Lessons for Plan Sponsors from the Market Volatility

For the most part, during the August 19 through August 25 market dive, most broad equity asset classes—U.S. stock, emerging markets, real estate, etc.—took big hits, notes Rod Greenshields, consulting director at Russell Investments in Seattle.

But, while these asset classes were seeing losses from 7% to 11%, the Barclays Aggregate Bond Index was up 0.1%, he notes. “This reinforces why you have bonds. Plan sponsors have been questioning bonds, with expected interest rate increases, but the volatility in recent weeks shows why they need bonds,” Greenshields tells PLANSPONSOR.

Joe Halpern, CEO of Exceed Investments in New York City, adds that the equity products that have fared better during the recent market swings are the ones that look to provide some downside protection, by being tactical or having a hedge in place. “A few products in the market have done that and been able to reduce the pain by having less downside,” he says.

According to Greenshields, strategies that have held up best do not sell when the market swings down—not selling in the short-term is the best strategy.

But, why certain investments hold up better is not same for all scenarios, he says. “For the recent period, so much of equity volatility seems to stem from people’s concerns over China and the ripple effect it would have over our economy. But, the people looking at the U.S. economy saw a disconnect from those fears. Unemployment numbers and sales numbers weren’t showing a recession would follow.”

Greenshields notes that these spurts of major market volatility have happened pretty regularly historically, but it hasn’t happened in a while, and people tend to react more when that is the case.

Halpern tells PLANSPONSOR now is a great opportunity for plan sponsors and their advisers to reassess what they have in their retirement plan portfolios. Over the past few years, there has been innovation in investments, looking for ways to protect during downturns and diversify when market shake-ups happen. 

“This is a good opportunity to look around to see some of products that are faring well and what makes sense to incorporate into portfolios. A market upheaval allows you to gauge managers and how certain products perform in the market,” he says. “It comes down to two questions: What do I need to do to the portfolio to prepare for further volatility; and what can plan participants deal with, afford and handle behaviorally?”

Halpern says the problem with some products is they have no exposure to the market and only provide safety on the downside, so they are not taking much risk and don’t have good exposure during the upside. “What we focus on is defined outcome investing. We provide a level of definition to the downside and to the exposure on the upside, so the end user understands risk/reward,” he says.

Exceed Investments co-launched a suite of three indexes with the NASDAQ last September that provide defined exposures to the S&P 500. Exceed’s first fund, SHIIX, is a defined outcomes product focused specifically on income generation and wealth preservation. SHIIX, which follows one of the indexes, seeks to provide a floor on loses to 12.5% and upside gain limited to a target of 15%.

According to Halpern, Exceed did back testing and analysis back to 2001 which shows, in 2008, when the market was down 38%, the product was down only 11%. In 2013, when the market was up 32%, the product was up more than 13%. More recently, Halpern shares, at the end of August, the product was down 7%, but the market was down 12%.

Plan sponsors and advisers cannot control the market, but they have control over setting up diverse investment options in retirement plans, Greenshields says.

“Equities are more interesting to people, so they get more headline news. People like to talk about stocks, and bonds are boring in comparison,” he notes. “One result of this is that plans have many more investments available to access slices of the equity market, but maybe have only one or two bond funds.”

He points out that if participants are told not to put all their money in one basket, they will look at what baskets are offered, and they tend to spread their money evenly among those choices. “Some investors may put too much in stock funds simply because there are more of them in the plan.”

Greenshields notes that the entire universe of fixed-income investments is large in number and large in dollar. He suggests plan sponsors align that with the number of fund options in their plans. He points out that in a “balanced” fund, 40% is primarily in U.S. bonds, while the 60% of equity is sliced up among different types.

According to Greenshields, Russell Investments is a big proponent of risk-based and target-date funds in defined contribution (DC) retirement plans because they insulate participants against behavioral biases. “Good plan design is the best thing to counteract market challenges,” he says.

“While its good [for plan sponsors and advisers] to look at how investments are doing in the short term, they need to think about the overall time horizon, because that’s when participants get the benefits of investments—over the long-term,” Greenshields concludes.