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The Principal Financial Group has published a report, entitled ‘A 360 Degree Approach to Preparing for Retirement’, assessing innovations, gaps and trends within the US retirement system.
Among its findings, the report identifies key areas of innovation in lifecycle investing and paints a rosy picture for the exchange-traded funds industry.
The report was based on a survey of 148 asset managers, plan sponsors and financial advisors with active involvement in the 401(k) plan space. The respondents had combined assets under management totalling $15 trillion. The survey was followed by 30 interviews with a cross-section of respondents.
The report notes that the participant-directed defined contribution (DC) plans are the cornerstone of the private sector retirement system in the United States. Currently, they account for about $9.7 trillion of the approximate $16.5 trillion in total pension assets. But in the eyes of many, they also paint a bleak future of inadequate savings, poor investment choices, high charges and inadequate retirement nest eggs.
However, the report notes that the winds of change have been evident since the Pension Protection Act of 2006. The 2006 Act has accelerated innovations in the two phases of lifecycle investing: the Accumulation Phase and the Decumulation Phase.
In Accumulation Phase, target-date funds have emerged as one of the top investment innovations of the last decade. With an age-based glide path of asset mix, they have gained traction, holding $500 billion of assets in 2012 — a figure likely to grow at a compound annual growth rate (CAGR) of 15%.
Evolving out of the traditional target-risk funds, target-date funds will morph into a best-in-class retirement product via two routes over time — hybrid target-date funds and target-income funds. The new variants of target-date funds will shift the focus from asset maximisation to liability matching, thus shedding the tyranny of market or peer benchmarks that cost investors dearly in the past.
The report identifies significant innovation in the ETF space, citing plans to create ETFs based on lifestyle risk, with distinct tilts towards healthcare, life sciences, fuel, transportation and retirement communities.
In the Decumulation Phase, diversity will characterise the emerging line-up of new products. In fact, two sets of generic retirement income funds are already emerging alongside annuities.
The first set covers diversified-income funds that aim to deliver a combination of regular income, inflation protection and low volatility. The second set focuses on managed drawdown accounts. Some seek to pay a percent of principal to the retiree each year, ranging from 3% to 7%. Some seek to distribute principal over a pre-defined period, typically 10 to 30 years.
The use of ETFs, the report highlights, is nascent. More and more financial advisors are likely to channel assets into them, such that the total ETF assets will top $9.5 trillion by 2020, up from the current level of $1.7 trillion.
As their registration process becomes less onerous, active ETFs in particular are likely to proliferate and drive this growth, the report suggests.