Retirement Investors Should Diversify Fixed Income

April 29, 2014 (PLANSPONSOR.com) – For the past 30 years, investors, including retirement plan sponsors and participants, have found comfort in fixed-income investments.

Bond rates have had a more than 30-year bull run, and fixed income has not only protected investors capital, it has made them money, explained Andres Garcia-Amaya, vice president and global market strategist at J.P. Morgan Asset Management. However, he told attendees of the 43nd Annual Retirement & Benefits Management Seminar, hosted by the Darla Moore School of Management at the University of South Carolina, and co-sponsored by PLANSPONSOR, things are set to change, and investors need to diversify their fixed-income holdings.

Bond rates are set to rise after the bull run, so it is important to diversify within fixed-income portfolios from just U.S. bond funds, Garcia-Amaya suggested. Portfolios should include high-yield bonds, floating rate loans, and asset-backed securities, for example.

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He recommended investors also diversify globally. A J.P. Morgan analysis showed for the last year, a 10-year U.S. Treasury bond lost investors 2%, but if they had a 10-year German bond, they would have gained 2.6%. Garcia-Amaya showed the Congressional Budget Office (CBO) analysis of the 2014 Federal Budget forecasts borrowing will comprise 15% of financing. He said the government will probably do more to encourage banks to loan, interest rates will rise, and banks will loan more, getting things going so interest rates are likely to continue to rise—another reason to diversify fixed income.

Garcia-Amaya noted the economy did not bounce back after the 2008 to 2009 recession the way it historically has after other recessions. This is because consumption—the biggest component of the gross national product (GDP)—was hit hardest during the last recession, he explained.

He noted that housing, especially, was one of the hardest-hit assets of the last recession. However, it is expected things will get better, he said, adding that for the middle class, their biggest asset is their home, and the federal government’s work on the housing market will improve the net worth of the biggest segment of individuals. So, consumption will improve, but Garcia-Amaya does not expect equities to have as good a run as they have in the past five years.

He said companies’ price to earnings ratio (the amount investors are willing to pay for earnings) has bounced back to historical averages, which will keep stock returns from reaching double digits. “Going forward, we expect less returns and more volatility,” he said.

He recommended investors also diversify their equity assets globally. He pointed out 49% of stocks in the world are U.S. stocks, but this means 51% are not. “This doesn’t match the typical [retirement plan] participant’s portfolio,” he noted. He conceded that U.S. investors invests in dollars, so they do want their majority of assets to be invested in the same currency, but Europe’s growth is expected to accelerate in the next three to five years.

The bottom line, according to Garcia-Amaya is to diversify, but stay balanced and rebalance.

CalPERS Reduces Investment-Related Costs

April 29, 2014 (PLANSPONSOR.com) – The California Public Employees’ Retirement System (CalPERS) has been able to significantly reduce the costs for its investment operations over the past two fiscal years.

CalPERS recently underwent a CEM Benchmarking Survey, for comparison against peers in the retirement industry, which found that for fiscal year 2011 to 2012 and fiscal year 2012 to 2013, CalPERS reduced its investment-related costs by about $80 million. (CEM is an independent provider of objective benchmarking information.) The findings show the main factors contributing to this reduction were reducing external management fees and the number of external consultants, as well as the insourcing of various management functions.

In addition, the CEM survey found the actual cost of running the CalPERS investment program is 53.5 basis points less the benchmark cost of 59.2 basis points due to CalPERS’ internal management of public assets, passive management of equities, and its lesser use of fund-of-funds compared with its peers.

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Wylie A. Tollette, chief operating investment officer for CalPERS, spoke about the reduction efforts at a recent CalPERS Investment Committee meeting. He said CalPERS internally manages 86% ($189 billion) of its public market assets, which are 67% of the total plan assets. He pointed out that while internal management drives lower total costs, the tradeoff is that more internal staff is required. Tollette said the CalPERS Investment Office is working to reduce reliance on external consultants and advisers, using them only when capabilities such as scale or technology or expertise cannot be replicated internally at a reasonable cost.

Tollette also outlined some steps for reducing costs in the area of fees, specifically external management fees paid on private fund assets (e.g., private equity, real estate, etc.):

  • Shift away from fund-of-funds vehicles to direct relationships;
  • Scale asset management fees;
  • Consolidate portfolio across fewer relationships to gain pricing leverage;
  • Negotiate favorable terms on fees with new commitments; and
  • Increases focus on co-investment opportunities that have no carry fees.
“CalPERS has gone to great lengths to understand the role of costs in its portfolio and how best to mitigate their impact,” says Henry Jones, a CalPERS board member and chair of its Investment Committee, based in Sacramento, California. “It’s nice to see positive results from our efforts.”Tollette said the ongoing aim of the CalPERS Investment Office is to “enhance the cost-effectiveness of our investment program to improve net returns on assets.” He said there are several areas where this can and has been done, including:
  • Management Reporting: Transitioning from inadequate reporting and data to an automated financial reporting system, as well as the development of timely and meaningful financial reports.
  • Cost Awareness: Transitioning from a limited understanding of the total cost to manage the CalPERS portfolio to a comprehensive knowledge of these total costs.
  • Fee Reduction: Transitioning from an insufficient focus on management and consulting fees paid to the development of monitoring processes that track and communicate cost-saving efforts.
  • Cost Management: Transitioning from a budget process that encouraged the use of external managers and consultants to greater flexibility to manage use of external versus internal resources in the best interest of the fund.
  • Benchmarking: Transitioning from difficulties in comparing cost performance against relevant peers to the development of meaningful benchmarking statistics and outperforming relevant peers per unit of value.

“CalPERS has gone to great lengths to understand the role of costs in its portfolio and how best to mitigate their impact,” says Henry Jones, a CalPERS board member and chair of its Investment Committee, based in Sacramento, California. “It’s nice to see positive results from our efforts.”

More information about CalPERS efforts to reduce costs can be found here.

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