Considering the president’s signing of the Countering America’s Adversaries Through Sanctions Act into legislation slightly over a year ago and the recent highly-publicized trade war between the U.S. and China, it’s unsurprising that retirement plan sponsors, participants and advisers are wondering whether, if at all, retirement savings will be affected.
In most minds, trade, as an economic event, is out of bounds in the retirement planning sphere, but this is wrong. While trade wars may be defined as unjust practices or penalties imposed by federal governments—such as unfair and expensive tariffs raised by countries in order to spite one another—the consequences impact investment classes, including equities and emerging markets, which affects defined contribution (DC) and defined benefit (DB) plans as well.
Trade sanctions, for example, can introduce greater risks for investment classes, which in turn reflects on these securities going forward, says Greg Woodward, managing director for the Portfolio Strategies Group at Manning & Napier. To combat this, he asks investors to consider the current economic climate, and whether purchased investments are appropriate.
“We should certainly look at the environment, look at the pricing and try to understand where we are in the cycle,” he says. “What types of equities are you buying? What kind of fixed-income are you buying? Try to position the portfolio for some of those risks.”
Impacts on DC and DB plans
In connection with DC and DB plan sponsors, effects from trade wars and sanctions can influence underlying equities and assumptions driving the return on plan assets, says Bill Kornitzer, CFA, portfolio manager at Buffalo Funds.
While there is a risk, Kornitzer says plan sponsors mustn’t need to reconsider investment menus or plan asset allocations. They ought to instead focus on portfolio holdings.
“They should check their holdings and make sure they understand what the potential effects of what the trade actions could be, with respect to their underlying investments,” he says. “For our portfolio holdings, in terms of what we’ve managed, we’ve looked at how these trade wars could impact our holdings’ fundamentals. We don’t see a lot there on specific company holdings, but there could be a little bit of overall economic pressure to various countries, depending upon how the actions actually come out.”
In the case where tariffs do or don’t effect plan participants, Woodward recommends plan sponsors consistently utilize all plan features and tools to keep them calm, from target-date funds (TDFs) to participant education communications.
“You should be thinking about the long run and diversification and what menus look like, irrespective of what happens in a year-to-year basis,” he notes. “I think you should regularly review your menu and make sure there are options for all types of participants, whether that’s participants who are going to have an automatic default option, or those participants who are going to choose on their own.”
Similar to DC plan sponsors, employers with DB plans must recognize particular industry risks with certain tariffs and keep an eye on underlying plan portfolios.
“They need to understand the specific industry risk around specific tariffs and how the tariffs might impact their business directly, and then look at the underlying portfolios for their plans, and make sure that they’re sheltered or hinged from any potential damage tariffs can have,” Kornitzer says.
Woodward echoes this statement, adding how investors managing DB plans must consider investing in particular environments, like one with lower expected economic growth, given the recent trade war between the U.S. and China, where the latter has previously held a substantial portion of global growth increases.
“It may mean taking some of your equity risk down,” he says. “Equity has compounded over a double-digit range in the last eight, nine, 10 years, probably well above kind of expected or actuarial rates of return. Investors in DB plans need to start thinking about derisking the portfolio a little bit, particularly if they’ve had elevated allocations to equities.”
Instead, DB plans may find success in moving to fixed-income exposures, but it comes with new sets of risks related to interest rates, Woodward points out.
Look for opportunity
Rather than fearing over trade wars and sanctions, Kornitzer recommends investors search for increased market volatility surrounding trade war talk.
“Buy out assets at better prices, which should help plan returns over time,” he says. “Now again, you have to be industry-specific and a little careful, and at least somewhat judicious of what you’re looking for, but in the overall scheme of things, it’s not a huge disaster.”
In reality, certain tariffs may only impact their respective industries. For example, steel and aluminum tariffs heavily affect steel producers who import to the United States. Kornitzer explains that while this could hurt underlying economies of those companies, it may also benefit U.S. companies in the steel and aluminum industries as they hold price floors and ceilings to raise prices against foreign steel.
“Look for the opportunities in investments, because overall, we’re talking about a slowdown in the rate of growth in these massive economies,” he says. “Will it impact one industry a little bit more than the other? Sure, depending on what industry the trade barriers are erected in, but that potentially provides opportunities within similar industries or within companies that do the same business within the U.S. or whichever companies are erecting the trade barriers.”
Brace for change
Because of trade sanctions between the U.S. and China, Woodward warns, it is wise for investors to expect adjustments. If the current trade war continues, he says, risk will increase and may potentially raise volatility. In an environment where low volatility has reigned for the past several years, trade sanctions may interrupt that momentum.
“When you think about where we are—eight, nine years into a market cycle, we’ve had terrific performance in just about every asset class. No matter where you’ve invested, you’ve done quite well, and I think that makes investors make decisions where they may be taking on additional risk cause they’re not expecting anything bad to happen,” he says.
To prevent investors from experiencing trouble, Woodward suggests plan sponsors and advisers keep an eye on the current, and prospective, market climate.
“Investors need to have that mindset, that we may have more risk, more volatility, and they need to start preparing their portfolios for that,” he says. “We don’t want to suggest or predict that anything bad will start to happen, but we think investors will need to start thinking about an environment going forward that may be quite different from what they’ve seen in the last seven to nine years.”
« ERISA Section 404(c): Back to Basics