Journey - J.P. Morgan Home | J.P. Morgan · Retirement Plan Business, shares her views on the growth of the segment and on small- to mid-sized business owners’ needs and priorities

PLUS> A Word

Michael Falcon, Head of Retirement, J.P. Morgan Asset Management

> Stat LifeInflation hurdle is higher in retirement

> Legislative CornerPension plans and deficit reduction

> Executive Perspective Julia Bates, Managing Director, J.P. Morgan

Small- to Mid-Market Retirement Plan Business

JourneyRetirement Insights and Solutions from J.P. Morgan Asset Management

ISSUE 8FALL 2012

16 Best PracticesA conversation with ITT’s Director of Global Benefits and Wellness Programs

6 Speaking InvestmentsStriving for better investment outcomes

13 Plan Design StrategyA research-based framework that can help plan sponsors achieve plan goals

22 Managing Inflation Risk in RetirementImportant considerations for protecting retirement assets

The J.P. Morgan Retirement Symposium: Converging Forces was a two-day event held in New York City that brought together more than 100 prominent industry leaders from across government, academia and business to discuss the cultural, political and economic forces impacting retirement.

Guest speakers included the Right Honourable Tony Blair, former prime minister of Great Britain and Northern Ireland; Peter G. Peterson, founder and chairman of the Peter G. Peterson Foundation; and Jamie Dimon, Chairman and Chief Executive Officer, J.P. Morgan Chase & Co.

A C O L L E C T I O N O F I N S I G H T S A N D P E R S P E C T I V E S

The compendium book “Observations and Thoughts from the 2012 J.P. Morgan Retirement Symposium: Converging Forces” offers event highlights and summaries from key sessions that explore a broad range of retirement-related issues, including plan design trends and best practices, legislative and regulatory retirement policy, individual behavior, retirement product innovation, defined contribution participant communication and savings history and culture in America.

Visit www.jpmretirementsymposium.com to view a digital copy of the book and other event materials. To request a hard copy, contact your J.P. Morgan representative or email us at [email protected].

O b s e r v a t i o n s a n d T h o u g h t s

F r o m t h e

2 0 1 2 J . P . M O r g a n r e T i r e M e n T S y M P O S i u M :

C O n v e r g i n g F O r C e S

J.P. Morgan holds inaugural Retirement Symposium

Top from left to right: Mary Callahan Erdoes, Chief Executive Officer, J.P. Morgan Asset Management; Dr. David Kelly, Chief Global Strategist, J.P. Morgan Funds; the Right Honourable Tony Blair, former prime minister of Great Britain and Northern Ireland. Bottom from left to right: Sheldon Garon, Nissan Professor of History and East Asian Studies, Princeton University; Michael Falcon, Head of Retirement, J.P. Morgan Asset Management; Ray Boshara, Senior Advisor & Policy Officer, Federal Reserve Bank of St. Louis; John Galateria, Head of Defined Contribution Investment Solutions, J.P. Morgan Asset Management; Sheena Iyengar, S.T. Lee Professor of Business, Columbia Business School; Donn Hess, Head of Product Development, J.P. Morgan Retirement Plan Services.

http://www.jpmretirementsymposium.com

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the ContentI S S U E 8 Fa l l 2 0 1 2

IN THIS ISSUE

2 A WordMichael Falcon, J.P. Morgan Asset Management’s Head of Retirement, shares his thoughts on how the convergence of four key trends is shifting industry focus toward improving participant outcomes.

4 Stat LifeInflation can have an outsized effect on older people due to changes in spending priorities and lifestyles as they age.

5 Legislative CornerTax preferences related to retirement savings are likely to be part of the broader debate on tax reform as policymakers consider various reform alternatives.

6 Speaking InvestmentsPanelists from J.P. Morgan Asset Management’s Global Multi-Asset Group (GMAG) discuss target date investing, the role of nontraditional assets in DC plans, participant behavior, glide paths and GMAG’s portfolio construction process and latest research.

11 Executive PerspectiveJulia Bates, Managing Director, J.P. Morgan Small- to Mid-Market Retirement Plan Business, shares her views on the growth of the segment and on small- to mid-sized business owners’ needs and priorities for their plans.

13 Plan Design StrategyA research-based framework that can help plan sponsors develop a strategy and put a process in place for making effective plan design decisions.

16 Best PracticesDeb Macchia, ITT’s Director of Global Benefits and Wellness Programs, shares her insights on the retirement plan rationalization and benefits issues resulting from last year’s spin-off of ITT Corporation into three new companies.

20 DisconnectedHow plan sponsors can take advantage of available plan design elements to reach disengaged employees.

22 Managing Inflation Risk in RetirementUnderstanding inflation’s relationship to the business cycle and impact on different asset classes and portfolio construction is critical to protecting retirement assets from the ravages of inflation.

28 Did You Know?Snapshots of Americans’ views on saving and investing for retirement.

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For more information, email [email protected].

J.P. Morgan Asset Management JOURNEY 1

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2 JOURNEY Fall 2012

a Word

Earlier this year, we held our inaugural retirement sym-posium, the 2012 J.P. Morgan Retirement Symposium: Converging Forces, where more than 100 prominent

Shifting to a new mindset

industry leaders and decision mak-ers from across government, academia and business gathered to focus on the broad forces shaping retirement today. We heard from fiduciaries who voiced concern for the retirement outlook of plan participants and their families; policymakers who are trying to bring a dialogue around retirement to the politi-cal forefront; and other thought leaders who have dedicated their careers to edu-cating individuals and the industry. All of us were challenged to think differently. One key takeaway from this event: plan

sponsors, advisors and consultants need to shift to a new mindset that focuses on improving participant outcomes instead of examining individual plan features and investment products independently.

Converging trendsThis new way of thinking stems from the convergence of four key trends. The first trend is the emergence of defined contribution (DC) plans as the primary retirement savings vehicle. Yet, even as more Americans save for retirement in DC plans and individual retirement

accounts, most people aren’t prepared or confident enough to deal with the responsibility of making the right in-vestment decisions. The second trend reflects the aging demographic that is af-fecting employers. Many of these compa-nies are not only facing a potential talent drain, they are also coping with higher costs related to older workers’ medical and workers compensation costs. Mean-while, plan sponsors are developing strategies to help workers manage the transition from accumulating assets in their DC plans to spending down those assets in retirement. The third trend—increased market volatility and the low-yield environment—has fundamentally changed the way the industry looks at risk and return expectations. Plan spon-sors can no longer rely on rising markets to get plan participants to their 6% to 8% returns. Finally, since financial and retirement security are key concerns for all of us, we—as stakeholders—therefore have a collective responsibility to help shape the policy dialogue on retirement.

The shift to a new mindsetWhile each of these trends would likely prompt significant change on its own, the simultaneous convergence of all four is forcing the industry to think different-ly about how best to solve the retirement plan challenges faced by plan sponsors, their advisors and participants. To that end, we believe plan sponsors should embrace an outcome-focused strategy. Under this new way of thinking, plan sponsors need to start by defining what they want to achieve—improving partic-ipant retirement readiness—to ensure that all their decisions align with this crucial premise. This may require some plans to rethink the balance between risks, costs and ease, and how these fac-tors intersect to potentially maximize optimal outcomes. In some cases, plans may need to adjust their traditional cost/




benefit analyses by focusing instead on the value of what they’re getting. Focusing on participant outcomes can also better align plan design to the firm’s overall corporate strategy. There is grow-ing evidence that financial wellness has a direct line to productivity. Spending a bit more to get employees to stronger financial positions may easily pay for itself with the cost savings of a more productive workforce. Ignoring outcomes can actually lead to decisions that, at first glance, seem like a prudent choice but may actu-ally hurt participant outcomes. For example, adding more funds to plans’ investment menus initially seemed like a good idea, but research shows that more choices typically result in poor participant asset allocation decisions. An outcomes-focused approach also means thinking about how participants engage with their plans. The reality is that participants, on average, invest less than they should, borrow too frequently and change jobs without rolling over their assets appropriately, all behav-iors that make DC investing difficult. By understanding, acknowledging and harnessing these types of behaviors in a constructive manner through the ef-fective use of automatic enrollment and contribution escalation programs, plan sponsors can place and keep par-ticipants on prudent retirement savings and investing paths.

Change can bring opportunities for those who look aheadIn general, plan sponsors can improve participant outcomes and position their plans for success in four key areas: plan design, investments, administration and communications. Plan design can have the greatest im-pact on plan participant success. Typi-cally, plans that are quick to adopt more innovative design features and services

have a higher percentage of participants who are on track to achieve adequate levels of retirement replacement in-come. But we also find that dialing up plan sponsor or employee investment in the plans can deliver roughly the same improvement in results. Plan sponsors can significantly enhance the potential success of their plan by adding even just a few new innovative features. Meanwhile, as the DC regulatory envi-ronment becomes more complex, offer-ing different forms of investment advice for participants is more important than ever. Plan sponsors can help improve investment outcomes by proactively expanding the number of participants benefiting from professional diversifica-tion. Based on our own data, investors

in professionally diversified strategies, such as target date funds, typically reap higher median returns than so-called “do-it-yourself” investors and participants us-ing self-directed brokerage accounts. Adding target date funds as the plan’s qualified default investment alternative (QDIA) or conducting a re-enrollment can help get more participants into well-diversified products. Alternatively, plan sponsors can also replace individual funds offered in their core menus with a few professionally managed portfolios. This approach not only eliminates the redundancy and confusion of most ex-

panded core menu lineups, but it also forces participants to focus their invest-ment decisions on asset allocation in-stead of individual fund selection. On the administrative front, there are opportunities to improve plans’ ef-ficiencies and economics by rigorously benchmarking plans against their peers or analyzing participants’ transactions. Doing so can help plan sponsors identify specific strategies to strengthen partici-pant outcome potential, either through innovation or investing in the plan. Meanwhile, broadening companies’ communication efforts to address over-all financial wellness while providing participants with a comprehensive view of their benefits can also help employees prioritize their financial goals and take action to achieve them. Each of these areas offers plan spon-sors and their advisors key opportuni-ties to prepare participants for the road ahead. It is an exciting time to be in a position to influence and spur change in DC plans. Navigating this new real-ity requires a new mindset, while the changes and dislocations offer oppor-tunity to those who adapt. Whether one is a plan sponsor, advisor, consul-tant or policymaker, the decisions we make during the next few years are likely to affect the retirement security of millions of Americans for decades to come. Building on our thinking from the Retirement Symposium, we intend to actively continue the dialogue with our partners to ensure that more par-ticipants get over the retirement finish line as safely as possible.

“Navigating thisnew reality requires

a new mindset, while the changes and dislocations

offer opportunities to those who adapt.”

Michael FalconHead of Retirement J.P. Morgan Asset Management

4 JOURNEY Fall 2012

Stat life

Inflation Hurdle is Higher in RetirementAs we age, the things we spend money on change as a function of changes in our priorities and life-styles. Compared with younger people, the average retiree spends more on health care and less on transportation, education and other categories with low historic inflation. As life expectancies increase, so does the likelihood that having health issues will require medi-cal care. It’s estimated that retirees spend on average three times more on health care than do 25- to 35-year-olds. Since health care also has one of the highest inflation growth rates, outstripping housing, transportation, food and beverages and other categories over the last thirty years, the net effect is that the infla-tion rate is higher for retirement-age Ameri-cans than for younger individuals.

For retirees on fixed incomes, the impact of inflation can be particularly devastating. Inflation is a constant threat to purchasing power and ranks as the #1 concern among preretirees.* Even at today’s low inflation lev-els, retirees run the risk of earning negative real returns from traditional income sources paying historically low yields.

Plan sponsors and retirement plan advisors should make sure to highlight the negative consequences of inflation in their participant education programs. Similarly, financial advi-sors should factor in above-average inflation when planning a client’s expense withdraw-als and investment during retirement. Invest-ment discussions should include an overview of how individual asset classes respond dif-ferently to rising and falling inflation, as well as how an allocation to inflation-protection strategies may help protect and enhance long-term real returns.

Spending and Inflation

Spending by age and category

25 to 35 years of age

65+ years of age

5% Medical Care

4% Other

16% Food & Beverage

42% Housing

21% Transportation

2% Education

6% Entertainment

5% Apparel

15% Medical Care

5% Other

15% Food & Beverage

40% Housing

16% Transportation

1% Education

6% Entertainment

3% Apparel

Apparel

0.9%

Inflation by spending category, 1982–2011

EntertainmentEducationTransportationHousingFood & Bev.OtherMedical Care

0.9%

2.0%2.7%

2.9%3.0%

5.2%5.3%

* Source: The 2011 Risks and Process of Retirement Survey, sponsored by the Society of Actuaries (SOA), March 2012.

Source (Top chart): Bureau of Labor Statistics, Consumer Expenditure Survey. Data as of December 31, 2011.Source (Bottom chart): Bureau of Labor Statistics, Consumer Price Index, J.P. Morgan Asset Management. Data represents annual percentage increase from December 1981 through December 2011 with the exception of entertainment and education, which were first published in 1998. “Other” category consists of personal care products (1.4%), reading (.4%), tobacco (.6%) and other miscellaneous items (2.1%).

Tax Reform:What’s around the corner?

A convergence of events on January 1, 2013, could significantly affect our federal tax code, includ-ing tax preferences related to retirement savings. These items include:> Expiration of the “Bush tax cuts,” which would increase the

highest marginal rate from 35% to 39.6% and increase the lowest rate from 10% to 15%. Capital gains and dividend rates would increase for all taxpayers as well.

> Expiration of the “payroll tax holiday,” which would increase the rate that wage earners pay into Social Security from 4.2% to 6.2%.

Congress and the administration would seem to have three options:> Reach some “grand bargain” prior to expiration that would

presumably retain some portion of the tax cuts while ad-dressing deficit concerns. It seems extremely unlikely that any deal could be struck prior to the November election, leaving it to the lame duck Congress. It is hard to imag-ine any agreement being reached, particularly if there is a change in control of either branch of Congress or the White House.

> Pass some temporary extension that would effectively kick the problem down the road for the new Congress to address.

> Allow the tax cuts to expire. While this approach has raised concerns from some economists, it would

allow legislators to maintain that they didn’t vote for a tax increase. They could then craft a new tax and deficit reduc-tion package retroactive to January 1, 2013.

Regardless of the approach Congress takes, it appears that reducing the tax expenditures related to retirement savings would at least be up for discussion. The Office of Manage-ment and Budget estimates the 2013 cost of retirement sav-ing deductions to be $165 billion, second only to tax expen-ditures related to employer-sponsored health care and ahead of the home mortgage interest deduction. The two approaches getting the most discussion are the Simpson/Bowles Commission’s recommendation and Presi-dent Obama’s proposal in his fiscal year 2013 budget. The Simpson/Bowles recommendation would limit all contribu-tions (both employee and employer) to the lesser of $20,000 or 20% of compensation. The President’s proposal would limit the value of certain deductions to 28%, including retire-ment, health insurance, mortgage interest and all itemized deductions. This means that joint filers with incomes of more than $250,000 ($200,000 for single filers) would pay taxes on some portion of their contributions to a 401(k) plan and also on any employer contributions. Presumably, these amounts would again be subject to taxation upon distribution. Obviously, members of the retirement industry will work

hard to limit any negative impact that could decrease re-tirement savings. In any event, the New Year will see a new debate on tax reform that we will monitor closely.


Legislative corner

6 JOURNEY Fall 2012

A panel discussion with J.P. Morgan Asset Management’s Global Multi-Asset Group

BuildingSmarter DC Investment Solutions

to Drive Better Investment Outcomes

Building

speaking Investments


Asset allocation remains one of the best tools that investment professionals have to influence investment outcomes. For the defined contribution (DC) in-dustry, asset allocation solutions such as target date funds are becoming in-creasingly important as plan sponsors seek to improve investment outcomes for their participants. The Global Multi-Asset Group’s (GMAG) professionally managed, multi-asset class DC solutions combine the benefits and characteris-tics of diverse markets and investment styles, tailored to specific investor goals. Each DC investment strategy is designed to incorporate participant behaviors and retirement funding needs into portfolio construction. Depending on the client’s distinct investment challenges, GMAG is focused on delivering strategic and tacti-cal asset allocation, enhanced asset class diversification, inflation protection and risk management solutions. The global team includes more than 70 investment professionals and manages over $75 bil-lion1 in assets under management.

In a panel discussion with Journey magazine, members of GMAG’s target date portfolio management team—Anne Lester, Daniel Oldroyd and Joseph Simonian—discussed current trends in target date investing, the role of nontraditional asset classes in DC plans, participant behavior, glide paths

plan sponsors is another innovative development. Custom strategies give plan sponsors more control and access to best-in-class managers and nontradi-tional asset classes, such as direct real estate. Participants can take advantage of these diversifying asset classes in a way they didn’t or couldn’t before.

Journey: Where do you see opportuni-ties for innovation in the core menu?

Oldroyd: The key is to provide par-ticipants with a set of well-diversified, easy-to-use building blocks. Last year we launched our new approach, Core Menu InnovationSM, a strategy that does just this by consolidating the entire core menu into three diversified portfolios of stocks, bonds and cash alternatives. While the average DC plan includes 18 different in-vestment options, the average participant invests in just three to four funds.2 Core Menu Innovation aims to replace com-plex and often redundant fund lineups with three institutional-quality portfolios. The goal is to get participants to focus on asset allocation, not fund selection.

Journey: You were one of the early proponents of adding nontraditional asset classes to your target date solu-tions. What is your view on the role of these asset classes in TDFs?

Oldroyd: Adding nontraditional asset classes, such as real estate and commodi-ties, is potentially a way to improve in-vestment outcomes and address inflation risks. The key for plan sponsors is to add nontraditional asset classes in a thought-ful way. Generally, we do not believe that they make sense as stand-alone core menu options given that the majority of participants do not know how to use them appropriately. Rather, participants are better served by accessing these types of asset classes in professionally man-aged solutions, such as TDFs.

and GMAG’s investment process, in-cluding portfolio construction. The team members also shared their views on the changes and innovations that need to take place to improve invest-ment outcomes for participants.

Journey: As the DC industry contin-ues to evolve, what are some of the more effective investment innovations you are seeing plan sponsors adopt?

Oldroyd: Over the last few years, plan sponsors have been increasingly adopt-ing target date funds (TDFs), which we be-lieve are a significant innovation from an investment standpoint. We believe that these funds are, by far, the most effective investment solutions to meet the invest-ment needs of the vast majority of DC par-ticipants. TDFs, which provide an asset allocation that gradually becomes more conservative as the fund nears its target retirement date, are optimal investment solutions that are intended to provide the right exposure to the right assets (including nontraditional asset classes), to the appropriate participant age cohort at the appropriate time.

Journey: TDFs are emerging as the preeminent investment solutions in DC plans. What are some of the specific innovations that you are seeing in target date investing?

Simonian: The growing prevalence of custom target date strategies for larger

Building

1 As of June 30, 2012.2 Source: Profit Sharing Council of America’s 53rd Annual Survey of Profit Sharing and 401(k) Plans, 2010; J.P. Morgan Retirement Plan Services.

Building



8 JOURNEY Fall 2012

really make or break the TDFs’ glide paths. But whether you are building an off-the-shelf product or a customized solution, you have to build an opti-mized glide path for the average par-ticipant population. In all cases, you have to speak to a pool of participants and behaviors. If you don’t, you’re not building an optimal TDF.

Journey: What are GMAG’s research priorities and plans?

Lester: We spend time examining our views around capital markets and how those views may be changing. There’s a commitment to research here that looks at markets on an ongoing basis—what are returns and correlations going to be and how is the asset market changing?

We also spend time looking at behav-ioral factors such as what are individuals saving, how are they saving and how is that behavior working? As the industry and plan sponsors do more with auto-matic features, that is something we’re going to try to get more clarity on. Given that we are at the beginning of the so-cial experiment in plan sponsors’ use of these tools, we’re trying to become more granular in understanding how the choices that plan sponsors make—in terms of automatically enrolling em-ployees into plans and increasing their contributions, as well as automatically defaulting them into a QDIA—will po-tentially shift behaviors over the long term. It’s too early to tell but it’s some-thing we’re very interested in.

Simonian: Currently, we are in the process of updating our 2009 publica-tion “Ready! Fire! Aim?,” which looks at how participants save, invest, take withdrawals from their plans and re-main in the plan. Two critical questions we asked in that publication are, “How are we defining success? And how can

path, commodities don’t really add much, as they are expensive and volatile.

When you own an asset class, why you own it and how much you own depend on the role that the asset class plays in your port folio. Is it there to diversify the equity allocation or is it serving as part of an inflation-sensitive allocation? Knowing this will help you un derstand how much you want to own and at what point in the glide path.

Simonian: Some asset classes play a dual role at different points in the glide path. REITs, as Anne said, can play an eq-uity role. At the same time, they do have distinct characteristics that differ from other forms of equity. At other points in the glide path, REITs play more of an inflation-protection role. Part of our role as an asset allocator is figuring out how and when to use them. And when you’re adding something new, such as nontraditional asset classes, you have to make sure it can play a role in general, as opposed to being redundant or sub-tracting from the performance of your overall strategy.

Journey: How do participant behav-iors influence portfolio design?

Oldroyd: When it comes to DC invest-ing, it is important to incorporate par-ticipant behavior into portfolio design. At J.P. Morgan, we deal with that “real world investing” by applying the lessons we’ve learned in building institutional solutions for defined benefit plans. We also take into account our experience with individual participants that is gained through our relationship with J.P. Morgan Retirement Plan Services.

Simonian: Without access to partici-pant behavior, it’s difficult for target date managers to say they’ve built the best glide path. Investor behavior can

Lester: Plan sponsors are real izing that giving people lots of choices and saying “good luck” may have unintend-ed consequences. In general, you want to put novel or high risk/high reward op tions, such as commodities, real es-tate or Treasury Inflation-Protected Securities (TIPS), into a context that participants can benefit from and are unlikely to misuse.

When considering whether to add these options, you have to ask: How is this change or innovation go ing to in-crease the probability that investment outcomes will be better? If you can’t answer that question, you shouldn’t do it. Can you say that adding a TIPS or commodities fund will lead to better in-vestment outcomes? How do you know that participants aren’t going to try to market time the fund or put all (or none) of their money into it?

Making sure that these options are incorporated into a usable format, such as within a qualified default invest-ment alternative (QDIA) or as part of a broader Core Menu Innovation strat-egy, is just as important as the decision to include them.

Journey: If plan sponsors have a TDF, how do they determine if and when to add nontraditional assets to the fund’s glide path?

Lester: The first step in adding any new asset class to a TDF is to ask yourself what role is that asset class playing, why are you including it and how are you going to measure its effectiveness? Real Estate Investment Trusts (REITs), for example, offer diversification benefits all along the glide path, while also offering infla-tion protection. Commodities, however, make more sense at the end of the glide path, given their benefit as an inflation-sensitive asset. Earlier in the TDF’s glide

http://www.jpmorganinstitutional.com/cm/Satellite?blobcol=urldata&blobheader=application%2Fpdf&blobkey=id&blobtable=MungoBlobs&blobwhere=1321480589295&ssbinary=true

http://www.coremenuinnovation.com


you, as a target date manager, articulate something beyond ‘not wanting to run out of money before you die’?” While that kind of question may be the ulti-mate definition of success, it is difficult to use as a guiding framework for asset allocation because there are too many unknown variables.

One of the key takeaways in “Ready! Fire! Aim?” is that success should be defined in a way that is appropriate for a fiduciary, which is to maximize the number of individual participants who reach the minimum level of income re-placement at the point of retirement. If you get that definition wrong, you get ev-erything wrong. And again, I don’t think people spend enough time asking them-selves, “What is the point of a DC plan?” It’s not to maxi-mize your pot of gold. It’s to create income replacement.

Lester: A key part of our research agenda is to con-tinually ask ourselves if we have the right defini-tion of success, and what might be changing in the future? There’s a whole host of industry, regula-tory and plan design questions that might change the definition of success.

Journey: How is GMAG addressing risk at various points in TDFs’ glide paths?

Simonian: Because our portfolio con-struction process and analysis are sim-ulation-based, we’re looking at various scenarios related to volatility. From a tactical standpoint, some of the risks that we seek to manage, particularly at the later stages of the glide path, include: the risk that participants will outlive their savings (longevity risk),

the risk that the value of assets or income may not keep pace with inflation (inflation risk) and the risk that the value of one’s assets will be reduced by a rise in inter-est rates (interest-rate risk). For example, roughly at the mid-point of the glide path, we start to add TIPS, commodities and inflation-sensitive asset classes to address inflation risk, which we view as a quasi-liability for participants.

Journey: Some TDFs are start-ing to incorporate “tail-risk” strate-gies in their plan design. What is GMAG’s view on such strategies?

Simonian: In general, tail-risk hedg-ing strategies refer to using derivatives to protect against unexpected sharp market declines. Investors have to pay for that quasi-insurance protection in normal times, but they gain protection if the market crashes. For people closer to retirement, there’s some logic to us-ing such strategies because they want to protect their money and consolidate their gains. Younger participants, however, still have decades to recover from any equity market loss. Investors, for their part, have to do a cost-benefit analysis since these strategies can be costly, which can be an

issue for cost-sensitive target date inves-tors—and the strategies may not pay off.

Oldroyd: If you focus on tail-risk strate-gies in the construction of a TDF, what you’ve done is create a TDF for one eco-nomic scenario and one market outcome: an episodic market downturn. What you will find is that over the long term, this strategy will underperform because of all those embedded costs. Instead, what you want to try to do is design a TDF that will work well in multiple market conditions. In that regard, we have explored and will continue to explore using tail-risk hedg-ing in certain environments.

Journey: Can you describe GMAG’s portfolio construction and asset alloca-tion process?

Oldroyd: In creating portfolios or in-vestment solutions for DC clients, we start to build a framework by carefully defining the goal: Who are we invest-ing for? What are their challenges? What are we trying to achieve and how can we build these portfolios in terms of modeling our strategic asset alloca-tion? Risk is also a key input to the pro-cess. In sizing portfolios and looking at asset classes, we’re asking ourselves,

continued on p. 27

“We believe that what sets us apart from

our competition is the breadth and depth

of our asset allocation research.”




The role of real estate in DC plans In recent years, defined contribution (DC) plans have become the main re-tirement savings vehicle for individuals, while regulatory changes have fostered the growth of target date funds (TDFs) within DC plans. Meanwhile, the typical DC plan has underperformed the typi-cal defined benefit (DB) plan by about 100 basis points over the past decade,1 spurring plan sponsors to consider some of the same private market diversifying alternatives, such as direct real estate, that DB plans have used for decades. DC plan sponsors may want to con-sider direct real estate as an allocation in their portfolios, given some of the asset class’s benefits: strong risk-adjusted per-formance, superior diversification, stable income and inflation-protection features.

Implementing direct real estatePlan sponsors can gain access to direct real estate through TDFs or, for larger plan sponsors, through custom target date solutions that are tailored to their employee populations. In some cases, plan sponsors may want to add a real estate allocation to existing proprietary asset allocation funds. In that case, they may be able to “unitize” or “paper clip” a direct real estate allocation to those funds.

The liquidity question Sophisticated investors and DB plans have long been willing to accept some illiquidity in exchange for direct real es-tate’s potential for strong risk-adjusted performance gains. There is, however, growing acceptance of the use of less liquid assets in asset allocation portfo-lios used in DC plans. While target date funds can require more liquidity than a

typical DB plan, they require much less than an individual buying real estate directly. The advantage of allocating a small percentage of assets to direct real estate, say 5% to 10% on average, is that even extraordinary events in the markets and in the plan—such as mas-sive layoffs or market declines—would not cause the participant to notice any illiquidity. Stress tests using the recent financial crisis bear this out. Many DC plan sponsors also insist that if an investment option can be daily traded, it should be daily val-ued. Real estate can meet these value requirements more easily than other types of private equity for a number of reasons. The U.S. commercial prop-erty market, for example, is much more transparent than other types of private equity, is liquid and is relatively homo-geneous. J.P. Morgan Asset Manage-ment has a rigorous and established process in place that includes conduct-ing appraisals throughout each quarter, valuing 100% or more of assets each

quarter and recognizing information when it is known.

Benefits for DC participants Adding direct real estate can reduce portfolio risk since a blended real es-tate portfolio generally exhibits lower volatility than most publicly traded in-flation-sensitive assets. The addition of a mere 7% allocation to most publicly traded inflation-sensitive assets would have increased portfolio volatility over the last 10 years, whereas a 7% alloca-tion to a private/public real estate blend would have decreased portfolio volatil-ity during the same period (see chart). What’s more, real estate can play a key role in a TDF’s inflation strategy. Real estate returns have exhibited inflation sensitivity due to the asset class’s short-term inelastic supply, as well as its pro-pensity to appreciate during periods of excessively accommodative monetary policy. When inflation picks up or the economy accelerates, real estate tends to do well.

Adding direct real estate can reduce portfolio risk10-year historical volatility (%)

11.10%

10.80%

10.50%

10.20%

9.90%

9.60%

9.30%60/40

PortfolioCommoditiesREITsDirect Real Estate/

REIT blend

Stan

dard

Dev

iatio

n (V

olat

ility

) Allocating 7% blend of direct real estate/REITs to a 60/40 stocks/bonds

mix can reduce portfolio volatility

Sources: NCREIF, NAREIT Equity Index, DJ Commodities Index, J.P. Morgan Asset Management. 60%/40% portfolio reflects 60% S&P 500 and 40% Barclays Aggregate Bond Index. Real estate is 75% NCREIF ODCE and 25% MSCI U.S. REIT. The above graphs are shown for illustrative purposes only. As of June 2012.

1 Source: Towers Watson January 2010 report.


1 Cerulli Quantitative Update—Retirement Markets 2011.

How would you characterize the growth of defined contribution (DC) plans among small- to mid-sized businesses? DC plans have been around since the early 1980s and have gained more traction among small- to mid-sized businesses over the last 15 years. Although the recent 2008 market correction forced many small businesses to cut some of the benefits offered to employees, others are adding retirement plans to differentiate them-selves from their competitors in a dif-ficult environment. As the population continues to age, more companies are realizing the importance of providing retirement benefits as a competitive differentiator and are being more in-novative with their retirement plans by adding automatic features designed to help improve the retirement readiness of their employees.

E X E C U T I V E P E R S P E C T I V E

Opportunities for the Small- to Mid-Sized Retirement Plan MarketIn a recent interview, Julia Bates, Managing Director, J.P. Mor-gan Small- to Mid-Market Retirement Plan Business at J.P. Morgan Asset Management, which provides bundled services for plans from start-up to $40 million in total plan assets, shared her views on the growth of the small- to mid-sized retirement plan market, as well as some of the challenges and opportunities that plan sponsors face in this market.

What are some of the unique challenges that small- to mid-sized plan sponsors face? What’s unique about this mar-ket segment, which makes up 99% of the plans and 32.8% of the assets in the retirement plan market,1 is that the same people who are setting up the companies’ DC plans are also usually the people who are running the day-to-day businesses. In a perfect world, one person or a benefits team would be responsible for running the plan. But in this market, the person running the plan tends to have many other business responsibilities as well. As a result, run-ning the DC plan is only a small part of the company’s mandates and isn’t the primary focus.

Also, we have seen that clients’ re-

sources have been stretched thin over the last five years, which means they need more support from their plan pro-vider and financial advisor than ever before. That is prompting more plans to look for partners who are proactive about monitoring and improving the performance of their plans, who can bring them new ideas and who can up-date them on trends and developments in the retirement industry.

What are the priorities for small- to mid-sized plans? Many business owners in this segment are looking for efficient,

effective recordkeeping solutions. Because plan sponsors see the value of a bundled solution (given that they may not always have this exper-tise in house), they are usually looking to lever-age a firm with retire-ment solutions exper-tise. Plan sponsors in

this space are also focused on providers who can provide competitive fees and a solid fund lineup.

Fiduciary responsibility, ongoing compliance and fees are also top con-cerns, so many plan sponsors want a partner who can provide fiduciary support and transparency around fees. Many plan sponsors in this space also seek to work with an advisor or con-sultant to the plan who will take on fiduciary responsibility. Ultimately, since these business owners want to provide a plan that helps employees become retirement-ready, they tend to be focused on a plan design that can result in good participation and defer-ral rates, as well as one that can pro-vide employees with good investment diversification.


What are some of the latest trends in plan design that you are seeing in this group? As we’ve learned, the majority of par-ticipants are “accidental investors,” and they need some simple solutions that are going to help them achieve a digni-fied retirement. Especially in this mar-ket, there’s a desire to keep it simple. To that end, plan sponsors have been adding target date funds (TDFs) and are increasingly adding automatic features such as automatic enrollment and au-tomatic contribution escalation to their 401(k) plans. Others are engaging in a full-plan re-enrollment to shift partici-pants out of their current investment allocations into TDFs.

What are the regulatory issues that these plan sponsors are facing? Under the De-partment of Labor’s new rules, which require more robust disclosure about the fees charged on 401(k) plans, plan sponsors, regardless of size, need to get an understanding of the fees they’re pay-ing. My sense is that because many of the smaller companies have been busy running their businesses, they haven’t been as focused on this issue. Overall, the new fee disclosures should provide plan sponsors with an increased aware-ness of the fees they are paying.

Going forward, now that the market-place is even more transparent, service providers and advisors will have to define what they offer and how they bring value to the plan sponsor client and their participants. If, for example, clients are trying to get advisory and investment services, they need to make sure they’re paying appropriate levels of fees for plan administration and in-vestment management.

What can firms such as J.P. Morgan As-set Management offer? As a global fi-nancial leader, we bring the resources,

ing as sets between $3 million and $40 million want plan providers that are easy to do business with, are effective partners and can offer creative solu-tions to difficult problems. Fortunate-ly, at J.P. Morgan, we have developed a flexible service model and innovative solutions to help these cli ents achieve their plans’ objectives.

Why is J.P. Morgan increasing its fo-cus on this market space? We believe that small- to mid-sized businesses will comprise the fastest growing retirement segment in the years to come. Since small- to mid-sized companies are focused on running their businesses, they need a trust-ed partner who can help them with their plans and reduce their administra-tive burdens.

We understand that each company is different, and so are their retirement

plan needs. Building a plan designed to meet these unique needs is precisely why we created Retirement LinkSM ear-lier this year, a product that connects small- to mid-sized companies to the strength of J.P. Morgan. Retirement Link provides access to our leading retire-ment thought leadership and superior client service. With access comes results, built on outcome-driven investment so-lutions and innovative plan designs.

intellectual capital and investment management experience to help plan sponsors and advisors build plans that meet their goals, while improv-ing participants’ retirement outcomes. Through the use of our strategic con-sulting framework, for example, client advisors take into consideration plan design, investments, communications and administration to help construct and implement appropriate retire-ment plan solutions for businesses and their employees. We, as a firm, spend a lot of time listening to our clients and making sure we understand their priorities and concerns for their plans and participants.

Every client is then assigned a dedi-cated client service team that helps con-vert and implement the plan. Part of the team’s goal is to help companies with the design of their plans: how much they should contribute to their plans,

what features they should include and what investment choices they should have. Our new Plan Design Guide, for example, is a framework that al-lows advisors to help plan sponsors benchmark and enhance their DC plans’ effectiveness to ensure that the plans are on track to evolve and im-prove over time.

According to the Boston Research Group 2011 Plan Sponsor Satis faction Study, plan sponsors with plans hold-

“We believe that small- to mid-sized businesses will comprise the fastest growing retirement segment in the years to come.”

12 JOURNEY Fall 2012


EE AS Y S T E

S

CON

T

NV E S

AME

C

5

PLAN

1

6

D E STRATEGY

I G N

IN

M E N TOVA

2 3


Determining a strategy and putting a process in place for making decisions about plan design is critical for achiev-ing plan goals. Many plan sponsors struggle with how to improve their plans and are seeking advice from their advisors, consultants and service providers. J.P. Morgan has developed a research-based framework that can help plan sponsors develop a strategy and help guide them through a process for making plan design decisions. Based on J.P. Morgan’s extensive research study on how plan sponsors make plan design decisions, two primary in-fluences on plan design have emerged: innovation and investment.

Innovation is defined by how quickly the plan sponsor adopts new features and services, while investment is defined as how much money the plan sponsor and participants invest in the plan. The relationship between these two fac tors can be used to identify where a par ticular plan sponsor fits within a group of four distinct plan sponsor pro-files (see next page), which can be help-ful in developing and refining a plan’s strategy. Knowing a plan’s profile type

gives plan sponsors and their advisors insight into the specific priorities and plan features that might be appropriate for a given plan. Working together, they can then measure the poten-tial impact of their plan design decisions by evaluating the plan’s projected retirement-income re-placement rates. Ultimately, they should compare their results with those of a peer group with similar benefits programs and goals. This benchmarking can be particularly useful in helping companies determine best prac-tices that may enable them to be a more competitive employer within their industry.

Once plan sponsors have iden-tified and agreed upon their pro-file, they can evaluate specific plan features and services and create an action plan around implementation. There are four key areas on which plan spon-sors should focus their attention: plan design, investments, com-munications and administration. Ultimately, in addition to provid-ing a road map of potential plan

design opportunities for a given plan profile, an action plan can provide an excellent way for plan sponsors and their advisors to document plan design decisions for a plan’s fiduciary file. Having a robust process that enables plan fiduciaries to engage with each other on important issues impacting the business, its employees and the plan is an impor-tant first step in developing a clear plan design strategy that optimizes the plan and drives better participant re-tirement outcomes.

Retirement plan committee members may come from different areas of the business—from finance and corporate strategy to human resources and benefits administration—yet each brings a unique perspective on the goals and priorities of a company’s defined contribution (DC) savings program.

I

N

V

E

S

I N N O V A T I O N

M

E

N

T

To learn about the J.P. Morgan Plan Design

Guide, contact your J.P. Morgan representative,

or call 877-576-4632.

https://www.jpmorganfunds.com/cm/Satellite?pagename=jpmfVanityWrapper&UserFriendlyURL=contentdet_module&smID=1327728342679

https://www.jpmorganfunds.com/cm/Satellite?pagename=jpmfVanityWrapper&UserFriendlyURL=contentdet_module&smID=1327728342679


FOUR DISTINCT PROFILES DRIVE PLAN DESIGN STRATEGY AND PROCESS

Profile 1

Profile 3

Profile 2

Profile 4

Generally focused on proactively

placing participants on a strong

savings and investing path. Tends to

offer an expanded range of time-tested

plan features when improvements in

projected income replacement rates

justify additional cost.

Generally focused on retaining

talent in a highly competitive

industry. Tends to adopt new features

when improvements in projected

income replacement rates justify

additional cost.

Generally focused on maintaining

employee satisfaction in an

established talent market. Tends

to adopt new features when they

lead to better projected income

replacement rates at little to no

additional cost to the firm.

Generally focused on running an

efficient plan, often in a high-turnover

industry. Tends to offer more basic,

time-tested features, sometimes

adopting new services when they

lead to better projected income

replacement rates at little to no

additional cost to the firm.

27%

29%

20%

24%

Source: J.P. Morgan Retirement Plan Services proprietary data aggregating retirement plan information maintained by Retirement Plan Services as of December 31, 2010.

of plans

of plans of plans

of plans


ITT trivestiture triggers rationalization of employee retirement benefit plansHow to divide and prosper

With Deb Macchia, Director of Global Benefits and Wellness Programs, ITT Corporation


lution that would address the needs of every individual.

How did you manage the rationaliza-tion process?We worked with a team of senior execu-tives, including the newly appointed lead-ers of all three companies. This included Chief Executive Officers, Chief Financial Officers, Heads of Human Resources and others. Most of these people wore many different hats as part of the process. Each individual had to look at both the new and the old through different lenses and decide what was best for each of the three new companies. After we decided on our approach, a number of implementation teams went to work. This included working groups set up by our external partners such as J.P. Morgan, which created teams of em-ployees to coordinate related elements of the spin-off, including documentation, contracts and investment-related mat-ters. Most importantly, one person at J.P. Morgan was appointed project manager to coordinate the work of all of the firm’s functional groups, with ongoing support from our relationship manager.

What were some of the elements of your new benefits plan?Working closely with the newly ap-pointed leaders of the three companies, we came up with an overall plan design that we believe is very competitive and very fair to the employees, and that also includes a transition period to bridge changes from one plan to another. First, the two smaller companies—the “new” ITT and Xylem, both of which have relatively small numbers of U.S. employees—decided to freeze pension benefits earned under the former re-tirement plan by all active, eligible em-ployees as of the date of the spin-off. In addition, they introduced an enhanced 401(k) savings plan. Interestingly, those employees now working at these two companies who had already earned full retirement benefits as

Generally speaking, ITT had a very attrac-tive defined benefit (DB) plan. But, over the years, benefits formulas had been adjusted so that we were offering three versions of the plan. Because we’d been in business for so long, we had many long-service employees sitting side-by-side with newer employees with different benefits. So we were looking at whether a traditional DB plan was still the right approach for the organization.

How did the announcement of the spin-off affect the work you were al-ready doing?We had actually received Board approval to make certain changes to the plan two months prior to the spin-off announcement. So we went back to the Board and said, “What do we do now? Do we move forward with the plan that was in place? Or do we put the brakes on and let each company make its own decision about what’s right for its employees following the spin-off?” The Board’s response was, “Take the perspective of the three new companies and see what you come up with.”

What did you do then?We took a detailed look at what other companies were doing, especially those of our size and in our relative peer groups. And, of course, we carefully considered what we could afford. We needed new plans that were ap-propriate for our new culture and new financial parameters. The “new” ITT, for example, is now the smallest of the three companies in terms of employ-ees and revenues. It’s like a start-up but with the legacy of an older, much larger organization. And what worked in the old world doesn’t work in the new world, either from an administra-tive or financial standpoint. There was a tremendous amount of thoughtful discussion around what the new plans would be. There were no easy answers. And there was no one so-

On January 12, 2011, ITT Corpo-ration announced its plans to split its organization into three separate, independently oper-ated, publicly traded companies: a defense company (now known as Exelis Inc.), a water company (now known as Xylem Inc.) and a highly-engineered industrial products company (which has retained the ITT name). As part of this trivestiture, which was completed in less than 10 months, ITT was faced with the complex task of ratio-nalizing the retirement benefit programs of approximately 40,000 employees worldwide and creating new plans for the three separate companies. As one of several key decision makers in this process, Deb Macchia, who serves as ITT Corporation’s director of Global Benefits and Wellness Programs, played a significant role in the design and imple-mentation of the benefits plans for the three companies. Journey spoke recently to Ms. Macchia about the successful com-pletion of this initiative, as well as about some of the lessons learned as part of the overall process.

What retirement plans did you have in place when the legacy organiza-tion announced its plans to split its business into three companies?Historically, the legacy corporation was essentially a holding company with many different businesses. As a result, its retirement plans were very frag-mented, with lots of plans managed at a local level using different approaches and benefits formulas. There was no

overarching benefits philosophy in the

U.S. or globally.


part of the former plan were able to be-gin collecting their pensions immediately upon the spin-off. At the “new” ITT, for example, there are some employees who are collecting pensions while still being actively employed. And special transition provisions allowed employees who were close to full retirement benefits to con-tinue to earn additional pension credits. Second, the third company—Exelis, which is predominantly in the U.S. de-fense business and is now the larg-est of the three companies in terms of revenue, market capitalization and em-ployees—also introduced an enhanced 401(k) savings plan. But it also offered current, eligible employees a one-time choice between receiving employer floor (i.e., minimum contribution) and match-ing contributions in the enhanced 401(k) plan or remaining in the U.S. salaried re-tirement plan under the traditional pen-sion plan formula. In doing so, the company continues to offer an attractive benefits plan that is very competitive with plans offered by other firms in its industry. Finally, there were no changes to the types or amounts of benefits of any of the firm’s retirees. And Exelis has now assumed full responsibility for provid-ing pension benefits to all of the legacy firm’s U.S. retirees, regardless of wheth-er they worked in the defense business.

What changes did you make to the plan to make participants aware that you weren’t taking away key benefits?From a plan design standpoint, we kept the company match the same be-cause we felt it was competitive from our benchmarking standpoint: 50%

of the first 6%. In the legacy company, we had a core contribution, or floor, of ½%. This contribution is now generally 3% or 4% but can go as high as 12%, based on a point system that combines employee service and age. This is a big change in our thinking because it helps us to reward service and age and not just simply age, as we did in the past.

How did employees react to the changes? And how did you respond?As you can imagine, we were concerned that certain of our employees would re-act negatively to the changes. But that didn’t happen. If concerns were raised, an individ-ual having the strongest relationship with the employee—perhaps his or

her manager or someone from Human Resources—would speak individually to the employee. He or she would dis-cuss such matters as the value of the employee’s current pension, how close the employee was to reaching certain retirement milestones, the benefits of the transition credit, what the em-ployee would give up if he or she left the company and what our competitors were offering to their employees.

What other issues remain following the spin-off?Even though we accomplished a great deal as part of the spin-off, we still have

lots more work to do. For example, al-though we froze the DB plan for our U.S. salaried employees, we still have 12 local, DB plans in the U.S., some of which are active and some of which are not. So we need to continue to determine how we administer these plans going forward. We also still have 14 different defined contribution (DC) plans. Although J.P. Morgan is the recordkeeper for all of these plans, we need to consolidate plan documents and continue with general cleanup.

How will you manage the ongoing changes to your retirement plans?We have two primary governing bod-ies: a Benefits Administration Commit-tee (BAC), which is responsible for all

administrative mat-ters, and a Pension Fund Trust and In-vestment Commit-tee (PFTIC), which oversees all invest-ment matters. BAC’s au-thority comes from the Board’s Com-pensation Com-mittee, and is the governing body for all DC-related mat-ters, including the

choice of recordkeeper, plan design and strategic and tactical plans. Its mem-bers include representatives of Human Resources and Finance, with participa-tion but no voting rights by members of the Legal Department. PFTIC, on the other hand, has over-sight of the fund lineup, including de-termining the right approach for what we offer our employees. Its member-ship is similar to that of BAC.

What might you do differently if you had the chance?There was so much change going on after the announcement—everything


seemed so overwhelming, with many employees wondering how their jobs would be affected and/or which compa-ny they would work for—that we were reluctant to convey too much informa-tion for fear of a communications over-load. Of course, we hosted webcasts and pushed information out through our Human Resources staff and by email or mailings to employee homes. But our employees still wanted more. Also, the fragmented nature of the legacy company, as well as the variety of local plans, made it difficult to devel-op standard communications materials for use across all businesses. Our ma-terials needed to reflect local practices, and were modified accordingly. As a result, even though we worked hard to maintain tight controls over the mes-sage, we couldn’t always control how the message was delivered across the organization. If there was one constant theme throughout the process, it was the im-portance of employee education. Most employees don’t fully understand the value of what their employer pays on their behalf. And we need to keep edu-cating them to this important fact.

The size of the “new” ITT DC plan now stands at about $150 mil-lion, compared with the $2 billion of the legacy company. How has this changed how you administer the plan?Regardless of our size, we need to stay focused on participant communica-tions and education. We’ve had a DC plan for many years, but we need to go above and beyond when it comes to educating our employees about the plan, helping them understand how it fits into their overall retirement plan-ning and helping them make wise in-vestment decisions. As a result, we will continue to educate our participants on how to use investment tools and how to maximize the value that the company

is giving them. From a financial standpoint, our fo-cus is on the fund lineup. We need to be sure we’re not only selecting the best fund alternatives but also the most cost-effective ones. We’re also in the process of choosing a new, independent invest-ment consultant. This isn’t because the one we’ve used in the past hasn’t done a good job. Instead, we need to find a consultant that best complements our internal resources and is better suited to supporting a plan of our size.

What do you look for in a 401(k) plan provider?Our first priority is execution and doing business with a partner that has very crisp internal controls in place. This is particularly important for us because we don’t have consistent payroll sys-tems across all of the businesses. So we have a far more difficult execution pro-cess for the day-in, day-out processes that have to take place to run our plan.

Having a partner with strong controls helps us identify where there could be a breakdown in data so we can clean it up and fix it going forward. It also serves as a second-level review in which we work together to identify problems and improve our internal processes. Without a doubt, our other important priority is customer service. Knowing our employees can call and get consis-tent information from knowledgeable, licensed people takes a tremendous burden off of our internal Human Re-sources team. If, for example, an employee comes to us and says, “Where should I invest my money?” we take great comfort in say-ing, “You need to call customer service to get more information about what we offer.” Employers spend a lot of money on their benefits plan and it’s important that our employees understand their benefits. So having sharp customer ser-vice is very critical, in my mind, to the delivery of our benefits program.

TITLE: Director of Global Benefits and Wellness Programs

COMPANY: ITT Corporation

DUTIES: Member of company’s Human Resources leadership team, with responsibility for design and implementation of companywide benefits and wellness strategy.

BACKGROUND: Joined ITT in September 2008 as a member of the firm’s global benefits team; appointed to current role upon spin-off of company in October 2011. Previously worked for 20 years at Hitachi America Ltd., with increasingly responsible positions in benefits functions for the company and its U.S. subsidiaries.

EDUCATION: MS (honors) in Human Resource Management, Mercy College (NY); BBA in Human Resource Management, Pace University (NY).


DisconnectedParticipants acknowledge responsibility

but remain disengaged

Reality is to the contrary, however, ac-cording to a review of activity among par-ticipants in the J.P. Morgan Retirement Plan Services recordkeeping system. Consistent, and limited, patterns of en-gagement emerge in examining partici-pant activity for the past three calendar years. From 2009 through 2011, just over a third of participants visited their DC plan accounts online five or more times in the course of 12 months. Furthermore, the most common activity was a quick account balance check with a visit of less than 20 seconds. A second group of par-ticipants, accounting for 21% of the population, vis-ited the account site or called the Retirement Ser-vice Center twice during a 12-month period. Finally, the remaining 45% initiat-ed no contact at all, mean-ing these individuals are neither inquiring about their accounts nor effecting any transactions. Consid-ering the market volatility in both the fall of 2008 and the third quarter of 2011, the overall consistent, and low, level of engagement may be surprising on the surface. Both market events gen-erated high web traffic and call volume compared with historical levels, but the

percentage of participants who reached out was actually very small. Although the majority of participants nationally expect their DC plan to be their primary source of income in re-tirement,1 additional research from J.P. Morgan suggests that the discrepancy between acknowledgement and en-gagement might not be so unexpected after all. Since 2005, J.P. Morgan has col-lected information about participants’

investing preferences. That work has shown that some 69% of participants would prefer to delegate their account management by using, for example, a managed solution like a target date fund (TDF). Only 30% of participants

actually prefer to be ac-tively engaged in the in-vestment selection and monitoring process. Con-sidering these preferenc-es and the actual engage-ment activity, the results are actually consistent in the end. How does this participant reality af-fect plan sponsors’ decisions around

plan design features, par-ticipant services and com-munication and education programs? Plan spon-sors can take advantage of elements that actually help participants stay the course without requiring any action by participants. Features like automatic en-rollment, automatic contri-bution escalation and the availability of managed investment solutions such

as TDFs may be suitable for that silent majority of participants who prefer to delegate their retirement saving deci-sions, while still recognizing their im-portance. These tools serve as “guard-rails” by keeping participants on the savings and investing path.

1 J.P. Morgan Retirement Plan Services Participant Survery, 2010.

With some 91% of defined contribution (DC) participants acknowledging personal responsibility for their financial security in retirement, one might expect a commensurate level of interest in account monitoring, or at least increased engagement.

“Only 30% of participants actually prefer to be actively

engaged in the investment selection and monitoring process.”




Managing assets outside of DC plans can be a particularly daunting challenge for individuals. Almost 80% of individu-als participating in DC plans withdrew their entire account balances within just three years of entering retirement, according to research published by J.P. Morgan Asset Management.1 As these individuals roll their savings out of DC plans to consolidate this money with their other investments for retirement,

many will be looking for ways to manage inflation risks.

Inflation’s impact on older AmericansIt is not surprising that for the past 10 years, retirees and preretirees have in-creasingly rated inflation as their top re-tirement concern, outpacing other risks such as health care and long-term care.2

Many may have vivid memories of the high inflationary periods of the late 1970s and early 1980s. They also may be very aware that inflation dispropor-tionately affects retirees due to differ-

As the retirement savings system has evolved from being dominated by defined benefit (DB) plans to being dominated by defined contribution (DC) plans, managing assets to meet the needs of Americans approaching and living in retirement has become increasingly complex. One risk, however, has remained constant: the fear that inflation will significantly erode purchasing power over time, particularly as Americans are living longer.

1 Ready! Fire! Aim?, J.P. Morgan Asset Management Global Multi-Asset Group. 2009.2 2011 Risks and Process of Retirement Survey Report, Society of Actuaries. March 2012.


ences in spending habits and more prevalent price increases in the cat-egories where the elderly tend to buy more goods and services. For example, older Americans typically spend more on medical care, which has seen some of the largest increases in inflation (see Stat Life on page 4). Against this backdrop, it is important to revisit inflation: how it has actually behaved over time and how various asset classes typically used to outpace inflation performed during those same periods. With these insights and the help of a financial advisor, participants can effectively address inflation with-in their retirement portfolios through an actively managed and diversified approach.

Revisiting the facts about inflationThe reality is that with the exception of the 1970s and early 1980s, there have been only a few periods when inflation spiked above its long-term average of 4%, according to research from J.P. Mor-gan Asset Management’s Global Multi-Asset Group (GMAG), which manages investment vehicles designed to meet the needs of DC plans and individual investors. Empirical evidence suggests that the inflation cycle has historically consisted of alternating, small, episodic movements of increasing or decreasing inflation marked by sporadic, larger re-gime shifts. A key consideration, as outlined in GMAG’s recently published paper, “The retirement inflation threat: Three things to know when addressing inflation risk in defined contribution plans,” is to understand the factors that drive asset behavior, as well as the intersection and relationship between inflation and business cycles. As Exhibit 1 illustrates, GMAG has iden-tified four types of inflationary envi-ronments over the past 40 years: low and rising, low and falling, high and

EXHIBIT 1 : PERFORMANCE OF ASSETS ACROSS DIFFERENT INFLATION CYCLES (PERCENT)

Source: J.P. Morgan Global Multi-Asset Group. Inflation Sensitive Equities based on HSBC Gold Metal and Mining Index; REITs based on MS REITs Index; TIPS based on BarCap US TIPS Index; and Commodities based on GSCI. All returns monthly from January 1971 to March 2012. High inflation determined by YOY Headline CPI greater than 4.0%. Rising inflation defined as YOY CPI greater than prior 3 months.The above information is provided for illustrative purposes only. Results shown are not meant to be representative of ac-tual investment results. Past performance is not necessarily indicative of the likely future performance of an investment.

Low and Rising Inflation(27% of the time)

18.8

12.6

16.3

12.7

Low and Falling Inflation(33% of the time)

9.0

21.0

18.2

3.4

8.3

High and Falling Inflation(20% of the time)

-3.9

-1.4

15.3

5.4 5.8

High and Rising Inflation(20% of the time)

27.5

0.2

14

9.7

2.2

13.4

http://www.jpmorganinstitutional.com/cm/BlobServer/The_Retirement_Inflation_Threat.pdf?blobkey=id&blobwhere=1321476229876&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs&isAMIA=yes





rising and high and falling. Every asset has unique inflation-cycle sensitivities, meaning that returns typically vary de-pending on whether inflation is high or low, or rising or falling. Consider commodities. Commodity prices usually move in lockstep with inflation because they are a core compo-nent and sometimes a driver of inflation. They usually generate their strongest returns in high and rising inflationary periods, but as inflation peaks, and as ex-pectations of inflation start to fall, com-modity prices can fall quickly. Returns are also closely linked to the business cycle and can quickly turn negative in recessionary periods. Ultimately, the results show that ev-ery asset comes with specific asset class risks. Each asset tends to do well in dif-

ferent inflationary scenarios, but also comes with investment trade-offs for participants. There is no “set it and for-get it” solution that effectively protects portfolios from inflation risks, which means that a diversified strategy that adjusts as the inflationary environment changes is critical.

Time horizon: The most critical variableFor investors who are saving for retire-ment, have an extended time horizon and can withstand volatility, inflation may be less of an issue. Consider, for example, the historical probabilities of various asset classes beating inflation over time. As Exhibit 2 shows, as the time hori-

zon approaches rolling 10-year periods, the frequency with which most of these assets have historically beaten inflation approaches 100%. Those who are most at risk of underperforming inflation are individuals with shorter time horizons, or those near or in retirement who are tapping their portfolios each year to meet their retirement spending needs. One thing to note is that aside from the public equity markets, which have had poor returns over the past decade, the asset class with the worst historical record of beating inflation is commodi-ties, which tend to be highly leveraged to inflation and the business cycle. When the business cycle turns nega-tive, the volatility in that asset class can generate negative returns.

EXHIBIT 2: PROBABILITY OF BEATING INFLATION OVER ROLLING PERIODS

Source: Based on rolling monthly, quarterly and annual returns, January 1970 (or earliest available) through December 2011. Data sources include: Stocks—S&P 500 Index; Bonds—Citigroup US GBI All Maturities; REITs—NAREIT Equity Index; Commodities—DJ UBS Index; Private Real Estate—NCREIF Index; and Inflation—U.S. Headline CPI-Urban consumers; TIPS—Barclay Capital US TIPS Index and TIPS back-tested historical returns estimated from backfilled index. For illustrative purposes only.Note: Inflation-linked bonds have existed since the 1700s, but Treasury Inflation-Protected Securities (TIPS)—inflation-linked bonds issued by the U.S. Treasury—have only existed since 1997. Because there is no long-term history for government-issued, inflation-linked bonds, we are required to simulate a historical return series if we are to undertake any long-term statistical analysis. We do this by generating a historical real yield series and estimating total returns.

1 year

100

90

80

70

60

50

40

Quarter 2 year

Holding Period

% P

roba

bilit

y

3 year 5 year 10 year

Private Real Estate

CommoditiesBonds

REITsStocks

TIPS


Portfolio construction: Seeking robust inflation protectionFor advisors, managing inflation risks should be a core component of the retire-ment portfolio modeling and construc-tion process. At J.P. Morgan Asset Man-agement, we see four key factors that can help build a robust, diversified approach.

Time horizon of inflation

As we have seen, historical analysis indi-cates that most asset classes have beaten inflation over periods longer than 10 years, but no single strategy will work in

all scenarios over shorter time horizons. Combining asset classes into diversified portfolios may shorten this time horizon, but investors closer to retirement should begin to factor inflation risk into their portfolios at least 10 years before any liquidity is required from the portfolio.

Volatility toleranceVolatility is another key factor to keep in mind when constructing inflation-sensitive portfolios. Adding more risk assets—such as commodities, global natural resources equities, real estate investment trusts (REITs) and infra-structure equities—can result in higher expected returns. But adding risk assets also raises the portfolio’s volatility and increases the probability that the portfo-lio will be hit with negative real returns in low inflation and bear market envi-ronments. Constructing a portfolio with

a constrained approach to volatility can help deliver a premium over inflation with greater consistency than an ap-proach that focuses more exclusively on inflation-sensitive assets.

Return trade-offs

Meanwhile, investors, and the advisors who guide them need to think carefully about striking an effective balance be-tween how much inflation protection is really needed and how much growth the portfolio can give up to get such protec-tion. For example, while Treasury Infla-tion-Protected Securities (TIPS) can be useful for a portfolio in certain environ-

ments, in periods of contained inflation (which are more common than inflation-ary shocks or spikes), investors are pay-ing a premium for that protection in the form of returns that underperform other fixed income and inflation-sensitive in-vestments.

Investor risks

Finally, portfolios need to be tailored to different investor risks. DC plan par-ticipants, particularly those at or near retirement, are among the types of investors who are most at risk of un-derperforming inflation. For one, these individuals will likely need professional guidance once they roll their assets out of their plans. Once they start to spend from their portfolios in retirement, they will typically face a host of harmful fac-tors: limited investment returns from conservatively managed investment

portfolios; less time to recoup poten-tial short-term market losses; little or no increase in savings; and required spending on necessities, whose prices are likely to rise with inflation. As a result, many investors will also need advice on balancing capital preserva-tion needs with an inflation-sensitive return target.

Conclusion: There is no silver bulletIn summary, there are no easy solu-tions to protecting portfolios against inflation risks. Just because a particular inflation-protection strategy worked in

one scenario doesn’t mean it will work again in the next environment. In order to develop the most prudent investment defense, investors need to understand how inflation-sensitive assets are likely to perform across a variety of circum-stances and environments, and choose inflation-sensitive strategies based on their own specific goals and challenges. Investors should own those assets that are most helpful (and least hurtful), whether inflation is rising or falling, while also using a diversified strategy that protects the portfolio throughout the entire inflation cycle. Given the diversity of investors and the complexity of available choices and strategies, financial advisors can play a key role in helping individuals imple-ment these complicated strategies.

“A diversified strategy that adjusts as the inflationary environment changes is critical.”

1

2

3

4


“What is the role of this asset class and how does it fit?” We integrate each portfolio’s risk profile into the inter-relationships between different types of investments.

Simonian: We’re continually updat-ing, revising and improving the mod-els and software that we’re using since they are an important part of our asset allocation process.

Another part of our process relies on the bottom-up evaluations by our in-vestment and research teams around the globe. This qualitative research results in forward-looking risk/reward assumptions and examines structural trends within individual market shifts. This is essentially our top-down, mac-roeconomic process that is informed by the quantitative process. Typically, the quantitative process helps us frame the problem, while the qualitative process drives the decision making. For us, be-ing able to integrate insights from in-vestors across our global platform is part of the process and plays a key role in determining whether we include an asset class in a portfolio or overweight or underweight it. The investors’ expe-rience in each of these markets also fac-tors into our risk controls.

A key takeaway for plan sponsors when they are evaluating target date managers—whether for an off-the-shelf or custom solution—is to invest with a firm whose process they believe

Building Smarter DC Investment Solutions to Drive Better Investment Outcomes continued from p. 9

6 JoURnEY Fall 2012

A panel discussion with J.P. Morgan Asset Management’s Global Multi-Asset Group

BuildingBuilding Smarter DC Investment Solutions

to Drive Better Investment Outcomes

Building

J.P. Morgan Asset Management JOURnEY 7

Asset allocation remains one of the best tools that investment professionals have to influence investment outcomes. For the DC industry, asset allocation solutions such as target date funds are becoming increasingly important as plan sponsors seek to improve investment outcomes for their participants. . GMAG’s professionally managed, multi-asset class DC solutions combine the benefits and characteristics of diverse markets and investment styles, tailored to specific in-vestor goals. Each DC investment strat-egy is designed to incorporate participant behaviors and retirement funding needs into portfolio construction. Depending on the client’s distinct investment chal-lenges, GMAG is focused on delivering strategic and tactical asset allocation, enhanced asset class diversification, in-flation protection, and risk management solutions. The global team includes more than 70 investment professionals and manages over $75 billion1 in assets under management.

In a panel discussion with Journey magazine, members of GMAG’s target date portfolio management team—Anne Lester, Daniel Oldroyd and Jo-seph Simonian—discussed current trends in TD investing, the role of non-traditional asset classes in DC plans, participant behavior and glide paths, as well as GMAG’s investment process behind its portfolio construction. The team members also shared their views on the changes and innovations needed

tional asset classes, such as direct real estate. Participants can take advantage of these diversifying asset classes in a way they didn’t or couldn’t before.

Journey: Where do you see opportuni-ties for innovation in the core menu?

Oldroyd: The key is to provide par-ticipants with a set of well-diversified, easy-to-use building blocks. Last year we launched our new approach, Core Menu InnovationSM, a strategy that does just this by consolidating the entire core menu into three diversified portfolios of stocks, bonds and cash alternatives. While the average DC plan includes 18 different in-vestment options, the average participant invests in just three to four funds2. Core Menu InnovationSM aims to replace com-plex and often redundant fund line-ups with three institutional-quality portfolios. The goal is to get participants to focus on asset allocation not fund selection.

Journey: You were one of the early proponents of adding non-traditional asset classes to your TD solutions. What is your view on the role of these asset classes in TD funds?

Oldroyd: Adding non-traditional asset classes, such as real estate and commodi-ties, is potentially a way to improve in-vestment outcomes and addr ess inflation risks. The key for plan sponsors is to add non-traditional asset classes in a thought-ful way. Generally, we do not believe that they make sense as stand-alone core menu options given that the majority of participants do not know how to use them appropriately. Rather, participants are better served by accessing these types of asset classes in professionally man-aged solutions, such as TD funds.

to take place to improve investment outcomes for participants.

Journey: As the DC industry contin-ues to evolve, what are some of the more effective investment innovations you are seeing plan sponsors adopting?

Oldroyd: Over the last few years, plan sponsors have been increasingly adopt-ing TD funds, which we believe are a sig-nificant innovation from an investment standpoint. We believe that these funds are, by far, the most effective investment solutions to meet the investment needs of the vast majority of DC participants. TD funds, which provide an asset al-location that gradually becomes more conservative as the fund nears its tar-get retirement date, are optimal invest-ment solutions that provide the right exposure to the right assets (including non-traditional asset classes), to the ap-propriate participant age cohort at the appropriate time.

Journey: TD funds are emerging as the preeminent investment solutions in DC plans. What are some of the spe-cific innovations that you are seeing in TD investing?

Simonian: The growing prevalence of custom TD strategies for larger plan sponsors is another innovative devel-opment. Custom strategies give plan sponsors more control and access to best-in-class managers and non-tradi-

Building

1 As of June 30, 2012.

2 Source: PSCA’s 53rd Annual Survey of Profit Sharing and 401(k) Plans, 2010; J.P. Morgan Retirement Plan Services.

Building

“A key takeaway for plan sponsors

when they are evaluating target

date managers—whether for an

off-the-shelf or custom solution—

is to invest with a firm

whose process they believe in.”

in. Plan sponsors should interview investment managers to fully under-stand the investment process each manager uses. We believe that what sets us apart from our competition is the breadth and depth of our asset al-location research, our insights, access to data on participant behavior, a fully integrated quantitative and qualitative process and our global platform.

Journey: In summary, what do you see as the future of DC plan investment solutions?

Oldroyd: We see a future where TDFs will continue to grow and evolve and where a greater portion of DC assets migrate into TDFs, driven by a num-ber of factors, such as re-enrollment.

Tomorrow’s DC investment solu-tions are likely to be made up of professionally managed solutions that contain institutional-quality investments. We believe a drive to-ward the simplification of the core lineup—where multi-asset class solutions replace stand-alone funds

in the broader menu—will benefit many participants, especially those who want to exercise some control over their invest-ment lineup but may otherwise feel over-whelmed by the number of investments, are subject to inertia or are hampered by a lack of investment skills.


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Nine in ten H O U S E H O L D S W I T H D E F I N E D C O N T R I B U T I O N A C C O U N T S A G R E E D T H AT T H E I R

R E T I R E M E N T P L A N S H E L P E D T H E M T H I N K A B O U T T H E L O N G T E R M A N D M A D E I T E A S I E R F O R T H E M T O

S AV E . M O R E T H A N 80% S A I D T H E I M M E D I AT E TA X S AV I N G S W E R E A B I G I N C E N T I V E T O C O N T R I B U T E . 6

81% of participants believe that investment fees are very important

or somewhat important in decisions about their 401(k) investments.4

71% of retirement

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In 1991, a

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Two- thirds of

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source of retirement income.3

70% of employed Americans plan to work beyond age 64,

but only 28% of current retirees actual ly did. 2

Only 42% of employees say they have taken a r isk tolerance assessment and are

aware of whether their investment strateg y is conser vat ive, moderate or aggress ive. 3

Retirement plans by the numbers

J.P. Morgan Funds combines extensive market insights with prudent stock selection and strong risk controls. That’s how our

U.S. equity funds seek to deliver consistent outperformance.

jpmorganfunds.com/equity

Investors should carefully consider the investment objectives, risks, charges, and expenses of any mutual fund prior to investing. Contact JPMorgan Distribution Services, Inc. at 1-800-480-4111 or visit us at jpmorganfunds.com for a fund prospectus, which contains this and other fund informa-tion. Read the prospectus carefully before investing.

The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s fi nancial condition, sometimes rapidly or unpredictably. These price movements may result from factors affecting individual companies, sectors, or industries selected for the Fund’s portfolio or the securities market as a whole, such as changes in economic or political conditions. Equity securities are subject to “stock market risk,” meaning that stock prices in general (or in particular, the prices of the types of securities in which a fund invests) may decline over short or extended periods of time. When the value of a fund’s securities goes down, an investment in a fund decreases in value.

JPMorgan Large Cap Growth Fund—Overall rating Select Shares; Large Growth Category; 1510 funds. Three-year rating 5 stars; 1510 funds. Five-year rating 5 stars; 1297 funds. Ten-year rating 4 stars; 855 funds. JPMorgan Equity Income Fund—Overall rating Select Shares; Large Value Category; 1082 funds. Three-year rating 5 stars; 1082 funds. Five-year rating 5 stars; 955 funds. Ten-year rating 5 stars; 579 funds.

©2012, Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its providers; (2) may not be copied or distributed; (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damage or losses arising from any use of this information. For each fund with a three-year history, Morningstar calculates a Morningstar Rating™ metric each month by subtracting the return on a 90-day U.S. Treasury Bill from the fund’s load-adjusted return for the same period, and then adjusting this excess return for risk. The top 10% of funds in each broad asset class receives 5 stars, the next 22.5% receives 4 stars, the next 35% receives 3 stars, the next 22.5% receives 2 stars, and the bottom 10% receives 1 star. The Overall Morningstar Rating for a fund is derived from a weighted average of the performance figures associated with its three-, five-, and ten-year (if applicable) Morningstar Rating metrics. Past performance is no guarantee of future results. Different share classes may have different ratings.

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. Please note investments of any kind involve market risks that are influenced by the economic/political environment as well as prevailing market conditions. J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. and its affiliates worldwide. JPMorgan Distribu-tion Services, Inc., member FINRA/SIPC.

© 2012 JPMorgan Chase & Co. All rights reserved.

J.P. Morgan Funds

@jpmorganfunds

Morningstar ratings reflect the Overall rating, Select Shares for theperiod ended 6/30/12. Ratings reflect risk adjusted return.

Learn more about opportunities in equities bysubscribing to the J.P. Morgan Insights podcasts.

We believeour performance standardsare anything but standard.

Large Cap Growth Fund – SEEGX

(1510)

Equity Income Fund – HLIEX

(1082)

TARGET DATE FUNDS:

Target date funds are funds with the target date being the approximate date when investors plan to start withdrawing their money. Generally, the asset allocation of each fund will change on an annual basis with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value of the fund(s) is not guaranteed at any time, including at the target date.

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice.

Diversification does not assure a profit nor does it protect against loss of principal. Diversification among investment options and asset classes may help to reduce overall volatility.

Certain underlying Funds of the Target Date Funds may have unique risks associated with invest-ments in foreign/emerging market securities, and/or fixed income instruments. International investing involves increased risk and volatility due to currency exchange rate changes, political, social or economic instability, and accounting or other financial standards differences. Fixed income securities generally decline in price when interest rates rise. Real estate funds may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector, including but not limited to, declines in the value of real estate, risk related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by the borrower. The fund may invest in futures contracts and other derivatives. This may make the Fund more volatile. The gross expense ratio of the fund includes the estimated fees and expenses of the underlying funds. A fund of funds is normally best suited for long-term investors.

IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaf-filiated with JPMorgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

J.P. Morgan Funds are distributed by JPMorgan Distribution Services, Inc., member FINRA/SIPC.

J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. and its affiliates worldwide.

© JPMorgan Chase & Co., August 2012

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Retirement Insights and Solutions from J.P. Morgan Asset Management

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Journey - J.P. Morgan Home | J.P. Morgan · Retirement Plan Business, shares her views on the growth of the segment and on small- to mid-sized business owners’ needs and priorities