Being average means you are as close to the bottom as you are to the top.

—John Wooden, Wooden: A Lifetime of Observations and Reflections On and Off the Court

The third of four pillars of a well-balanced core lineup is equity investments, the focus of this chapter. Offering access to the equity markets within a defined contribution (DC) plan is fundamental—but what’s challenging is determining the number and types of equity choices. Whatever the number, the choices should provide participants with the opportunity to reap both capital appreciation and income from equity markets worldwide. Broadening the opportunity set beyond developed markets opens the door to the world’s most rapidly expanding economies and return opportunities. Unfortunately, today’s DC equity lineups often lack broad access to global markets. What’s more, lineups are often shackled to market-capitalization-weighted indexes, which may further hamper returns and heighten volatility.

By restructuring the equity lineup to include global, dividend, and enhanced index strategies, plan sponsors may improve DC participants’ risk-adjusted return opportunity and the likelihood of retirement success. In this chapter, we’ll examine how equity options fit in DC plan design and what strategies are available and in use today, and how they may evolve in the future. We’ll also consider the role of active and passive management in equity options, how behavioral economics influences the ways in which we evaluate market efficiency, and questions plan sponsors may have about currency hedging.

WHAT ARE EQUITIES AND HOW ARE THEY PRESENTED IN DC INVESTMENT MENUS?

Equity investments are also referred to as stock investments. Stocks represent an ownership stake in and a claim on profits of companies. Stocks may be issued in common or preferred shares. The latter combines the features of equities and bonds, as preferreds generally must pay dividends (which must be paid out before dividends paid to common shareholders), and have the potential of price appreciation (although usually do not carry voting rights). By contrast, common shares may or may not pay dividends and the dividends are never guaranteed. When people talk about stocks, they’re usually referring to common stock. Equity investors seek capital appreciation and possibly dividend income.

Stocks are issued by small, medium-, and large-size companies all around the world. Equity investors may prefer value stocks that have relatively lower price-to-book (P/B) and price-to-earnings (P/E) ratios, and identify those as the best bargain stocks the market has to offer. Or they may prefer growth stocks from industries with strong price momentum and higher P/E ratios and P/B ratios as indicative of the market’s confidence in a company’s ability to continue increasing earnings at an above-average pace. Depending on the market cycle, growth stocks may outperform value stocks or vice versa. DC plan fiduciaries often prefer offering a blend of value and growth stocks as this approach may reduce price volatility for participants.

Given the current expectations of slow global growth at the time of writing, equity markets have the potential to be meaningfully lower than their long-term, pre-2008 averages. In this light, achieving target returns will rely on thoughtful asset allocation with total return coming from some combination of beta (a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole), alpha (the excess returns of a stock relative to the return of the market as a whole), and/or income.

As discussed in Chapter 3, DC plan design historically has been driven by “filling the equity style box” (see Figure 7.1) and offering a range of equity choices, including U.S. large-, mid-, and small-capitalization stocks, and possibly value and growth strategies. Typically, there is at least one index strategy— commonly the S&P 500 Index, which falls into the large-cap blend style box—plus a non-U.S. developed market equity choice. While the style box approach provides many choices—filling the box would provide nine equity choices plus international equity—the long list of equity choices may unintentionally expose participants to excessive equity risk, including price volatility.

In our 2016 DC Consulting Trends Survey, at the median, consultants recommended that plans include six equity investment choices. Blended equity strategies are suggested more often than a style-based strategy (value or growth) for all market capitalization segments. As shown in Figure 7.2, consultants also recommended non-U.S. developed equity, either unhedged (70 percent) or hedged (35 percent). Given six seats in the stand-alone core lineup, consultants may suggest the following choices: a large-cap blend passive (typically the S&P 500 Index), large-cap dividend or blend active, mid-cap blend active, small-cap blend active, non-U.S. developed active, and emerging markets active. Others would suggest a shorter list of four strategies by combining mid- and small-cap into a “smid” strategy and blending non-U.S. developed and emerging into a non-U.S. fund. As you can see in Figure 7.2, just over half of respondents recommend inclusion of a global (51 percent) and 43 percent recommended a U.S. all-cap fund; consultants recommending the broader blends are also likely to recommend a shorter list of core equity offerings. Within blended strategies, consultants’ recommendations are similar to those suggested for the stand-alone lineup.

In practice, plans offer a range of equity options, according to data from the Plan Sponsor Council of America, including actively managed domestic equities and international/global equities (with 80 percent and 75 percent of plans offering these), and indexed domestic and international/global equities (at 78 percent and 51 percent of plans, respectively). In comparison, plans are less likely to offer a stand-alone emerging markets fund (at 37 percent of plans). With the exception of emerging markets, the larger the plan size, the more likely it is to offer each of these options. PSCA also reports the number of choices in each category, showing plans on average offer 9.2 equity funds, including 4.8 actively managed domestic equity funds and 1.8 passively managed domestic equity funds. Similarly, actively managed international equity offerings are more prevalent than passively managed (at 1.6 and 0.6 of funds, respectively). Only 19 percent of plans offer company stock, yet the larger the plan, the more likely this offering at 44 percent of the largest plans (those with 5,000 or more participants).

Asset allocation to equity offerings was reported at 58 percent with the majority of the allocation made to actively managed domestic equity (19.4 percent), company stock (16 percent), and passively managed domestic equity (14.1 percent). International equity captures the remainder of the allocation with actively managed international equity at 4.3 percent, passively managed at 3.2 percent, and emerging markets at 0.6 percent. These low levels may raise concern that DC participants may be underallocated to international equity, with only 14 percent of the equity allocation to international equities (as shown in Figure 7.3), given that the MSCI ACWI is composed of approximately 50 percent U.S. equities. (The Morgan Stanley Capital International All-Country World Index, or MSCI ACWI, is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world.) If we consider smaller plans (with less than 5,000 participants) that are not as likely to offer company stock, we still see an underweight to international stocks, at 17 percent of the equity allocation according to PSCA. The typical reason for this is simple: Individual DC investors express the home-market bias possessed by all investors across geographies, investing in assets they are most familiar and comfortable with and that they understand best.

In designing equity offerings, sponsors may first consider the balance of investment choices within their plan. By offering more domestic equity choices, it’s not surprising that the allocation to these funds overall is higher than international offerings. What also influences participant allocation is the tenure of the option on the investment menu; international funds are likely to be more recent additions and thus may lack the active allocation or investment growth relative to domestic equity offerings—these may have been offered for decades and have experienced not only early allocations but also asset growth.

As discussed in earlier chapters, menu design will influence a participant’s investment decisions. As discussed previously, given 10 investment options, many participants will allocate an equal percentage to each; thus, a DC plan with 10 investment choices, including seven equity options, may encourage participants to weight 70 percent of their assets to equities. Figure 7.4 provides the result of an experiment in which one group of employees was offered four fixed-income funds and one equity fund, while another group was offered four equity funds and one fixed-income fund. Consistent with the theory of naive diversification, the second group selected significantly more equity options than the first group—by a 25 percentage-point spread.

Given menu design concerns, plan sponsors are increasingly moving away from the style-box approach to either a risk-pillar menu or, more commonly, an asset-class-focused core lineup. One reason for the move away from the style box approach is that plan sponsors witness how the style-box construct inadvertently promotes performance chasing (entering or exiting a trend after the trend has already been well established). As noted above, growth and value moves in cycles, but so does large-cap versus small-cap, U.S. versus non-U.S., and developed market versus emerging market equities. The potential for participants with varied levels of sophistication to exclusively select funds with the best three-year past returns is significant. This decision is, however, often followed by a period of underperformance, after which time the fund is sold and the proceeds placed into another fund that now has the best three-year return, and the cycle continues. It’s also important to point out that style-box diversification has decreased over time as the correlation among equity styles has increased. Figure 7.5 shows that the average rolling three-year correlation to the S&P 500 Index among equity styles has increased since 2000. This reality is prompting more plan fiduciaries toward equity lineup consolidation, and to seek more diversifying assets.

Plans with a risk-pillar approach may offer a single equity choice, plus the three other diversifying risk pillars: capital preservation, fixed income, and inflation-hedging assets. This selection may be refined further by folding inflation-hedging strategies such as Treasury Inflation-Protected Securities (TIPS) into a broad income category, and risky assets such as real estate and commodities into a growth bucket. Plan sponsors with risk-pillar lineups often have sufficient scale to create multimanager (that is, white-label) investment strategies that blend investment approaches and best-in-class managers within each strategy. This approach may clean up the menu by combining many of the managers into a single offering, after which plans may seek additional investment managers or approaches to complete the risk pillar. In a DC Dialogue from September/October 2015, Gary Park, Director of Trust Investments at Schlumberger, described his plan’s streamlined core investment lineup:

We have four white-label investment options that serve as our core lineup. These include a short-term bond fund, a core bond fund, a U.S. equity fund and a global equity fund. Each fund is made up of select asset classes from our group trust. The trust has a broad range of asset classes, including large cap, small cap, low-volatility equity, international equity, emerging markets equity, Treasury Inflation-Protected Securities (TIPS), and intermediate bonds.

He goes on to explain the makeup of the two equity funds:

Yes, we have a U.S. equity fund that is broadly diversified to include all cap sizes and investment styles. There is not a bias toward a cap size or style, such as value or growth. We also offer a global equity fund that is made up of non-U.S. developed and emerging market equity plus U.S. equity, so participants gain broad exposure to the entire global equity market.

By including U.S. equity in the fund, we dampen volatility for participants. We also don’t want to overwhelm participants with too many investment choices. We know that when people have too many choices, they may not make any choices. By offering a globally diversified equity fund, they access the broad global equity markets without having to ask “Should I move between the U.S. and non-U.S. markets now?” The fund we offer gives them the opportunity to invest outside the U.S. without as much risk.

For many plan sponsors, reducing the core investment lineup to just three or four options may be viewed as too extreme, particularly if they are concerned about being perceived as taking away choice. Some plans may lessen the concern of a “take away” by offering access—possibly even transferring allocations—to favorite brand-name mutual funds via a brokerage window. For plans lacking the necessary scale for white-label strategies or preferring to offer more choice, an asset-class-focused menu may be more desirable. This approach often still requires at least some paring down of equity choices, possibly combining equity styles and eliminating redundancies, and then adding more diversifying assets such as global equity, inflation hedging, and fixed income. As discussed in Chapter 3, Figure 7.6 shows the movement from a style-box to an asset-class or risk-pillar focused core lineup.

Simplifying a menu can help participants make better selections and improve their ability to stay the course—rather than chasing performance or, more likely, fleeing an investment during a sudden market decline, and thus locking in losses. Combining investment strategies and styles may help dampen abrupt swings in performance.

GETTING THE MOST OUT OF EQUITIES

Once sponsors have determined the structure, they may focus on selecting the best strategies for each asset or risk category. When considering equity returns—which are driven largely by capital appreciation and possibly by income—the opportunity set (all risk-and-reward combinations that can be constructed with the available assets and within the environmental constraints) is a good place to start. As Figure 7.7 shows, total global stock market capitalization was $66.9 trillion at the end of Q4 2015, according to the World Federation of Exchanges. Non-U.S. equities, including Asia-Pacific and EMEA (Europe, the Middle East, and Africa), accounted for over half of global stock market capitalization.

To maximize capital appreciation opportunities, DC participants may benefit by accessing high-growth markets, including many emerging markets (EM). Figure 7.8 shows that many developing countries are projected to have faster GDP growth than developed countries in North America and Western Europe. Given that EM represent over half of the world’s GDP, investing in these markets—directly or via developed market companies that source earnings from EM—may offer a significant opportunity for capital appreciation.

These markets, however, also may expose participants to greater risk. Thus it may be preferable (and advisable, given naive diversification) to offer a blend of higher-growth markets and more stable—if slower-growing—developed markets. Figure 7.9 shows that over the more than 15 years ending December 31, 2015, a strategy that blended U.S. large-cap, non-U.S. developed, and EM equities had lower volatility and maximum drawdown than an EM-only strategy. Notably, participants gained 150 basis points (bps) in return relative to a blend without EM, with a slight increase in volatility.

Going forward, consultants expect these general relationships to continue; in 2016, consultants forecast over a three- to five-year horizon both higher expected returns and volatility for EM and non-U.S. developed equities compared to U.S. large-cap equities, with median forecast returns of 9.9, 7.3, and 6.6 percent, and volatility of 26.5, 20.2, and 17.7 percent, respectively, based on PIMCO’s 2016 Defined Contribution Consulting Support and Trends Survey. Given the level of historic as well as expected volatility for EM, it’s not surprising that few plans offer this investment option as a stand-alone core option. Blending EM along with developed-market equity or also with a U.S. large-cap core allows plans to potentially capture the enhanced return opportunity, yet with dampened volatility.

CONSIDER DIVIDEND-PAYING STOCKS

DC participants, retirees in particular, also may benefit by seeking income, including via dividend-paying stocks. Against a backdrop of low interest rates and slow growth, these may offer more attractive and more stable total returns than non-dividend-paying companies. In a low-growth environment, dividend payments may provide a larger percentage of equity returns. Even as rates rise, dividend-paying stocks may offer higher return potential than non-dividend-paying peers—and even fixed income (see Figure 7.10). Further, dividend-paying equities usually have lower volatility and lower correlation with broad equity markets.

EVALUATING EQUITY STRATEGIES

As discussed, DC plans may get the most out of equities by restructuring core menus to provide access to equities in markets globally, including dividend-paying stocks. But before doing so, we suggest plans evaluate a range of statistical measures, both historically and prospectively. The key measures include:

• Risk-adjusted return measures the return delivered relative to the risk taken.
• Correlation to the S&P 500 shows the potential diversification benefits of different equity strategies relative to a common core equity investment offering.
• Downside risk measures potential loss. We suggest using a forward-looking measure of potential risk exposure, for example, value-at-risk (VaR) at a 95 percent confidence level. (VaR estimates the minimum expected loss at a desired level of significance over 12 months.)

• Dividend yield can be an important component of total return from equities. Over the 15-year period, the MSCI ACWI High Dividend Index had an average dividend yield of 3.9 percent, the highest among the 14 equity indexes listed in Figure 7.11.

In addition, plan sponsors should consider metrics for actively managed strategies. These include active share, which helps determine potential for outperformance relative to benchmarks, and the upside-versus-downside capture ratio, which shows whether, and by how much, a strategy has gained or lost relative to a broad market benchmark during rising and falling markets.

Figure 7.11 offers a comparison of these measures across various slices of the global equity markets.

LESS IS MORE: STREAMLINING EQUITY CHOICES

Reducing the number of equity choices may help improve returns and reduce risk. In Figure 7.12, assuming a naive diversification approach, we can see that streamlining from six options (current equity portfolio, which is equally weighted across six asset classes) to four options (consolidated equity portfolio, which is equally weighted across four asset classes) provided a better risk-adjusted return, lower correlation to the S&P, and a higher dividend yield over the more than 15 years ended December 2015.

SHIFT TO ASSET-CLASS MENU MAY IMPROVE RETIREMENT OUTCOMES

We suggest plan sponsors evaluate the current plan lineup relative to one that includes global equity and dividend strategies. For example, a lineup may include six equity options, two fixed-income options, one capital preservation choice, one inflation-hedging strategy, and one global balanced option. Figure 7.13 shows this current or typical DC lineup, which, if naively diversified, would have 60 percent allocated in equities, three-quarters of which are in domestic stocks.

Consolidating domestic equity strategies and adding global equity options can give participants a more balanced DC menu (Figure 7.14) with the potential for better risk-adjusted return, lower correlation with the S&P, lower maximum drawdown, and lower VaR (95 percent) than the current portfolio under the “typical menu” (see Figure 7.15 for asset allocation details).

ACTIVE VERSUS PASSIVE—THE ONGOING DEBATE

In addition to the plan design considerations such as style-box, asset-class, or risk-pillar approaches, other important considerations are whether plans and participants should use actively managed equity strategies, passive strategies, or strategic betas instead—or a blend of some of each, depending on the asset class. (Strategic beta is an approach that mixes elements of both passive and active investing, usually incorporating one or more factor tilts relative to standard market indexes.) As shown in Figure 7.16, while 37 percent of consultants believe active management is not important for U.S. large cap equities, 63 percent believe it is at least somewhat important. By comparison, the participating consultants believe active management of EM, non-U.S. developed, and U.S. small-cap equity is important or very important at 96, 88, and 80 percent, respectively.

Consultants may explain that they assign lower importance to actively managing large-cap U.S. equity as they may view these markets as more efficient. Few consultants believe all equity markets are efficient; those that do may follow the efficient market hypothesis (EMH) formulated by academic Eugene Fama in 1970. The EMH holds that it is impossible consistently to “beat the market” over time, as stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. Yet over time, top performing portfolio managers have been able to beat the market—that is, they have been able to outperform the benchmark for their strategy. (see Figure 7.17)

In April 2015, as part of our DC Dialogues series we spoke with Professor Richard H. Thaler, Charles R. Walgreen Distinguished Service Professor of Economics and Behavioral Science at the University of Chicago Booth School of Business, about his most recent book, Misbehaving: The Making of Behavioral Economics in which he writes about market efficiency and why he doesn’t believe markets are efficient. We asked him to explain his thinking:

It’s important to stress that there are two aspects of the efficient market hypothesis. I like to refer to these as the “no free lunch” component and the “price is right” component. The “no free lunch” component is that you cannot beat the market, a belief held by noted colleagues at the University of Chicago. Much of academic debate has been about this component. I think the real question is whether beating the market is impossible or hard. My colleagues argue impossible, and I would say hard.

On average, studies have shown that large-cap equity managers tend to underperform the market after fees. This means that investors should be cautious. And people who invested in Ponzi schemes should have known better. No one can beat the market by 10 percent a year every year for whatever number of years in a row. The markets are too efficient for that.

Now, we know that certain parts of the market are more efficient than others. Large caps are more efficient than small caps. Liquid traded equities are more efficient than less liquid private equity. Emerging markets are less efficient than developed markets. Overall, I would give the “no free lunch” component of the efficient market theory something like a B+ or A–, so mostly true.

When we asked him about the “price is right” component of the efficient market hypothesis, he said:

The “price is right” component refers to the fact that prices are supposed to be equal to their intrinsic value. This one is much harder to test because who knows what the intrinsic value is. If I ask you what the intrinsic value of Apple is and whether it’s really worth its $700 billion market cap or whatever that number is, nobody can answer that question.

That means this component of the efficient market hypothesis can be harder to evaluate. . . . There’s lots of research on mispricing, including the market bubbles we have experienced over the last 30 years. . . . Market bubbles are of enormous importance as a public policy matter. Central bankers and policy makers have to be worried about frothy markets. We’ve seen what can happen when a frothy market—especially one that’s accompanied by substantial leverage—crashes. We’re still digging our way out of one seven years later. So I think we need to worry a lot more about that. And when it comes to that part of the efficient market hypothesis, I think it’s quite dubious.

Fischer Black, the co-inventor of the Black-Scholes option pricing model, once said that stock markets were efficient, by which he meant prices were correct within a factor of two. But, as I write in my book Misbehaving, I think that had he lived to see 2000, he would have revised that to within a factor of three. And that’s not a very efficient market.

Rather than moving to fully active equity management, many may be interested in an approach that falls in between active and passive, often referred to as smart beta or what Morningstar thought leader John Rekenthaler refers to as strategic beta. Rekenthaler explains that strategic beta means “investing in indexed portfolios—but not the usual variety of index that copies an entire market. Strategic-beta funds own part of a marketplace, those securities that are exposed to a particular factor (or factors). . . . The concept is actually quite simple. A value-style index fund is a strategic-beta fund that uses the single factor of value.”¹ Other options include multifactor strategic-beta funds that use more than one factor, such as the two factors of small and value.

In Rekenthaler’s view, the strategic beta approach is the simplest of paths for those who wish to invest actively, as this approach is less complex and more transparent than many other investment innovations. Instead, with a strategic beta approach, a model that sorts for the factors that drive active performance, including low liquidity, cheap stock-price multiples, and high stock-price momentum.

“Today’s investors,” comments Rekenthaler,

recognize the importance of cost as never before, and they are equally aware of the struggles of active management. . . . Some will opt for fully passive portfolios. Most, however, will retain some thrill of the chase by blending passive with active. And that active portion might well take the form of strategic beta, particularly as investing actively through strategic-beta funds reduces surprises and eases information-gathering.

Using a strategic beta approach such as a fundamentally weighted index may enhance participant returns and reduce risk.

STRATEGIC BETA: CONSIDER ADDING FUNDAMENTALLY WEIGHTED EQUITY EXPOSURE

By investing in broadly diversified portfolios that de-link stock price from portfolio exposure, participant outcomes may improve. Traditional indexes weight stocks in proportion to their market capitalization. Because weights in a market-cap index are proportional to a company’s market value, distortions in stock prices flow into investors’ portfolios. Portfolios that select stocks based on fundamental measures, in contrast, gauge a company’s economic footprint using publicly available financial data, including, for instance, sales, cash flow, book value, and dividends.

The primary source of outperformance over long periods for non-price-weighted portfolios is trading against the market’s most extravagant bets—which are also those most likely to be wrong. As Figure 7.18 shows, adding fundamentally weighted U.S. equity indexes may provide notably better risk-adjusted returns.

Incremental alpha (excess return), compounded over the years, can be substantial. As Figure 7.19 demonstrates, a January 1999 investment of $100,000 in the consolidated portfolio with fundamental indexing could have grown to $280,018 by December 2015, compared with $246,353 and $248,427 in the current and consolidated portfolios, respectively.

CURRENCY HEDGING: AN ACTIVE DECISION

In addition to management style (active versus passive), plan sponsors and participants need to make decisions about whether it makes sense to implement currency hedging for non-U.S. strategies. In PIMCO’s 2016 Defined Contribution Consulting Support and Trends Survey, we also asked consultants why plan sponsors should consider hedging non-U.S. currency exposure (Figure 7.20). Notably, we were not specific as to fixed income or equity. The majority of consultants (53 percent) said plan sponsors should consider currency hedging given the potential for reduced volatility. They also noted concern that “plan participants do not understand” (and thus should not be exposed to) currency risk (39 percent), and the reality that “plan participants live in the United States” and can be expected to spend their retirement dollars there.

When asked whether they would recommend hedged or unhedged fixed-income options, an approximately equal percentage of consultants suggested the inclusion of foreign or global hedged (35 percent) as those who suggested unhedged (33 percent). Similarly, with emerging markets, fixed income hedged (14 percent) was suggested by about the same percentage as unhedged (13 percent). For equity, nearly three-quarters of consultants (70 percent) recommended unhedged non-U.S. developed as a stand-alone core fund, and 40 percent suggested unhedged emerging-markets equity; about a third suggested hedged non-U.S. developed (35 percent) and hedged emerging markets (27 percent). Notably, for blended portfolios such as white-label core or custom target-date strategies, consultants preferred unhedged strategies for both non-U.S. fixed income and equity strategies whether developed or emerging markets.

Why the difference between hedging fixed income and equity strategies? Some may argue that equity strategies are already volatile, so the currency hedging wouldn’t make much of a difference, or that the risk will wash out over time, so why do it? As you can see in Figure 7.21, the currency hedging of MSCI EAFE and the Barclays Global Aggregate significantly reduces volatility. In percentage terms, the fixed income volatility is cut in half, declining from 6 percent to less than 3 percent; although not as dramatic, the equity volatility dropped from 16 percent to 13 percent by hedging currencies. Hedging may add or subtract from returns depending on the relative movement of the U.S. dollar. As noted in Figure 7.20, only 14 percent suggest hedging for the “potential to enhance returns” and 17 percent said that “over the long run, currency risk adds little value.”

You may also hear that currency hedging is expensive. Currency hedging costs are currently minimal as we write; your consultant or investment managers can tell you current costs. Given a low hedging cost, we believe plan sponsors should consider hedging currencies for both fixed income and equity. The volatility reduction benefit is clear and is an important consideration for plan participants.

OBSERVATIONS FOR EQUITY ALLOCATIONS WITHIN TARGET-DATE STRATEGIES

In Figure 7.22, you see the total and breakout allocations of equities within the Market Average and Objective-Aligned Glide Paths. The average allocation to equities across the Market Average glide path is 69.6 percent, while the Objective-Aligned has an average of 60.0 percent. Looking at individual vintages, the difference is greatest at the beginning, with a 12 percent difference 40 years from retirement, diminishing noticeably by 10 years from retirement, to a final difference of below 5 percent at retirement.

Segmenting the equity allocation further, the comparison is even starker. The Market Average glide path has a higher allocation to U.S. large cap throughout the glide path, as well as more U.S. small cap. The differences are relatively small within non-U.S. equities, but again with higher exposures in Market Average. In emerging market equities we see a higher allocation in the Objective-Aligned throughout, but especially in earlier vintages. Viewing this through the lens of real liability, less exposure to U.S. equities and more relative exposure to emerging markets as a diversifier improves correlation to PRICE without compromising the risk/return profile.

IN CLOSING

Plan sponsors should consider designing core investment menus that offer equity choices that are balanced relative to other DC investment offerings, and maximize DC participants’ opportunity to gain from both capital appreciation and income. Often DC plans offer too many equity choices, yet fall short of providing sufficient opportunity to maximize returns and minimize risk. By studying historical and forecasted future risk/return relationships among equity markets—as well as between passive and active management—plan sponsors may craft a set of equity strategies that offers both total return and risk-mitigation potential and helps DC participants meet their retirement income objectives. To reduce volatility in international equities, plan fiduciaries should consider currency hedging back to the U.S. dollar—a hedging policy may be just as relevant in equity as it is in fixed income.

QUESTIONS FOR FIDUCIARIES

1. What is the overall investment structure of your plan? Do you want a style-box, asset-class, or risk-pillar core lineup?
2. Is the number of equity options overwhelming relative to other investment choices?
3. Are the equity choices overlapping in market size or approach? Has “style drift” occurred, and the choice diverged from their stated investment style or objective?
4. Would white-label or multimanager strategies make sense?
5. Does your plan offer access to non-U.S. developed and emerging market equity?
6. Do participants have the opportunity to invest in dividend-focused strategies?
7. Should you hedge non-U.S. equity strategies back to the U.S. dollar?
8. Is your small cap strategy capacity constrained?
9. Do you offer passive investment strategies?
10. Are there better approaches to maximize value for participants?