On June 13, 2019, the World Economic Forum (WEF) Retirement Investment Systems Reform project released its third white paper titled, “Investing in (and for) Our Future,” with Mercer as project partner (disclosure: I serve on the Expert Committee for this project). The paper makes the concerning observation that “retirees in six major economies should expect to outlive their savings by eight to nearly 20 years on average, with women and Japanese retirees outliving their savings for longer.”
While a previous WEF paper focused on the need for retirement systems to provide a “safety net” pension and improve access to cost-effective retirement plans for all, as well as to support initiatives to increase contribution rates, the latest release went further to identify two key actions that retirement systems should take to make them more effective:
I recently had the honor to be able to interview Han Yik, Head of Institutional Investors at the WEF, and Amish Gandhi, Lead Author and Project Collaborator, who was seconded to the project from Mercer, and explore their thinking about these two action steps. The following Q&A was edited lightly for length and clarity.
Neil Lloyd: Han, can you tell us what you mean when you say, “Consider risk from the perspective of someone saving for retirement?” And is this something you think the U.S. retirement system has figured out correctly?
Han Yik: I think the idea stems from thinking strategically for the long term, an idea that has gained a lot of traction lately through comments by industry leaders such as Larry Fink, the CEO at BlackRock. Larry has been very vocal about how companies and corporations need to be thinking for the long term.
Similarly, both the U.S. government and individuals as retirement savers need to be thinking about pension savings from a long-term perspective as well. As to the question whether the U.S. has this right, I think there is room for improvement in two key areas: daily liquidity and daily valuation. Retirement assets are supposed to be accumulated over many years - decades actually - and therefore the idea that we as long-term savers should have the ability to liquidate, rebalance, and trade on a daily basis does not make sense. In fact, there’s ultimately a cost associated with having those options - a cost that is ultimately borne through reduced long-term returns.
Neil Lloyd: Amish, you were very involved with the work around improving asset diversification globally. What were your learnings for the U.S.?
Amish Gandhi: We considered typical allocations for defined contribution (DC) plans that tend to heavily invest in public markets (think public equities such as the S&P 500) and thought about the appropriateness of this. The number of listed companies in the U.S. has significantly declined, from a peak of around 8,000 in 1996 to less than 4,500 companies in 2017. The opportunity set in the U.S. is nearly half of what it was 20 years ago. While the market capitalization of public markets as a percentage of GDP remains high, the average 401(k) or DC investor currently doesn’t have private equity in their portfolio. That’s limiting opportunities if you want deep and broad exposure to the U.S. equity market.
Also, in the U.S. there is significant pressure on fees, particularly within the 401(k) space. In isolation, this is a good thing because fees have come down for most Americans. But we feel it’s important that fee pressures don’t stifle innovation and prevent Americans from achieving better diversification in their portfolios.
Neil Lloyd: Many have observed how qualified plans have had limited traction with alternatives, which is in line with your comments on daily liquidity and daily valuations. While people might not need actual access to their capital daily, people have gotten used to seeing real-time values and, if needed, being able to transact daily. Han, how can we move the argument for alternative asset classes forward without necessarily getting pushback from participants about not having the same access to their money that they’ve had in the past?
Han Yik: I think that’s a great question. One of our key findings is that we actually do want to plug some of the liquidity holes, in assets clearly earmarked as retirement assets. We think that there should be limited access to those funds for other purposes. There currently are a number of ways in which participants can access their retirement money early, such as home purchase and college tuition. But if the ultimate goal of the system is to secure sustainable and adequate retirement income, then I think we do need to limit the conditions for early withdrawals. That access comes at a cost, in the form of reduced accumulation of your retirement nest egg. Similarly, the option that people have to check and trade on their daily balances also comes at a cost. I’d be curious to see how often people actually rebalance their 401(k) accounts. I am willing to bet that it isn’t daily. But again, providing the ability to do so comes at a cost in retirement accumulation.
Neil Lloyd: Decumulation is a hot topic these days, and it’s discussed at some length in the paper. What would you highlight from your deliberations?
Han Yik: I would stress the need for stronger fiduciary rules and protections. This move globally from defined benefit plans to defined contribution plans has shifted the burden of investment risk, financial management risk, longevity risk, and other risks away from the government and employer onto the individual.
So, we either need to arm people with the tools to be able to make those decisions themselves, or we need to have strong rules in place so that they can be confident that the advice they are receiving is in their best interest -unbiased, and transparent in terms of what fees pay for, and where they come from. I think having strong fiduciary rules in place to protect individuals is one of our key recommendations for decumulation.
Neil Lloyd: Amish, along these lines, there was interesting wording in the paper about “retiring retirement.” Can you discuss what that’s about?
Amish Gandhi: We have been mindful about what retirement actually means in today’s world, and in particular whether people stop working when they reach retirement age. A global Mercer survey notes that only 32% of people expect to completely stop working at the point of retirement, and McKinsey separately reported that, from a survey of six developed nations, around 7% to 16% of people over age 65 make up the independent workforce, or what is known as the “gig economy.” I think that highlights why we need to rethink what a retirement solution should look like. Or at the very least accept that circumstances will differ greatly person-to-person, and that an element of personalization is going to be required.
Neil Lloyd: To both of you, any last words or comments?
Amish Gandhi: The challenges identified in the project appear to be very daunting, but with concerted and committed action - from policymakers, corporations, and individuals - I am optimistic that we can help improve retirement outcomes for generations to come.
Han Yik: In a lot of the conversations we’ve had with people inside the industry, we’ve learned that it’s impossible to separate what people will need in retirement without considering the costs of healthcare. And while healthcare costs for retirees vary from country to country, it can become a significant part of retirees’ expenditures as they continue to age. Ultimately, when we’re looking to solve this problem of what individuals need in retirement, we can’t ignore the cost of healthcare.
Neil Lloyd: Thank you both for a great discussion.
Hear our perspectives on the latest retirement news and trends. Receive articles directly in your inbox as soon as they are posted.
Please see Important Notices for further information.
Mercer does not provide tax or legal advice. You should contact your tax advisor, accountant, and/or attorney before making any decisions with tax or legal implications. This does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances