MSCI EAFE

MSCI EAFE

MSCI EAFE

DJ UBSCmdty

Asset Alloc.

Real Estate

Market Neutral

15.0% 8.4% 7.4% 39.2% 20.7% 14.0% 26.9% 11.1% -23.8% 28.0% 108.7%

Barclays Agg

Russell 2000

Real Estate

Real Estate

Russell 2000

Real Estate

Russell 2000

Market Neutral

Russell 2000

Russell 2000

Barclays Agg

11.6% 2.5% 3.8% 37.1% 18.3% 12.2% 18.4% 9.3% -33.8% 27.2% 84.8%

Asset Alloc.

MSCIEME

Asset Alloc.

S&P500

Asset Alloc.

Asset Alloc.

S&P500

Asset Alloc.

DJ UBSCmdty

S&P500

Asset Alloc.

0.6% -2.4% -5.4% 28.7% 12.5% 8.0% 15.8% 7.3% -36.6% 26.5% 60.8%

Russell 2000

Asset Alloc.

MSCIEME

Asset Alloc.

S&P500

Market Neutral

Asset Alloc.

Barclays Agg

S&P500

Asset Alloc.

DJ UBSCmdty

-3.0% -3.4% -6.0% 25.2% 10.9% 6.1% 14.9% 7.0% -37.0% 22.5% 50.9%

S&P500

S&P500

MSCI EAFE

DJ UBSCmdty

DJ UBSCmdty

S&P500

Market Neutral

S&P500

Real Estate

DJ UBSCmdty

Russell 2000

-9.1% -11.9% -15.7% 22.7% 7.6% 4.9% 11.2% 5.5% -37.7% 18.7% 41.3%

MSCI EAFE

MSCI EAFE

Russell 2000

Market Neutral

Market Neutral

Russell 2000

Barclays Agg

Russell 2000

MSCI EAFE

Barclays Agg

MSCI EAFE

-14.0% -21.2% -20.5% 7.1% 6.5% 4.6% 4.3% -1.6% -43.1% 5.9% 17.0%

MSCIEME

DJ UBSCmdty

S&P500

Barclays Agg

Barclays Agg

Barclays Agg

DJ UBSCmdty

Real Estate

MSCIEME

Market Neutral

S&P500

-30.6% -22.3% -22.1% 4.1% 4.3% 2.4% -2.7% -15.7% -53.2% 4.1% -9.1%

Ass

etC

lass

Asset Class Returns

Inve

stin

g

The best and worst performing asset classes vary greatly year to year

Source: Russell, MSCI Inc., Dow Jones, Standard and Poor’s, Barclays Capital, NAREIT, J.P. Morgan Asset Management.

The “asset allocation” portfolio assumes the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCI EAFE, 5% in the MSCI EMI, 30% in

the Barclays Capital Aggregate, 5% in the CS/Tremont Equity Market Neutral Index, 5% in the DJ UBS Commodity Index and 5% in the NAREIT Equity REIT Index.

Asset allocation portfolio assumes annual rebalancing. All data except commodities represent total return for stated period. Past performance is not indicative of future

returns. Please see index definitions on the disclosure slides. “10 Year” returns represent cumulative total return and are not annualized. These returns reflect the

period from 1/1/00 – 12/31/09. *Market Neutral returns include estimates found in disclosures.

19

19

RETIREMENTINSIGHTS Structuring a Portfolio to Match Investor Goals

Needs

Wants

Legacy

Incr

easi

ng R

isk

For illustration purposes only.J.P. Morgan Asset Management.

Considerations Potential SolutionsTime horizon not only of yourself, but also of your heirs or endowment

What are your desires/wants?How much risk are you willing to take?

What are your basic needs?What income sources do you have or will you need to create?

EquitiesAlternatives

EquitiesBonds

Social SecurityPensionAnnuitiesBondsCash Instruments

How will you structure your investments in retirement to meet your goals?

Ret

irem

ent

1212

RETIREMENTINSIGHTS

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

25 30 35 40 45 50 55 60

Benefit of Saving Early

Compounding can greatly impact the amount of savings over the long term

• Susan invests $2,000 annually between the ages of 25 and 35.• In total, she invests $20,000.

• Bill invests $2,000 annually between the ages of 35 and 65.• In total, he invests $60,000.

Susan stops contributing

Bill starts investing

$314,870

$244,692

Savi

ng

The above example is for illustrative purposes only and not indicative of any investment. Account value in this example assumes an 8%

annual return. Source: J.P. Morgan Asset Management.

Growth of Savings Accounts

Age

1

Guide to Retirement2010 Edition


Building BlocksA blueprint for adding direct real estate to your DC plan

DEFINED BENEFIT PLAN participants have long enjoyed the benefits of direct real estate in their retirement plans but most DC-plan participants do not have access to commercial real estate in their 401(k) plan. While the PPA (2006) encouraged DC plan sponsors

to offer institutional-like fund choices, directly-owned commercial real estate is still a very small slice of the typical DC investor’s pie. Some DC portfolios do access real estate through REITs (real estate investment trusts); real estate securities that trade on public markets. However, in doing so, investors lose much of the diversification benefit of real estate since REITs have shown higher correlations to the broader equity markets than a direct real estate investment would. Given the attractive long-term return and diversification attributes of direct real estate investing, as well as the fact that 90% of investable commercial property in the U.S. is privately held, it makes sense for plan sponsors to consider how to create a real estate allocation that includes both direct properties and REITs.

Going DirectDC plans have not generally provided participants with stand-alone options in a wide array of alternatives such as hedge funds, infrastructure and private equity. This is due largely to the reasonable worry that many participants will not fully understand the impact illiquidity and sometimes opaque pricing of alternatives have on their role in a port-folio. Instead, participants may best benefit from the per-formance characteristics of direct real estate by investing in a professionally-managed diversified portfolio such as a TDF or risk-based fund—that may, itself, have an allocation of 5% to 15% to direct real estate depending on philosophy and structure.

A Buyer’s GuideAs TDF managers and designers consider direct real estate allocations, they are faced with questions they have not typi-cally had to answer when evaluating stock and bond funds. As with all funds, a real estate fund should be selected based on its manager’s ability to generate excess returns. However, real estate funds should also be evaluated for their ability to implement daily fair valuation and liquidity—which points to a blended fund of direct real estate and real estate securities. Daily fair valuation is necessary because plan participants trade into and out of TDFs on a daily basis and should not do so on stale underlying property values. A fund manager with a long tradition of establishing unit values on behalf


of open-end fund investors in real estate is a good place to start. This manager should have a process whereby an inde-pendent fiduciary oversees the evaluation of each property’s value on a quarterly basis. These property valuations should be distributed as evenly as possible during each quarter and not artificially clustered toward the end of each month. Ex-ternal third-party appraisals should be performed regularly and property values should be adjusted to reflect credible, arms-length bids—well before property sales close. Manag-ers should keep track of each asset’s divergence between fi-nal appraised value and sales price. Finally, debt should be marked to market daily. As noted above, the liquidity of any real estate fund needs to be protected from excessive daily trading by 401(k) plan participants. Participants who invest in stand-alone real es-tate options often increase their trading after large changes in market prices, suggesting they consider these allocations to be speculative. At a minimum, 75% of a real estate fund’s investors, weighted by NAV, should be target-date funds and other managed accounts. Perhaps the worst outcome is a fund that clusters its prop-erty valuations toward the end of the month and also has most of its NAV coming from trading decisions by individual plan participants. Participants can easily game this type of valuation. Fund managers can avoid market-timing activity by randomly distributing property revaluations over the trad-ing days of the year and by having a large enough allocation to the unpredictable real estate securities market. Speaking of REITs, what might be the proper allocation to this sector? While real estate securities’ high volatility and broad market correlation argue for a low allocation, REITs have the daily liquidity that DC plans need and do a reason-able job incorporating forward-looking expectations about the property market, arguing for a higher allocation. By mix-ing these counterbalancing factors with traditional efficient frontier techniques and liquidity availability models, we would lean toward an allocation within the total real estate segment of 20% to 25% in REITs with the balance in direct commercial properties.

Get RealCurrently, DC plans have but a small allocation to U.S. real estate when compared to the DB plans they are increasingly replacing. TDFs and managed accounts will continue to open the door to more active participation in the U.S. commercial property market, though caution and well-advised strategies are absolutely necessary for investors to gain full advantage of the potential reward.

Benefits of an Allocation to Commercial Real Estate in DC Portfolios

DIVERSIFICATION: Real estate has a cycle of its own that has very low correlation with stocks and bonds

INCOME COMPONENT: A large portion (65% to 80%) of total return comes from income

POTENTIAL INFLATION HEDGE: Contractual provisions may allow landlords to pass price increases in operating expenses directly to tenants

MODERATE VOLATILITY: Returns from unleveraged, institutional-grade core real estate are expected to be between investment-grade bonds and large-cap stocks

Risks that can Derail a Recovery in Commercial Real Estate

POSSIBILITY OF A DOUBLE-DIP RECESSION can lead to rising unemployment which translates into empty office buildings and apartments

RISING INTEREST RATES will place pressure on margins and potentially decrease total returns

REPEAT OF CREDIT CRISIS can cause significant liquidity issues if interbank market seizes up

Real Estate Poised for a ReboundWhile stocks and bonds have rebounded from recent crisis troughs, commercial real estate has yet to rebound. But recent signs of a recovery in real estate values could serve as an indication of an attractive investment environment in the asset class over the coming years.


ity because they face the same speculation and turnover that pure real estate securities funds face.

A Buyer’s GuideAs target date fund managers and designers consider direct real estate allocations, they are faced with questions they have not typically had to answer when evaluating stock and bond funds. As with all funds, a blended direct and securities real estate fund should be selected based on its manager’s ability to generate excess returns. However, real estate funds should also be evaluated on their ability to implement daily fair valuation and liquidity. Daily fair valuation is necessary because plan participants trade into and out of TDFs on a daily basis and should not do so on stale underlying property values. A fund manager with a long tradition of establishing unit values on behalf of open-end fund investors in real estate is a good place to start. This manager should have a process whereby an inde-pendent fiduciary oversees the evaluation of each property’s value on a quarterly basis. These property valuations should be distributed as evenly as possible during each quarter and not artificially clustered toward the end of each month. Ex-ternal third-party appraisals should be performed regularly and property values should be adjusted to reflect credible, arms-length bids — well before property sales close. Man-agers should keep track of each asset’s divergence between final appraised value and sales price. Finally, debt should be marked to market daily. As noted above, the liquidity of any direct property fund needs to be protected from excessive daily trading by 401(k) plan participants. At a minimum, 75% of such a fund’s NAV should be hidden within target-date funds and other man-aged accounts. Perhaps the worst outcome is a fund that clusters its prop-erty valuations toward the end of the month and also has most of its NAV coming from trading decisions by individual plan participants. Fund managers can avoid market-timing activity by randomly distributing property revaluations over the trading days of the year and by having a large enough al-location to the unpredictable real estate securities market. Currently, DC plans have but a small allocation to U.S. real estate when compared to the DB plans they are increasingly replacing. TDFs and managed accounts will continue to open the door to more active participation in the U.S. commercial property market, though caution and well-advised strategies are absolutely necessary for investors to gain full advantage of the potential reward.

Benefits of an allocation to commercial real estate in DC portfolios

DIVERSIFICATION: Real estate has a cycle of its own that has very low correlation with stocks and bonds.

INCOME COMPONENT: A large portion (65% to 80%) of total return comes from income

POTENTIAL INFLATION HEDGE: contractual provisions allow landlords to pass price increases in operating expenses directly to tenants

MODERATE VOLATILITY: Returns from unleveraged, institutional-grade core real estate are expected to be between investment grade bonds and large-cap stocks

Risks that can derail a recovery in commercial real estate

POSSIBILITY OF A DOUBLE DIP RECESSION can lead to rising unemployment which translates into empty office buildings and apartments

RISING INTEREST RATES will place pressure on margins and potentially decrease total returns

REPEAT OF CREDIT CRISIS can cause significant liquidity issues if inter-bank market seizes up

Real Estate Poised for a ReboundWhile stocks and bonds have rebounded from recent crisis troughs, commercial real estate has lagged behind. But recent signs of a recovery in real estate values could serve as attractive opportunities to invest in the asset class over the coming years. Price Recovery: Trough Through March 2010

Source: Barclays, NCREIF, Bloomberg, J.P. Morgan

2%13%

43%

78%63%

17%1%0

1020304050607080

Treasuries AAACorporate

BBBCorporate

High YieldBonds

Stocks U.K. RealEstate

U.S. RealEstate

Perc

ent

Total Return Recovery: Trough Through March 2010


DC: The Next Chapter

What are the key emerging trends you are seeing in the DC industry? In the wake of the financial crisis of ‘08/’09 there is a growing recognition that the DC structure—both in terms of design and investments—must evolve to help strengthen workers’ retirement out-comes. There is increased interest in how DB best practices can be applied to DC platforms and a renewed focus on participant behavior to help improve retirement saving patterns.

What are some lessons learned in the wake of the financial crisis for DC plans? Leading into the crisis, market conditions and overconfidence led many investors to seek investments that paid a higher yield or delivered the strongest total return relative to peers. As a result of this narrow focus, many participant portfolios were exposed to risk that had not been anticipated or understood. This realization elevated the importance of a disciplined selec-tion process. The takeaway here is: know what you own, and more impor-tantly, why you own it.

What caused such negative surprises? There’s no single answer. Sector bets and quality of underlying holdings were key issues that impacted core fixed income, and in turn stable value. Commercial paper liquidity was one of the factors at root of the challenges that many money market funds saw.

Equity volatility was most frightening to investors due to typical participant exposure. Surprises came when par-ticipants discovered that they were exposed to unanticipated risks, for ex-ample, a large cap domestic stock fund with significant international equity exposure or managers that took on sector or concentration risk to produce outsized returns.

Weren’t TDFs designed to minimize this market volatility? Many plan spon-sors were caught by surprise by the wide performance gap among TDF strategies over the last few years, particularly the sharp declines of some funds at or near their target dates. Prior to the market crisis, these products were often viewed as interchangeable in terms of their as-set allocation strategies. The truth is that TDFs vary widely in their equity

allocations, diversification levels and risk/return expectations. The severe market volatility underscored the impor-tance of selecting a portfolio design best aligned with a plan’s investment goals.

So in this new era how should plan sponsors rationalize their core fund line-up? Plan sponsors can reduce con-fusion and redundancy, without limiting performance, by simplifying their lineup with carefully screened investment op-tions in most core asset classes. In the past, many plans relied primarily on to-tal return and fee comparisons to make investment choices for their fund line-up. Today, we’re seeing plans increas-ingly reassessing their existing invest-ment options and placing more weight on risk-adjusted returns, seeking invest-ments that offer performance consis-tency, style purity and portfolio quality.

continued on p. 31

The DC industry has entered a transformational period that is expected to change the shape of the retirement landscape for years to come. The recent financial crisis—viewed as a primary catalyst for change—has exposed a multitude of shortfalls around plan design, communications strategy and investment fund line-ups. To gain further insight into how the industry is addressing these evolving trends, we spoke to David Musto, Managing Director, Head of J.P. Morgan’s DC Investment Solutions Business.


Outside the (Stable Value) Box

Innovative alternatives for traditional stable value funds

Although Stable Value is the largest conservative option in the DC market, recent market conditions have highlighted inherent constraints faced by plan sponsors when

offering a Stable Value fund. It has become apparent that the traditional Stable Value option (a popular option with participants) will need to evolve to improve flexibility

and to better meet the needs of both participants and plan sponsors.

Traditional Stable Value Tested by the recent severe market downturn, Stable Value funds performed admirably, offering participants a place to shelter balances from market declines, while still earning a yield substantially higher than most money market funds. Stable Value contracts were the key ingredient that enabled these funds to perform as expected, even in the recent mar-ket crisis. However, these same contracts contain embedded protections that are sometimes viewed by plan sponsors as too constraining and by wrap issuers as ineffective. Today, wrap supply and demand are out of balance: three large wrap issuers have left the market since 2008. New issu-ers are on the horizon, albeit in limited scale and demanding higher fees. In addition, most issuers found that their contrac-tual protections, if exercised during the crisis, would have been compromised, resulting in increasing the issuer’s risk of loss. Discomfort with these contract protections coupled with market uncertainty and overall de-risking at financial institu-tions has caused virtually all issuers to cease accepting new deposits. Most wrap issuers that remain committed to the business are requiring new investment parameters, new con-tract terms and higher fees. Over time, a more normal equilib-rium and increased flexibility should return to the Stable Value market. In the meantime, some plan sponsors may con-sider shifting toward an admittedly more flexible money mar-ket fund option—a less than ideal choice in the construct of building one’s retirement nest egg.

P L A N D E S I G N D E C I S I O N T R E E S t a b l e V a l u e a n d i t s S i b l i n g s

OptionPrice behavior

Long-term return expectation among these three options Plan sponsor view

TRADITIONAL STABLE VALUE FUND

Daily price stability

Highest Believe the benefits of daily price stability and higher return potential outweigh constraints

STABLE INCOME FUND

Price stability, but not daily

Close to highest Seek improved flexibility while maintaining enhanced long-term return objectives

CASH PLUS FUND

Daily price stability

Lowest Seek flexibility and price stability over the cost of diluted return potential


Alternatives to Stable Value For plan sponsors seeking more flexibility than traditional Stable Value currently affords, two alternative approaches may be considered based on blending unwrapped assets with Stable Value assets.

Cash Plus Fund (Stable Value plus money market) One alternative is to allocate a mean-ingful portion, perhaps 20%–30%, of fund assets in an unwrapped cash vehicle like a

money market fund. By doing so, the overall fund would main-tain its stable daily price. The wrapped Stable Value assets would continue to produce returns that exceed cash during most market environments. In a period of sharply rising short-term rates or an inverted yield curve, the money market assets would enable the fund’s return to rise more quickly than that of a dedicated Stable Value Fund. The plan would benefit from a significant source of unconstrained liquidity and should have

more flexibility for plan events such as corporate downsizing or plan changes. There are many benefits to implementing such a blended fund, including a stable daily price, meaningful outperfor-mance versus money market funds and increased flexibility (relative to traditional Stable Value) for plan changes or other employer events. However, in the long run, the dilution effect of money market returns on the fund’s performance could meaningfully impair a participant’s retirement savings suc-cess. (Note: Pending Congressional legislation may impact the use of derivatives within this structure.)

Stable Income Fund (Stable Value plus bonds) Another alternative is to allocate a meaningful amount of unwrapped assets in bonds similar to the wrapped assets.1 Through this approach, the fund would be expected to achieve a higher

long-term return that is more appropriate for retirement savings (similar to traditional Stable Value). These unwrapped assets would experience daily fluctuations in price. However, be-cause the unwrapped assets would represent a smaller por-tion of the fund than the wrapped assets, volatility would be muted at the total fund level and offset by the steady daily income from Stable Value contracts. The perfor-mance of such a fund would likely be dominated by the Stable Value allocation. In this structure, a plan has the freedom to pursue actions—e.g. communication, plan changes, employer events—that would normally be constrained by the wrap contracts in a tra-ditional Stable Value fund, but with the understanding that the

downside might be a price ad-justment consistent with the normal price changes of the fund. This flexibility would materially liberate the plan sponsor from reliance on wrap issuer approval, while still maintaining an invest-ment strategy that has long-term principal preservation goals and retirement invest-ment objectives. Compared to the Cash Plus strategy, this fund con-struct targets higher long-term returns while aiming to preserve the objectives of traditional Stable Value funds: providing principal

preservation and returns in excess of cash. Decisions, Decisions Even as the financial crisis has waned, the events have re-vealed shortcomings in portfolios and contract structures. Investment strategies are evolving. But beyond the logical investment evolution, some plans may be looking for more flexibility while keeping the traditional benefits of a Stable Value option. As with any decision, there are trade-offs to these alter-natives. Given each option’s unique features, the trade-offs (see chart) can help plan sponsors determine which of these options may make the most sense for their plan.

1 Underlying wrapped assets and unwrapped assets are available with a range of risk and return characteristics.

Q: What works best—a printed newsletter with product and investment ideas or a website version of the same? It seems that a number of plans are veering toward websites and emails only and nothing printed. Do you have research? —OLD FASHIONED INK IN OHIO

Dear Old Fashioned: We don’t have an apples to apples evaluation, but we believe that a combination of the two works best with the participant ultimately selecting which format he or she prefers. Your participants will make it clear to you how they prefer to receive information—and what information they value the most—if you provide feedback mechanism—paper, a phone number, and a website.

Q: 401(k) providers talk about “to versus through” as if it’s a fiduciary question, but isn’t it the responsibility of the plan sponsor to help the participant “to” his or her retirement and then, transfer that responsibility to the employee? —CURIOUS IN

CONNECTICUT

Dear Curious: Many plans feel a paternalistic instinct to want to serve their employees well during their working years after retirement. Studies underscore the challenge that many participants face in obtaining financial advice. The TDF strategies in place throughout the industry are the subject of this debate, more than any other strategy, as the glide path

can be designed to either to retirement or post-retirement age. We would suggest that a well-grounded grasp of the issue can help the plan sponsor determine how to approach the question of ‘to versus through.’ It is a matter of clarity of communication and transparency of intention.

Q: We have a bit of a tug of war between the consultant who points out the

style drift of various funds in our line-up versus the fact that we offer a number of popular, visible brand funds that have done moderately well over time. Our participation rate is high, and most of these funds have generated returns above their peer group. — AFLOAT IN FLORIDA

Dear Afloat: If your question is how much credence to give the consultant, we would say ‘pay attention.’ The challenge for plan sponsors is to adhere to your Investment Policy Statement (IPS), exercise fiduciary oversight and enable your employees to participate with the best possible information.

Style drift is a danger as plans will load up on funds purporting to accomplish similar goals, e.g. participate in U.S. corporate growth. When the tide turns, and many funds own the same securities or are in the same sector, the participant who thinks she is diversified, bears the burden of correlated declines.

We would suggest a focus on your firm’s IPS which should set the course for your program and help with governance, and a regular review with your consultant of your funds in the line-up, their correlations and adherence to their stated objectives.

Everything you want to know about retirement (but were afraid to ask)

Working with J.P. MorganWe want to make it as easy and sensible for our clients to access us:

WEB jpmorgan.com/retirement for recordkeeping and plan administration information

jpmorgan.com/institutional for investment information for DC and DB plans

PHONE Call us at 800 988 9084

EMAIL [email protected] [email protected]



Following the bursting of the tech bubble in 2000 and two years of deteriorating funding status, corporate pension plans spent five years climbing out of the deficit hole. And just as a majority had clawed their way back to fully funded status, the credit crisis plunged them once again into negative territory. For plan sponsors, 2008 was a year of remorse; in hindsight, many wished they had taken the opportunity to lock in healthier funded ratios.

197

126

(165)

(308)

63

(40)

(140)(164)(219) (250)

(400)

(300)

(200)

(100)

0

100

200

300

400

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Est. 2009³

DOLLARS

-5

-4

-3

-2

-1

0

1

2

3

4

5PERCENT

Funding status % of S&P 500 market cap

226280

Where to from here?

1 Source: Historical data for 1997-2009 is based on the “S&P 500 2008: Pensions and Other Post Employee Benefits” article published by S&P on June 2, 2009; S&P 500 historical market cap per S&P’s website

2 J.P. Morgan: 2009 Estimate assumes the following returns: 26.46%, FI 5.93%, Real Estate -20%, and Other 24%

S&P 500 Pension Funded Status Snapshot: PBO basis1 ($bn)


Source: Company reports/10-Ks; eVestment, J.P. Morgan estimates.Note: Asset class returns are S&P500 for Equity, Barclays Long Government Credit for Fixed Income and J.P. Morgan estimates for Real Estate and Other. The universe includes all companies in the Russell 3000 as of May 19, 2009 as well as companies identified by screening the larger FactSet U.S. com-mon stock universe for companies with projected benefit obligations that are not in the Russell 3000 universe.

FUNDEDRATIO (%)

0

1

2

3

4

5

6

7

8

9

10

Average contribution as % of 2008 plan assetsAverage funded ratio 2008

Average funded ratio 2009

87.774.1 73.3 75.3

85.994.9

81.0 80.8 79.987.4

10.8%12.4%

7.1%

1.9%8.1%

<$1 bn (8) $1–5 bn (86) $5–10 bn (27) $10–25 bn (21) >$25 bn (7)0

5

10

15

SIZE (PBO–2009)

AVERAGE CONTRIBUTIONAS % OF 2008PLAN ASSETS

Source: Company 10-Ks; J.P. Morgan Asset ManagementNotes: Analysis includes 149 of the largest plans in the U.S. with published 10-Ks and 12/31 mea-surement dates; based on reported U.S. PBO and MVA. Excludes General Motors. Numbers in parentheses indicate number of plans in this category.

Fortunately, 2009 brought some measure of relief. The average funded status for 149 of the largest U.S. corporate pension plans increased from 75% in 2008 to 82% in 2009, with improvement seen across all size categories.

STATUS UPDATE

2009

It is too soon to say what further relief 2010 will bring. Equity returns are likely to be more modest, while real estate appears to be at or near a bottom; a rise in discount rates may lower liability values but when and how much is unclear. With the lessons of the past clearly in mind, corporate plan sponsors are continuing their search for the tools and strategies that can help them to generate the returns they need to meet benefit obligations while protecting their plans from further downside risk.

LOOKING AHEAD

2010 and beyond

(%)2008 Year End Allocation

2009 Return

Equity 51 +26

Fixed Income 40 +2

Real Estate 1 -20

Other 8 +24

Total Portfolio 100 +16

Estimated Return on Plan Assets for a Broad Universe of U.S. Pension Plans (2009)

Funded Ratios and Contributions for Largest U.S. Pension Plans by Plan Size

This progress in funded status was attributable to positive investment returns (estimated at 16%) and significant contributions, which helped asset growth exceed that of liabilities, despite a decline in discount rates. Strong equity performance (+26% on average) was the primary driver of portfolio returns.

Each issue, we answer questions we receive from readers. Please send your questions to: [email protected]


or bonds for a given investment strat-egy no matter where the companies are listed. Interestingly, institutional investors have invested more of their money with global funds than emerg-ing market or other regional-based strategies (excluding pure U.S. or tra-ditional multi-regional International) over the past two years, says J.P. Mor-gan’s Emmett. He adds: “If it makes sense for DB plans, why shouldn’t DC participants have access to the same opportunity?” So going global may involve a strategic rethinking of the fund line-up in more plans.

� JOURNEY Spring / Summer 2010

What are the big trends affecting mu-tual funds? We have seen a continued trend toward asset allocation funds and more “packaged” mutual fund suites such as TDFs. We expect to see even more risk-based asset allocation funds, and options that help participants po-sition themselves for retirement such as managed account programs. Plan sponsors and participants are increas-ingly looking for solutions that allevi-ate some of their worry by, for instance, turning responsibility over to a profes-sional manager. Another trend we see involves the heightened focus by plan sponsors and the general public on fees and overall transparency. We expect to continue to see an unbundling of fees attached to mutual funds.

What is the latest pattern you are seeing in DC plan fund line-ups? It’s not limited to DC plans, but broad-ly, investors are reassessing their fund line-ups as a result of what has trans-pired over the past two years in the financial markets.

What are the key legislative initiatives you are keeping an eye on? Our main concern on the regulatory side is that Congress might seek to mandate certain investments such as an annuity or in-dex fund option within all 401(k) plans. We think those decisions should be left up to plan sponsors. On the other hand, it seems that some of the pressure that had been brought to bear by legislators on things like TDFs—in terms of nam-

ing conventions and glide path require-ments—has dimin-ished as markets have recovered.

What is some of the newest think-ing in terms of

fund strategies? One of the big-gest lessons learned from the financial crisis is that investors were not diversified enough. We at J.P. Mor-gan have been strong advocates for in-creasing diversification through access to strategies that have low correlations to U.S. stocks and bonds. These alter-natives could include market neutral funds, inflation hedges, exposure to non-traditional asset classes through exten-sion strategies like international REITs, convertible bonds, commodities and absolute return fixed income strategies.

Isn’t the TDF structure one way to ac-cess these extension strategies? Yes, as it’s unlikely that any of these would be available as stand alone DC options. That doesn’t mean they won’t be one day, but many plans already have too many funds. Instead, we’re seeing plan spon-sors start to tap alternative strategies via TDFs which incorporate them. Some larger plans are developing customized TDFs with extension strategies.

continued on p. 30

Do funds have more fun? We sat down with George C. W. Gatch, CEO of J.P. Morgan Funds, who discussed the

evolving landscape for mutual funds. In the excerpts below, George weighs in on what’s new for fund line-ups

both within DC plans and in the broader marketplace.

The Feeling is MutualE x E c U t i v E p E R s p E c t i v E

Curious, though, as much of the re-search seems to indicate that investors in DC plans spend hardly any time on their investments... True, but there is a growing sense of urgency among plan sponsors. Many are taking a fresh look to make sure that they’re properly aligned in terms of risk and return. For example, some people who thought they had invested in a low-risk fixed in-come strategy woke up amid the credit crisis to find out that wasn’t necessarily the case.

Is there a difference in the DC/DCIO approach to fund selection? Essentially, we see it is being one in the same as far as decision-making goes for both channels. When a plan sponsor is thinking of changing the record keeper, then that’s an obvious juncture to con-sider changes in the fund line-up. But it’s probably prudent for DC plans to periodically—at least annually—review their funds’ performance and consider adding or streamlining.

Executive Perspective continued from p. 8

J.P. Morgan JOURNEY �


mean GDP growth in Brazil is forecast to reach 6.2% in 2010, according to J.P. Morgan Asset Management.

CaUtiONaRY NOtE: The MSCI Brazil Index is skewed towards commodity producers and exporters, and is dominated by the two largest companies listed on the exchange, which together account for around 40% of the market. Investors who stick to the benchmark index may have less than optimal diversification in their exposure to Brazil.

Going GlobalPlan sponsors tend to think of

domestic funds and foreign funds as separate categories, but global

funds seek out the sweet spot where those two worlds converge.

The world’s largest, fastest growing emerging markets are Brazil, Russia, India and China, also known as the BRICs. Some economists have predicted the combined GDP of these four powerhouses will overtake the developed world as soon as 2050. Today, they account for nearly half the world’s population and about 20% of the global economy. Here’s a primer on who the BRICs are and why they matter…

thE WOW! faCtOR: The biggest South Ameri-can economy, Brazil is defined by its competi-tive agricultural, mining, manufacturing, and service sectors. In the past decade, Brazil has promoted fiscal and monetary stability, turning the page on years of excess debt and hyperinflation. The twin domestic trends of rising investment and consumer demand


When it comes to buying things we use ev-ery day—like a car, coffee maker or even the shoes on our feet—most Americans look for attributes like price, quality and overall value regardless of the country of origin. While a Japanese car, Chinese-made percolator or pair of Italian shoes hardly qualify as exotic these days, it’s still un-usual to find fund line-ups with any more than a handful of investment options out-side the U.S. Of course, domestic equity

� JOURNEY Spring / Summer 2010

speaking Investments

ThE WOW! facTOR: Since the collapse of the Soviet Union, Russia has rapidly evolved into a more market-based and globally-integrated economy. Its growth is largely fueled by global demand for commodities as Russia is one of the world's largest exporters of natural gas, oil, aluminum and steel. The Russian economy grew at an average rate of

about 7% from the end of a 1998 financial cri-sis through the start of the global credit crisis in 2008. Its recent economic slump appears to have bottomed out in mid-2009.

caUTiONaRY NOTE: Russia’s dependence on basic materials exports makes it vul-nerable to high volatility in the prices of global commodities. Also, a legacy of highly concentrated ownership in major industries persists following the transformation of many formerly state-owned firms into business units of politically-connected "oligarchs."

ThE WOW! facTOR: India’s economy has grown an average of more than 7% per year since 1997, just a few years after the country began to implement policies designed to liberalize its economy by dismantling many regulations on foreign trade and investment. Although just over half of all Indians work in agriculture, the biggest growth engine is a

and fixed income funds are the top choice of many inves-tors—and for good reason. Too much of a good thing, how-ever, may unwittingly over-expose participants to single market risk—even if that market is as deep and mature as that of the U.S. So does it make sense to “overweight” American bonds and stocks in a retirement savings plan even as the investment universe grows increasingly global and diverse? The good ‘ole U.S. of A. boasts some of the most stable and transparent markets—not to mention being the world’s largest economy. So ‘buy America’ may make sense for long-term investors in the U.S., be it through stocks, bonds or real estate. But it’s worth keeping in mind that some foreign companies actually do more business in the U.S. than their American-based rivals. And some American firms do more business in certain foreign markets than their locally-based rivals do. In fact, it’s very hard to generalize about which mul-tinationals are best poised to capture growth in the U.S. and other markets. Just as British retailers and Canadian financial companies are a major presence in the U.S., American fast food chains and software firm are big players overseas. That’s the thinking behind global funds—a category of-ten confused with purely international strategies—to pro-vide exposure to both U.S. and foreign securities in a “best of class” search for attractive companies, no matter where they happen to be headquartered around the globe. “Where a company is domiciled doesn’t necessarily reflect where it does the bulk of its business,” says Nigel Emmett, Manag-ing Director at J.P. Morgan in New York. “Truly global firms often get most of their revenue from markets outside of their home country.” Consider the case for auto makers, energy companies or household toiletry manufacturers. Many brand names we’re familiar with in the U.S. are actually owned by

conglomerates based in Western Europe or Japan. So the only way to invest in, say, a company that makes a favorite brand of toothpaste or a popular video game console may be to increase “international” exposure. That is also an important consideration for another reason: economic expansion in most emerging markets is expected to outpace growth in the developed world over the next decade. While GDP growth doesn’t necessarily translate into higher corporate profits per se, the balance sheets of globally-oriented companies—both those based in the U.S. and those based overseas—stand to benefit from higher demand in the developing world. Those companies able to best access high-growth markets are likely to be long-term winners. “The real argument for going global is that you want the fund manager to be able to buy the best company in an industry irrespective of where that company may be based,” says Emmett. So what is the right share to allocate to a global strategy? It’s not a one-size-fits-all answer. As with other investment decisions, calibrating exposure in a fund line-up to foreign



1 Source: J.P. Morgan Asset Management, FactSet. As of December 31, 2009.

2 Based on IMP current estimates, subject to change. The above charts are for illustrative purposes only.

U.S. market share as a percentage of Global GDP2

Europe 19%

U.K. 9%

U.S. 25%

Non-U.S. 75%

EM 13%

Japan 8%

Pacific 5%

Canada 4%

United States

42%

EM countries (%)

China 2Brazil 2Korea 2Taiwan 1India 1South Africa 1Russia 1Mexico 1Other 2

MSci acWi country breakdown1

Speaking Investments contined from p.7


Aspart of our ongoing series of plan sponsor roundtables, on April 20 Journey hosted a panel at J.P. Morgan’s Retirement Plan

Services headquarters in Kansas City, Mo. Hosted by RPS marketing chief Kirk Isenhour, the round-table featured three plan sponsor representatives: Ed Gleason, Retirement Strategy Senior Specialist at American Airlines; Kate Stewart, Vice President at commercial printer Henry Wurst Inc.; and Melissa Conger, Corporate Compensation & Benefits Manag-er at specialty packaging producer Huhtamaki, Inc. In the hour-long discussion, the three panelists dis-cussed a number of issues centering on fund line-ups, including the optimal number of funds, monitoring processes, employee input and QDIAs. What follows are excerpts from our conversation...


ISENHOUR: With everything going on in the industry and on Capitol Hill, what’s been your latest action on investments? CONGER: At Huhtamaki, we added a TIPS fund on the advice of our consultant. It was a pretty seamless process from start to finish and we’ve seen several hundred thousand dollars flow in already. GLEASON: How many funds does your company’s DC plan have? CONGER: We have 16 in total.

ISENHOUR: How involved was the outside consultant in your decision process to add the TIPS fund? CONGER: We’ve already had a relationship with this con-sultant for about four years. So it only took six months from beginning to end—from review through implementation. That was much faster than in the past, when nine or even 12 months was typical. Part of the reason it has taken so long previously is that our investment committee only meets four times a year and we split our time between DC and DB plans. We still do that, but the consultant helped pave the way to our decision. ISENHOUR: What’s new with Henry Wurst’s plan, Kate? STEWART: We have about a dozen funds in our plan’s line-up, plus TDFs. Right now, we’re looking at the possi-bility of adding managed accounts. We’re constantly asking

ourselves: ‘Do we have the right number of funds?’ We’re satisfied with each specific fund, but we’re not so sure about the total number in the line-up. The pendulum swings back and forth on the optimal line-up. We used to think: ‘Are there segments of the market we’re missing?’ Now, we think it’s time to sit down and ask: ‘Do we belong in all of these funds?’ It comes down to properly connecting with our employees about their objectives.

ISENHOUR: What has been driving that process of rethink-ing the line-up?

STEWART: We have some new blood replacing some mem-bers of our investment committee, so we’re in the process of educating them about our plan’s offerings. We ask ourselves: ‘Is a dozen a good number?’ We deliberately choose the line-up, but is it more than the participants can absorb? I’m not sure, but we need to have that conversation. GLEASON: We have about 30 funds—two of them are frozen from accepting new investments, one of which is the company stock. Our main consideration is the diversity of our work force. Some of our participants are more experi-enced investors than others, they know the markets well and are eager for a brokerage window. These participants are the ones who typically ask when the plan is going to offer a gold fund! So by the end of the year, we should be putting in some type of brokerage window, understanding that maybe only 1-3% of our total number of participants will actually use it. Once that’s in place, we may look at reducing our core fund line-up down to a much more manageable number. STEWART: Does Huhtamaki have a brokerage window? CONGER: No, we don’t. STEWART: Actually, find that our brokerage window helps mollify the ‘vocal’ participant. Some of our people used to say: ‘Gee, if I only had a brokerage window, then I’d be happy.” Yet we’ve found that most don’t take advantage of the option now that we have it. ISENHOUR: How willing are participants to get help?

GLEASON: At American, we do a lot of retirement educa-tion for active employees—either through general financial advice or managed accounts. There are those who don’t know how to plan financially for the future at age 25 or 45. What makes us think they know what to do at 65 when their access to resources isn’t quite as robust? I’m always amazed when I see a participant equally invested in all 30 of our funds, three of which are risk-based. They just checked off every box! We may need to carry the education process and messages through even after retirement. CONGER: I think there may be a shift underway. While there are some people who can’t grasp the core concepts, there are plenty of others who do—but just don’t have the time to spend on mastering it. STEWART: I think the industry is moving that way be-cause of a lot more concern about volatility due to the finan-cial market’s gyrations over the past couple of years. I agree with Melissa that it’s not so much that people aren’t smart

Ed Gleason, Retirement Strategy Senior Specialist, American Airlines

Melissa Conger, Corporate Compensation & Benefits Manager, Huhtamaki, Inc.

Kate Stewart, Vice President, Henry Wurst, Inc.

I’M ALWAYS AMAzEd WHEN I SEE A PARTICIPANT EqUALLY INvESTEd IN ALL 30 Of OUR fUNdS, THREE Of WHICH ARE RISK-bASEd.—GLEASON

Plan Sponsor Roundtable continued from p. 14

In your view, what makes for a success-ful fund complex? While there are a lot of components, strong risk-adjusted returns are the most critical factor. But you also need a strong investment man-agement culture and a sense of conti-nuity among the team of investment professionals and their managers.

There is a lot of discussion about the relative virtues of commingled funds, SMAs and mutual funds. What is your view? Commingled funds and separately managed accounts (SMAs) provide increased flexibility for the plan sponsor, including the ability to negoti-

ate fees. On the other hand, mutual funds provide services that most commingled funds and SMAs don’t—such as a detailed prospectus, the oversight of an independent board and greater trans-parency, including daily valuations. And mutual funds have the added benefit of portability, the ability of the participant to take the assets with them if they leave or retire. How has the mutual fund industry fared in the wake of the credit cri-sis? It’s pretty clear that the image of mutual funds has actually improved a great deal compared to other investment vehicles and, at the end of the day, the mutual fund industry’s outlook is very strong. Share-holder and investor protection have proven to be very resilient and mutual funds continue to be the dominant investment vehicle of choice by indi-vidual investors. Think about it—more

than 80 million U.S. households invest in mutual funds.

What drew you to mutual funds in a bank as diverse as J.P. Morgan? I’ve been involved with mutual funds at J.P. Morgan since 1990. Twenty years ago, J.P. Morgan had seven mutual funds and $4 billion in assets under management (AUM). Today, we have over 100 funds and over $400 billion in AUM. In the early 1990s, it was hard to get fund managers interested in man-aging a mutual fund because there was more visibility running SMAs for pen-sion funds. Now, every fund manager we have wants to manage a mutual fund!

We moved from lifestyle funds a few years ago. Originally, our default option was a money market fund, and that was scary because we saw employees who retired with 100% of their retirement savings in money market funds. When we rolled out lifestyle funds, it had a positive reception. But there was still a lot of confusion. Some people put one-third of their money in the aggressive bucket, another third in moderate and the remaining third in conservative. When TDFs came along, we found that suited a lot of our employees. They are the solution to the age-old question: ‘What do I do with my money?’ It’s been two years now. When we started

having employee meetings, we made sure to put a quick enroll form and a pen on every chair. As a result, we got a very good response. Ask them to go home and do it on their PC? Forget about it! ISENHOUR: Do your plans see their ob-jective as getting participants to retire-ment or through retirement? GLEASON: We’re through. I think that’s mostly because we have DB plans which take them through retirement and we want our 401(k) plan to offer the same thing to all participants. STEWART: We’re focused on to. Ide-ally, we’d like to provide the tools for post-career retirement, but our focus is just trying to maximize where they are when they get to retirement age. CONGER: We’re also more to, even though we have a DB plan as well. We might get back to through at some point in the future. Several years ago we al-lowed employees to take a lump


DC: The Next Chapter contined from p.24


DC: The Next Chapter

What are the key emerging trends you are seeing in the DC industry? In the wake of the financial crisis of ‘08/’09 there is a growing recognition that the DC structure—both in terms of design and investments—must evolve to help strengthen workers’ retirement out-comes. There is increased interest in how DB best practices can be applied to DC platforms and a renewed focus on participant behavior to help improve retirement saving patterns.

What are some lessons learned in the wake of the financial crisis for DC plans? Leading into the crisis, market conditions and overconfidence led many investors to seek investments that paid a higher yield or delivered the strongest total return relative to peers. As a result of this narrow focus, many participant portfolios were exposed to risk that had not been anticipated or understood. This realization elevated the importance of a disciplined selec-tion process. The takeaway here is: know what you own, and more impor-tantly, why you own it.

What caused such negative surprises? There’s no single answer. Sector bets and quality of underlying holdings were key issues that impacted core fixed income, and in turn stable value. Commercial paper liquidity was one of the factors at root of the challenges that many money market funds saw. Equity

volatility was most frightening to inves-tors due to typical participant exposure. Surprises came when participants dis-covered that they were exposed to un-anticipated risks, for example, a large cap domestic stock fund with signifi-cant international equity exposure or managers that took on sector or con-centration risk to produce outsized returns.

Weren’t TDFs designed to minimize this market volatility? Many plan spon-sors were caught by surprise by the wide performance gap among TDF strategies over the last few years, particularly the sharp declines of some funds at or near their target dates. Prior to the market crisis, these products were often viewed as interchangeable in terms of their as-set allocation strategies. The truth is that TDFs vary widely in their equity

allocations, diversification levels and risk/return expectations. The severe market volatility underscored the impor-tance of selecting a portfolio design best aligned with a plan’s investment goals.

So in this new era how should plan sponsors rationalize their core fund line-up? Plan sponsors can reduce con-fusion and redundancy, without limiting performance, by simplifying their lineup with carefully screened investment op-tions in most core asset classes. In the past, many plans relied primarily on to-tal return and fee comparisons to make investment choices for their fund line-up. Today, we’re seeing plans increas-ingly reassessing their existing invest-ment options and placing more weight on risk-adjusted returns, seeking invest-ments that offer performance consis-tency, style purity and portfolio quality.

continued on p. 31

The DC industry has entered a transformational period that is expected to change the shape of the retirement landscape for years to come. The recent financial crisis—viewed as a primary catalyst for change—has exposed a multitude of shortfalls around plan design, communications strategy and investment fund line-ups. To gain further insight into how the industry is addressing these evolving trends, we spoke to David Musto, Managing Director, Head of J.P. Morgan’s DC Investment Solutions Business.

sum from their DB plan. At first, it was all lump sums. But in recent years, we’ve seen a good mix of those that roll over into an annuity and those that take a lump sum payment. We’re start-ing to do more retirement education—the full picture, not just retirement fi-nances, but wills and other things they need to take into consideration. That’s been eye-opening for the 40 or so em-ployees that have gone through it. GLEASON: We have an older work-force so our retirement readiness effort has been well received. The feedback on it is tremendous. It’s not financial planning advice, but rather education to get them thinking about all the reali-ties of retirement. STEWART: The majority of employ-ees today don’t have a DB plan. At our size, a DB plan is really cost prohibi-tive. So we’re very interested in coming legislation and regulation that is shift-ing us toward the idea that a significant percent of the employee population

may receive DB-like mandates. We’re cu-rious to see what that does to our overall structure and costs.

ISENHOUR: So what keeps you up at night? STEWART: Our concern is the regula-tory environment going forward. How can a plan of our size comply with some of the regulatory challenges proposed? From my perspective, I don’t disagree with the objectives of reforms. But it’s more along the lines of: ‘How do we get from here to there in a cost effective way?’ Some of the ideas might pose a big burden for the employer. So how would we adapt to and meet those new regula-tory requirements? CONGER: The biggest burden may fall on J.P. Morgan and other plan ad-ministrators when it comes to fee dis-closure. But certainly there may be a greater burden borne by plan sponsors as well. How do we communicate that? And how much of it will participants

really even understand? GLEASON: The regulatory burden and what we as plan sponsors will be required to do differently is our lead-ing concern. What will be the finan-cial impact on the employer from new mandates? Mandatory auto-enrollment would definitely have an impact. If you’re eligible for a company match and some participants aren’t even contributing, then the employer may become responsible for meeting those match commitments. That’s potentially a huge increase in the financial burden on companies. STEWART: Another thing is: What does a mandate do for pricing of plan services if you suddenly have a lot more small dollar accounts to administer? Your average plan balance could come down significantly and negatively im-pact plan pricing economics.

ISENHOUR: Thank you all for your three very unique perspectives.

Can more fund options result in bet-ter diversification and outcomes? It depends. Core menu discussions previ-ously focused on the number of available investment options with the assumption that participants were best served by an expansive selection. We saw the aver-age plan’s investment options increased from 10 in 1998 to around 19 today.Yet research shows that adding options for the sake of increasing investment choice may actually decrease participation rates due to participant indecision. And, more choices don’t necessarily lead to better diversification for participants or higher risk-adjusted returns. Correlations across

asset classes and results must be carefully considered when evaluating the appro-priateness of any new menu option.

When should plan sponsors consider adding new funds? In most cases, ei-ther to replace an under-performing fund or to fill a void that helps address specific risks. In the past, plan sponsors often limited their investment menus to traditional asset classes. Today we’re seeing the addition of inflation hedges, such as TIPS, commodities, and real es-tate, as well as non-correlated extended asset classes to help manage volatility–sometimes as single strategies and of-ten as packaged offerings.

Is annuitization an appropriate retire-ment income solution? There is clearly a place for these products to address the longevity risks faced by participants. Consider that the defined benefit plan naturally led participants to think in

terms of regular monthly income rela-tive to their household expenses and other financial needs. While the defined contribution plan may bring more flex-ibility for some in the manner in which their accumulated balance is accessed over time, it has also resulted in less focus by participants on the needs and choices faced in the decumulation phase of retirement.

Are there viable retirement income products that cater to the masses? There’s no silver bullet, but intense in-novation is underway. What the market has told us is that portability, flexibility, cost effectiveness and credit worthiness are important criteria in the develop-ment of these products. The industry continues to grapple with the right combination of features that address the differences in levels of participant demographics and psychographics.

For a Starter: U.S. Bond Intermediate Bond................................... Familiar flavorHigh Quality Bond ..........................Brand-new managerMoney Market ................ New strategy to suit your tasteTIPS .................................Prepared with inflation in mindCore Bond ....................................Same chef since 1982Tax Aware ..............................Using new, special sauces

Hearty diSHeS: U.S. eqUityLarge Cap Core ...........................Chasing the hottest dotLarge Cap Value ...................Same manager since 2009Large Cap Growth .............................Dine on new ideas

on tHe Side: aSSet aLLoCation Balanced ..................................... Changing the mix at willConservative Strategy ........................ Nothing but bondsModerate Strategy............................... Tracking an indexAggressive Strategy ............. Here, there and everywhereTotal Return ..............................New and improved flavor

Sweet indULgenCe: SPeCiaLtyTechnology ......................................... Extra hot and spicyHealthcare ........................ Prepared with low sodium saltEnergy...........................................At today’s market priceCommodities .............. Gold, potash, oils and orange juiceGold ...........................Ask your wait-person for availability

OLD CLASSICS NEW FAVORITES

This chart is for illustrative purposes only.


Lining Up For The Long Term

Our considered opinion is that the fund line-up is a powerful expression of possibility.

variations on this theme meander ad infinitum. Over the last several years, target date funds have unfurled their ban-ners. For investors and plan sponsors alike, the TDF solution—whether de-signed to help investors ‘to’ retirement or ‘through’ retirement, addresses the management of age-based risk and di-versification. Our considered opinion is that the fund line-up is a powerful expression of possibility. Plan sponsors who de-vote their investment focus to their DB plan, for example, would be well advised to apply a similar concentra-tion to the diversification and quality of product offered in the 401(k). Regu-larly parsing the line-up with respect to manager tenure, risk-adjusted per-formance against benchmarks (not simply against the peer universe), as-set strategy diversification including international and global, would be a profoundly helpful anchor to any re-tirement program protocol.

minimizing potential pain. When we ask plan sponsors how well they un-derstand all their investment offerings, the responses range from ‘quite well’ to ‘we need to review our plan, but we have other pressing concerns.’ A plan that has gone unevaluated for too long, acquiring more funds, more solutions without disengaging from those that have not fulfilled their in-vestment goals is not an uncommon phenomenon on the defined contribu-tion landscape.

Too many funds. Too many funds that purport to do the same thing.

Too many funds that purport to do the same thing but in truth have veered mightily from their objectives. Too many funds that have veered from their objectives and taken on too much risk but have not been properly re-calibrated for the participant—the

ovER THE laST dEcadES, what has distinguished DC plans from their DB plan brethren appears to reflect the public’s infatuation with all things growth-y and tech-y. DC fund line-ups gained weight in the upper reaches of the risk / reward spectrum taking on new strategies in technology, sector-specific and aggres-sive growth funds. Hot dot ‘theme’ funds and brand-name boutiques found their way onto the 401(k) roster. The vox populi cried out for more and many plan sponsors acquiesced. DC plans were trumpeted as the re-cruiter’s best friend. Underground blog communities rabidly parsed the compet-ing offers of employers’ 401(k) offerings. Company matches, fund transfers and open brokerage windows played a cen-tral role in how a firm’s ‘friendliness’, let alone desirability, was evaluated. As every American was acquiring financial IQ points in her/his ability to evaluate a Morningstar rating or style box one-pag-er, every American seemed to be forget-ting that there’s traditionally an inverse correlation between gain and pain. Risk is the pesky conscience that

haunts the mind of the participant as she decides to invest in exotic, can’t-miss niche strategies. But risk is per-haps the least understood dimension of the DC fund selection process. Diversi-fication is not only a key toward maxi-mizing potential gain, but also toward


O F T H E 22% O F P A R T I C I P A N T S I N V E S T E D

I N T A R G E T D A T E S T R A T E G I E S , N E A R L Y H A L F

(49%) W E R E D E F A U L T E D I N T O T H E M . 1

More defaulted (than non defaulted)

participants remain in a plan three years

after retirement: 22% for defaulted

participants, 19%

for the broader

participant

population.1

The average participant withdraws over

Defaulted participants generally have lower salaries.1

On average, defaulted participant contribution rates start more slowly and increase more slowly than the broader participant universe.1

While our data suggests that there were no changes to contribution rates in 2007, there were

notable declines in 2008: Initial contribution levels of those 20-25 years of age fell, on average,

to 5.7% from 6% in the 2001–2006 period. • The average time period to reach 8%

stretched five years, from age 40 in the original data to age 45.5. • The average time period

to reach 10% increased two years, from age 55 in 2006 to age 57 in 2008.2

per year at or soon after retirement.2

of participants borrow, on average, 25% of account balance.2

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J.P. Morgan Retirement Plan Services LLC P.O. Box 219300 Kansas City, MO 64121—9300

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