RETIREMENT INSIGHTS

3 myths about sustainability and DC

BlackRock |Feb 20, 2020

Volatility is a fact of investing life – but market turmoil on the scale we’ve seen this week can raise concerns among even the most battle-hardened investors about long-term market trends and impacts.

The BlackRock Investment institute has provided useful perspective in Market plunge: This is not 2008, but we want to share three action steps that plan sponsors may want to consider:

Action 1: Speak to your participants!

It’s a good bet that participants are worried – especially those without a great deal of investment experience. Fears about the coronavirus, which is at least partly responsible for the market jitters, may compound their uncertainty.

Reaching out proactively may help prevent nervous participants from making damaging mistakes by pulling out of the market. Per the Alright Solutions 410(k) Index, the final week of this this past February was one of the busiest five-day stretches in the 20-plus year history of the index.

Here are talking points you may want to consider:

  1. Reassure participants invested in a target date fund or similar qualified default investment alternative (QDIA) that it is designed for the long-term with periods of market volatility in mind.
  2. Remind participants in target date funds that they are designed to provide age-appropriate exposure, with reduced exposure to equities for older and retired participants.
  3. Pulling out of the market and missing a potential rebound can be costly. There are a number of ways to illustrate this, but the following chart makes a good case.
Potential rebound can be costly

 

Sources: BlackRock; Bloomberg, Morningstar as of 2/28/20.
Staying in the market means being invested for the worst days – and the best, which very often occur not long after steep selloffs. In fact, over the last 20 years, 24 of the 25 worst trading days were within one moth of the 25 best trading days. (Sources: BlackRock and Bloomberg.)

The following table illustrate that performance after selloffs is often very strong:

12-month performance following major declines

S&P 500 biggest declinesBlack Monday 8/25/87 – 12/4/87Gulf War 7/16/90-10/11/90Asia Monetary Crisis 17/1798-9/31/98Tech Bubble 3/27/00 – 10/9/02Financial Crisis 10/9/07 – 3/9/09US Credit Downgrade 3/10/11 – 10/3/11Trade War 10/3/18 -12/24/18
% decline -33.5% -19.9% -19.3% -49.0% -56.8% -19.0% -19.6%
Next 12 months +21.4% +29.1% +37.9% +33.7% +68.6% +32.0% +37.1%

Source: Morningstar as of 2/28/20. Returns are principal only not including dividends. U.S. stocks represented by the S&P 500 Index. Past performance does not guarantee or indicate future results. Index performance is for illustrative purposes only. You can’t invest directly in an index.

Retreating to the sidelines after a loss and sitting through a rebound may mean locking in losses. Even for professionals, correctly timing the markets is extremely difficult to do.

Action 2: Keep the whole lifecycle in view

Short-term market events can block our vision of the long-term. The purpose of a defined contribution plan remains the same, regardless of the age of a participant: to grow their savings enough to support their lifestyle after the paychecks stop.

Yet while the goal is the same for all participants, their needs depend on where they are in their career. Participants in, or near, retirement want market growth to help fund potentially decades of retirement, but they also want to mitigate losses that could derail their retirement plans or spending. Younger participants have more time to recover from volatility – and more time to contribute savings.

LifePath target date funds are designed with a heterogeneous participant population in mind. The chart for the LifePath Index Mutual Fund shows year-to-date and five-year performance for each target year.  And while there is no guarantee that this will always be the case, so far this year the objective of mitigating the downside for retirees has performed as designed:

LifePath Index Mutual Fund Performance

LifePath Index Mutual Fund Performance

 

Source: Morningstar Direct, as of 10 March 2020. Data shown is for the BlackRock LifePath Index Mutual Fund series – K share class. Returns of less than one year are unannualized. Returns are based on monthly net-of-fee returns. Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. Refer to www.blackrock.com to obtain current month-end performance. Investment returns reflect total fund operating expenses, net of all fees, waivers and/or expense reimbursement. Total annual fund operating expenses, and net annual fund operating expenses including investment related expenses (total / net) as stated in the Funds’ most recent prospectus are: Retirement – 0.16% / 0.10%, 2020 - 0.15% / 0.10%, 2025 - 0.16% / 0.10%, 2030 - 0.15% / 0.10%, 2035 - 0.17% / 0.10%, 2040 - 0.17% / 0.10%, 2045 - 0.19% / 0.10%, 2050 - 0.18% / 0.10%, 2055 - 0.20% / 0.09%, 2060 - 0.37% / 0.10%. The Funds’ net annual operating expenses take into account fees which BlackRock has agreed to waive voluntarily. BlackRock may discontinue these voluntarily waivers at any time without notice.

Action 3: Respond to volatility before it happens

Whatever your view on the current volatility, we expect participants to face bulls and bears throughout their career and retirement. We can’t say when, but we will see severe volatility again. Now is the time to prepare for the next round by considering the following questions:

  • How well do you know your participants?
    How they respond to volatility may be more important than the volatility itself. Take a look at asset flows to get a sense of how participants reacted. If necessary, develop a participant communication protocol so that you’re ready the next time.
  • Do you know how your participants are invested?
    A well-diversified, age appropriate QDIA can only benefit participants who are invested in them. Allocations for many participants may have greater risk exposure than you may assume.
  • How will your portfolios hold up?
    Stress test your current QDIA or target date fund to various market scenarios. Pay particular attention to fixed-income exposures: are they providing ballast for equities, or does credit exposure compound equity-like risk?
  • Have you developed a long-range forecast?
    Either independently or by working with your provider, explore long-term market expectations and consider their impact on participant retirement outcomes. BlackRock plan design analytics can help you review changes in the investment allocation or plan design enhancements to help identify potential improvements or exposures.

Speak to your BlackRock representative if you want to explore any of these issues.

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Sustainable investing is not about feelings; it is about being aware of increasingly critical investment analytics.

Myth #2: “The DOL has put up too many hurdles”

While Department of Labor (DOL) guidance has stated that sustainability cannot be the primary consideration when choosing investment options, it can be used as a “tiebreaker” between essentially similar options.

Fortunately, that hurdle may have become easier to clear as advanced data, more efficient implementations, and increased scale have improved results. The following charts compare returns for US, global, and emerging market indexes against alternatives that tilt the index’s exposure to favor companies with stronger ESG scores.

US large and mid-cap equities

US large and mid-cap equities

 

Source: Bloomberg Index Data

Global large and mid-cap (non-US) equities

Global large and mid-cap (non-US) equities

 

Source: Bloomberg Index Data

Emerging markets large and mid-cap equities

Emerging markets

 

Source: Bloomberg Index Data

As can be seen, ESG Indexes have performed at parity, or in some cases more strongly, than the parent indexes.

Myth #3: “Sustainable options are limited to specialty strategies"

In his CEO letter, Larry Fink stated, “We believe that sustainability should be our new standard for investing.” If, as we believe, sustainability is increasingly important for identifying critical risks and return opportunities, it would be poor fiduciary practice on our part to limit sustainable implementations to specialized options.

Fortunately, there are a number of ways to include sustainability objectives in investment analysis, ranging from the broadest applications to the highly focused. They include:

  • Baseline screens: They are designed to exclude companies or industries associated with specific activities. They can be applied to an index or a primary screen for an active manager.
  • ESG optimizations: Similar to the ESG Indexes in the charts above, a parent index can be weighted to favor companies with positive environmental, social, and/or governance ratings.
  • Thematic trends: Investment strategies may attempt to capitalize on specific transformative sectors, such as sustainable energy or transportation, that are expected to benefit from long-term sustainability-related trends.

At an even more basic level, as research into sustainable investing grows, as more and more investors move into the space, and as improved data becomes available, sustainability factors will increasingly sit alongside traditional investment metrics.

Sustainability and retirement investing

One final point on why DC plan sponsors should look at sustainable options: Risk and return drivers captured through the sustainability lens are quite often very long term. We’ve mentioned the challenge of pricing climate risk for mortgages and infrastructure bonds, and the potential of some transformative industries.

These long-range exposures and opportunities are aligned with the time horizons for the average participant. A 30-year-old participant may expect to be invested in their workplace retirement plan for 50 or 60 years. It is highly possible – even likely – that sustainable investment themes will affect their journey – and possibly their outcomes. That’s why we believe the time is now to take action to protect the future that participants are saving for.

Please contact your BlackRock relationship manager to learn more about our sustainable investment options.

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