DB Benefit Payments Continue to Stimulate Economy

July 30, 2014 (PLANSPONSOR.com) – The $476.8 billion in public and private defined benefit (DB) pension plan payments in 2012 supported $943.3 billion dollars in overall economic output in the national economy, an analysis finds.

Though this is less than the more than $1 trillion in economic output measured by the previous biennial study by the National Institute on Retirement Security (NIRS), it is roughly equivalent to the total output contributed by the entire transportation and warehousing industry, which generated $965.2 billion in total output in the national economy in 2012. According to the NIRS report, “Pensionomics 2014: Measuring the Economic Impact of Defined Benefit Pension Expenditures,” in terms of benefit source, $451.7 billion in economic activity stemmed from state and local pension benefit expenditures, $144.2 billion from federal pension expenditures, and $347.3 billion from private pension benefit expenditures.

Nearly $477 billion in pension benefits were paid to 24 million retired Americans, including $228.5 billion paid to about nine million retired employees of state and local government and their beneficiaries (typically surviving spouses); $70.7 billion paid to about 2.5 million federal government retirees and beneficiaries; and $175.6 billion paid to about 12.7 million private sector retirees and beneficiaries. 

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Expenditures made out of those payments collectively supported:

  • 6.2 million American jobs that paid nearly $307 billion in labor income;
  • $943 billion in total economic output nationwide;
  • $555 billion in value added (GDP); and
  • $135 billion in federal, state, and local tax revenue.

Each dollar paid out in pension benefits supported $1.98 in total economic output nationally, and each taxpayer dollar contributed to state and local pensions supported $8.06 in total output nationally, the analysis found. This represents the leverage afforded by robust long-term investment returns and shared funding responsibility by employers and employees.

The largest employment impacts occurred in the food services, real estate, health care, and retail trade sectors.

Nari Rhee, Ph.D., NIRS manager of research, and author of the study report, explains that when a retiree receives a pension benefit payment, s/he spends the pension check on goods and services in the local community. S/he purchases food, clothing, and medicine at local stores, and may even make larger purchases like a car or laptop computer. These purchases, combined with those of other retirees with pensions, create a steady economic ripple effect. In short, pension spending supports the economy and supports jobs where retirees reside and spend their benefits.

“Additionally, reliable pension income can be especially important not only in providing retirees with peace of mind, but in stabilizing local economies during economic downturns. Retirees with DB pensions know they are receiving a steady check despite economic conditions. In contrast, retirees may be reluctant to spend out of their 401(k)-type accounts if their savings are negatively impacted by market downturns. To the extent that DB pensions provide retirees with steady income available for spending regardless of fluctuations in the stock market, DB pensions may play a stabilizing role in the economy like Social Security,” Rhee writes.

This study analyzes data on DB pension plans in both the public and private sectors to assess the overall national economic impact of benefits paid by these plans to retirees. For state and local government pension plans, the study also analyzes these impacts at the state level for each of the 50 states and the District of Columbia.

The full report and state fact sheets can be accessed from here.

ETF Adoption Driven by Goals Investing

July 30, 2014 (PLANSPONSOR.com) – Interest in specific investment outcomes is likely to drive continued institutional exchange-traded fund (ETF) adoption, according to Cerulli Associates.

Investment managers that take the approach of acting as a tactical manager and show institutions various ways that they can incorporate ETFs into their asset-allocation models are seeing the most demand from institutional plan sponsors, the research suggests. One ETF strategist with whom Cerulli spoke stated smaller-sized corporate defined benefit (DB) plans appear to be especially interested in strategic ETF investing—usually because these plans may not be large enough for an efficient separate account structure.

The Cerulli analysis, presented within the July issue of “The Cerulli Edge – U.S. Monthly Product Trends,” suggests that ETFs may be poised for a “second act,” in which the vehicles are used to build complete investing solutions. Today the products are more often used as individual building blocks to complement mutual fund-dominated portfolios, the analysis shows.

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“This view makes sense because the dominant ETF sponsors—BlackRock, SSgA and Vanguard—have covered just about every imaginable index and market sector in an arms race of fee competition,” Cerulli researchers say. “Future innovation, and future growth, will not come from these core building blocks.”

Another ETF provider told Cerulli that institutional use of so-called “smart beta” or “strategic beta” strategies will be a key driver of institutional asset management mandates over the next three years and that exposure will likely come increasingly via ETFs (see “Institutions Like Smart Beta”). As Cerulli explains, strategic beta strategies are a hybrid between passive and active management whereby the investor is targeting new market exposures via different risk factors such as size, momentum, volatility and many others.

Although still a relatively small portion of overall ETF assets, at $360 billion as of June 2014, strategic beta ETFs garnered about $20 billion in net inflows year-to-date in 2014, according to the most recent data available from Morningstar. There are 342 strategic beta ETFs in the market today, Cerulli says, up from none 10 years ago. Much of the assets in existing solutions-based ETFs are found in non-market-cap-weighted ETFs—i.e. those taking a strategic beta approach. 

The analysis also reveals that institutional investors employ ETFs far less than retail investors in general. However, institutions such as endowments and foundations are reported to be significant users of ETFs.

Looking to the wider investment marketplace, both mutual fund and ETF assets continue to grow steadily, at respective rates of 3.1% and 0.9% from May to June 2014, Cerulli says. Taxable bond mutual funds have the highest flows year-to-date and achieved $10.5 billion in June alone. European stock, foreign large blend, and real estate ETF categories gathered the most year-to-date flows as of June, Cerulli says.

Cerulli’s analysis cites BlackRock research predicting the global ETF industry will grow to $3.6 trillion by 2017, partially driven by institutional solutions, as institutional investors look for more efficient fixed-income trading or a cheaper alternative to derivatives such as futures and swaps. As Cerulli observes, the growth in institutional ETF use has occurred over the past few years in concert with the growth in specialized fixed-income ETFs.

More than 70 new fixed-income ETFs launched in the past two years, the analysis shows. After years of low interest rates and the potential for rising rates in the near future, institutions are pursuing risk factor exposures such as shorter duration or credit in fixed-income portfolios. They are also using ETFs to move from long duration to short duration, and from longer term high-yield to floating-rate securities, as well as low-duration ETFs, Cerulli says.

One ETF strategist told Cerulli that they are targeting smaller institutions with tactical ETF portfolios designed to be representative of the institution’s unique business needs. One example is an ETF solution aimed for a smaller corporate pension plan that does not have the resources to do a thorough asset-liability analysis on its own. In another example, in BlackRock’s last investor day presentation, the company cited a case study of a large endowment client seeking to diversify interest rate risk in their fixed-income portfolio while not raising correlation to equities, which would be inconsistent with the client’s objectives.

More information on how to obtain a full copy of “The Cerulli Edge - U.S. Monthly Product Trends” is available here.

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