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Our story starts with a former Eagle Scout known as Barber. While his name had absolutely nothing to do with his ultimate professional calling, Barber Conable did, perhaps unwittingly, become the Sweeney Todd of the defined benefit plan.
Barber Conable lived a noble life and eventually found himself as the top Republican on the powerful House Ways and Means Committee in the late 1970’s. His district was Upstate New York, home to the likes of Eastman Kodak and Xerox, the corporate power brokers of that time. It turns out that the senior executives at those companies were looking to find a way to invest their deferred compensation in the equity markets while avoiding all taxes until actual receipt of the proceeds. As a solution for a few fat-cats, an obscure section numbered 401(k) was appended to the Revenue Act of 1978 and therein began the death knell of the paternalistic defined benefit plan.
Today, very few workers are covered by a defined benefit plan. They are mostly the province of public pension plans, collectively bargained union contracts, and pay-as-you-go sovereign promises that will all someday need a CARES Act bailout of their own (filed under SOS). It only took until the mid-1990’s for the majority of the workforce to be covered by self-funded 401(k) retirement plans for the first time, and that dominance has only grown over the last several decades. We have handed off the twin complexities of investment and longevity risk absent any accountability or responsibility as to how this might end.
This backdrop provides the perfect segue and call to action that are the underpinnings of CAIA Association’s The Next Decade of Alternative Investments: From Adolescence to Responsible Citizenship. Managing risk is a very complex task especially when the risk-free rate is set at zero, destroying the power of compounding even before contemplating inflation. The ability to take said risk is a function of age which can take on many forms, including the risk tolerance (or lack thereof) of a 65 year old retiree who could potentially live for another 30+ years, where products based on long-term outcomes are lacking in so many ways.
Think about the gray matter under the atrophying defined benefit scheme: a very sophisticated CIO investor office, long on credentials like CAIA, CFA and PhD; a smart pension consultant replete with a team of actuaries in the learned middle, and the triumvirate was rounded out with the asset manager offering access to all types of product across the entirety of the risk premia spectrum. How is it possibly acceptable to take all of these complexities, enveloped in such a sophisticated brain-trust, and dump them on the lap of Jane Q. Public and simply walk away in the hope that it will end well?
Our piece calls for all of us to take back part of the narrative and some of the responsibility beginning with education. We must approach every investor with informed consent and a commitment to help them understand and navigate a dizzying array of product offerings. Transparency must always be front and center and we need to recognize and resolve the agency problem so eloquently brought forward by the late Jack Bogle. Your client will be increasingly less sophisticated and will need your professional advice. Do not ever allow yourself to take advantage of that situation.
The final two calls-to-action really come back to the basics of a sound investment plan focused on diversification, which can only occur with fair and unfettered democratization of portfolio solutions. As markets become more efficient, the former becomes more elusive, especially when one is looking to find the pure beta exposure with often an alpha expectation/fee sitting on top. The recent movement by some global regulators to provide greater access to the private markets, especially at a time when that has become the new home for capital formation, must be very carefully embraced via the aforementioned education and transparency.
Our great industry will never become a respected profession unless we embrace this four-point call to action. The stakes are high, and it is the very neck of sound retirement outcomes that we have laid bare to our own version of an evil barber from Fleet Street. Let’s take back that narrative and put our clients first.
Seek diversification, education and know your risk tolerance. Investing is for the long term.
I'm wondering when employees can use their "401k" money to invest where and with whom they want versus the plans laid out by their employers, including an opportunity to invest in income producing real estate.
CEO of CREATE
4 年Thanks, Bill, for this insightful piece. You are right to focus on financial education. It remains the weakest link in the DC space. Across the OECD, the winds of change continue to shift all the retirement risks from employer to employee, seeing the employee as a ‘retirement planner’: a proactive individual capable of accessing the right information, making the right decision, monitoring the outcomes and doing the necessary course correction. The UK’s pension freedoms rest on this caricature. Yet, it is at odds with reality, as revealed in a multi-country study by the State Street Centre for Applied Research. Individual investors scored barely a ‘D’ grade in a financial literacy test in all the advanced societies. ? Nearly half of them didn’t know the annual return on their investments. Nearly 65 per cent didn’t know the fees they were changed “because it’s too difficult to calculate/find out”.? Other studies show that many are quick to invest in top-performing funds and are just as fast to offload when performance falters. They often over-rate their own ability, rely on the wisdom of the crowd and follow the path of least resistance.? In hindsight, risk has been transferred from those who were unable to manage it to those who don’t understand it. Yet, their retirement narrative remains one of high expectations and low preparation.?? Education may not necessarily guarantee better outcomes. but it can serve to narrow the gap.