Retirement Plans’ Rocky 2020…and Where Investors Go from Here

Episode Summary

Executive Summary: The episode examines how COVID-19 and market volatility affected defined benefit and defined contribution retirement plans in 2020. Mike Moran explains that low rates depressed pension funded ratios, while DC participants saw modest gains but often stayed defensive. The discussion emphasizes long-term investing, contribution needs, risk re-evaluation, and the growing demand for retirement income solutions.

Main Topics: 2020 Market Volatility and Retirement Plans (Priority: 5/5): The conversation opens with how the pandemic-driven selloff and rebound created a difficult year for retirement assets, though these plans should be viewed through a long-term lens. Defined Benefit Funded Ratios and Liability Pressure (Priority: 5/5): DB plans saw funded ratios weaken mainly because low interest rates increased liability values and some plans were cash-flow negative, intensifying funding pressure. Portfolio Responses by DB Plans (Priority: 4/5): Plans responded by rebalancing back to strategic targets, adjusting fixed income exposures, and in some cases pursuing opportunistic or distressed strategies. Defined Contribution Outcomes and Participant Behavior (Priority: 5/5): DC participants generally experienced modest positive returns, but many self-directed investors sold equities during volatility and did not fully re-enter the market afterward. Target Date Funds and Managed Accounts (Priority: 4/5): Growth in professionally managed default options reduced participant trading and helped explain why most 401(k) savers made few changes during the year. Retirement Income and Demographic Challenges (Priority: 5/5): As plan populations age, both DB and DC assets are increasingly in distribution mode, raising the importance of managing outflows and offering lifetime income solutions. Post-Election and Forward-Looking Strategy (Priority: 4/5): With potential election-related volatility and an expected low-return environment, investors are urged to stay disciplined, reassess risk, and adapt asset allocation and contribution assumptions.

Key Arguments: Retirement plans are long-term pools of capital, so short-term market swings should not drive wholesale strategy changes. DB funded ratios fell largely because liabilities rose as interest rates declined, even though equity markets recovered. Public pension liability assumptions also moved lower as expected long-term returns were revised down in a low-rate world. Many DB plans are cash-flow negative, so benefit payments reduce asset and liability dollars equally but can still lower funded percentages. Most DB plans rebalanced in the spring, which proved prudent given the equity rebound. Some plans added credit exposure and reduced duration risk after spreads widened and Treasury yields fell. A subset of plans used market dislocations to pursue distressed or other opportunistic strategies. DC target date funds and managed accounts helped keep most participants from trading aggressively during the volatility. Self-directed DC investors tended to sell equities and move to stable value or money market funds, but many did not buy back into equities later. The low-return environment implies that many sponsors may need to increase contributions and/or change asset allocation to meet future obligations. Aging participants and the shift into distribution mode make retirement income solutions increasingly important. A standard 60/40 portfolio may only deliver about 4% to 5% nominal returns going forward, so investors may need alternatives or active management. Risk tolerance should be re-examined, especially for those near retirement or with portfolios that became too equity-heavy.

Data Points: Target date fund share of 401(k) assets: Over 30% - Mike Moran said target date funds now account for more than 30% of 401(k) plan assets. Typical DB nominal return assumption: Around 6% to 8% - Many DB plans still use long-term expected return assumptions in this range despite lower market rates. 10-year Treasury yield: Around 70 basis points - Used to illustrate how difficult it is to meet return targets in a low-rate environment. Target date fund returns through first three quarters of 2020: Low single digits - Proxy for DC plan performance during 2020. Standard 60/40 portfolio expected nominal return: Around 4% to 5% - Moran suggested this may be the likely forward return range in the foreseeable future.

Pivotal Quotes: "these are long-term investors. They have pools of capital on the defined benefit side that will be paid out over many decades." — Mike Moran: Explaining why retirement investors should not overreact to short-term volatility. "low interest rates are not your friend." — Mike Moran: Describing why DB liabilities rose even as equity markets recovered. "the vast majority of participants really didn't do anything. And that's probably a good thing" — Mike Moran: Discussing DC participant behavior during 2020 market volatility.

Implications: Retirement investors should stay disciplined, reassess risk and savings needs, and prepare for lower expected returns. Sponsors may need higher contributions, while DC participants increasingly need managed solutions and retirement income options.