January 29, 2013 (PLANSPONSOR.com) - Plan sponsors face an “equity dilemma” of ensuring participants have adequate retirement savings while protecting them from volatility.
So how can they balance the need to keep an equity allocation high enough to ensure participants have enough retirement savings, with the need to keep the allocation low enough that they have greater protection from market risk? The answer is a low-volatility strategy in a portfolio’s equity sleeve, Mike Raso, senior vice president and director of institutional retirement at Old Mutual Asset Management, told PLANSPONSOR.
This strategy offers both downside protection and upside participation for investors, Raso said. Greater downside protection, especially near the end of a participant’s accumulation cycle, must be built into the equity sleeves of retirement plans to avoid a repeat of the 2008 financial disaster’s effect on retirees, according to Old Mutual’s paper, “The Target Date Equity Dilemma.”
While plan sponsors cannot control the contributions and time components, they can control investment volatility, which is why target-date funds (TDFs) are ideal beneficiaries of a low-volatility strategy, the paper explains. It outlines three main approaches to lowering the volatility of an equity sleeve in the TDF:
- Utilizing defensively oriented value managers;
- Hiring managers who use a quantitative approach to produce a portfolio designed to have the lowest expected volatility for a given set of constraints; and
- Utilizing alternatives (such as commodities, managed futures, real estate and hedging strategies) in conjunction with traditional equity strategies to smooth returns and create a low-volatility effect. “We’re really starting to see real estate make its way into customized TDFs,” Raso said. “Commodities are making their way, too.”