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Rethinking equities with retirement & recovery in mind

Streetlight in front of a geometric building

next issue no. 6: Investment corner

There is some conventional wisdom in the way plan sponsors talk to participants about achieving better retirement outcomes: Contribute early, maximize your contributions and take advantage of long-term appreciation. That said, this guidance may also lead to participants having heavy allocations to equities in their portfolios—and for good reason: the equity bull market that began in March 2009 was the longest in history, lasting 131 months. But these outsized gains in equity markets are prompting a number of questions: Are participants over-allocated today? Are they sufficiently diversified? And how should plan sponsors and participants utilize long-term strategic allocations in conjunction with rebalancing opportunities?

66% of DC participants’ assets were invested in stocks through equity funds, the equity portion of target date and non-target-date balanced funds, or company stock. 

— Source: The Employee Benefit Research Institute

The equity outlook

First, we must step back and look at where the economy currently is along its journey to recovery. The graph in Figure 1 may prompt concern as we see the 12-month forward price/earnings ratio reaching levels close to those in the late 1990s.

FIGURE 1 Are equities becoming overvalued?

Needless to say, the circumstances are much different today than they were in the late 1990s. Valuations in 2000 were reflecting hope for earnings potential for a large number of nascent companies, while in 2021 they are merely reflecting hopes for a return to 2018 levels of earnings. That is not too high a bar. An imminent collapse in equity prices seems unlikely under current circumstances absent a complete failure to contain and reverse the health crisis. Even then, as we learned last year, a dip might only be temporary as firms and consumers continue to adapt and evolve.

The short answer: Equities still look like a good option to help grow portfolios over the balance of this decade. This applies potentially even more to non-U.S. markets, where stock valuations are generally less stretched but real interest rates are far lower, in many cases. This doesn’t mean investors should shift to large tactical equity overweights by any means, but it does mean we believe that the risk-adjusted returns in a 60/40 or 50/50 portfolio will benefit from the equity portion over the next several years.

Of course, absolute returns matter, too. During the past five years, the S&P 500 has delivered average annual returns of 16.8%. To put that in context, that’s about the same five-year return you would have received if you’d courageously put money into the market in the middle of November 2008. These returns are going to be difficult if not impossible to replicate in the coming years given where valuations and interest rates are starting. But that makes it all the more important that plan sponsors choose their investments wisely. Diversification will be key.

Diversifying your options

According to TIAA’s 2020 Plan Sponsor Retirement Survey, plan sponsors are becoming increasingly concerned about diversification. Up from 27% in 2018, 50% of plan sponsors are concerned their participants do not have enough investment diversification in their retirement plans. A good place to start looking for solutions for this is revisiting the core menu equity investment options in context of the current market environment.

Many plan sponsors might think their plan menus are suitably diversified simply by the number of equity offerings available. On average, DC menus have a total of 13 equity offerings, which seems like it should be enough to provide participants with sufficient options for diversification within the asset class. Maybe not, though. Taking a closer look at the breakdown, out of 13 equity funds, U.S. equity funds comprised an average of 9.6 of the total offering, and only slightly more than 3 are dedicated to international equity (Figure 2).

FIGURE 2 U.S. equities comprise the majority of menu options

Expand your horizons

Although U.S. equities have outperformed other global markets over the last decade, our Equities Investment Council feels this trend could be poised for a reversal. As the global coronavirus pandemic starts to wind down, extensive fiscal and monetary policy actions should lead to a strong global economic recovery this year. In addition to international developed markets, emerging markets should benefit from several tailwinds including a weaker dollar, improving geopolitical outlook and attractive relative valuations.

To give participants non-U.S. exposure, we think plan sponsors should consider diversifying their portfolio with asset classes across geographies. Historically, portfolio risk is minimized when non-U.S. equity represents between 25% and 35% of total equity exposure, reflecting a potential optimal diversification point (Figure 3).

FIGURE 3 Portfolio risk as a function of international equity (1979-2020)

Did you know? 50% of plan sponsors are concerned that their participants do not have enough investment diversification in their retirement plans.

—  TIAA 2020 Plan Sponsor Retirement Survey

Simplify, but gain broader exposure

Market capitalization is another critical component of diversification. Instead of offering several large cap investment options, plan sponsors should consider replacing some with a selection of actively managed funds that include a variety of styles and market capitalizations. For example, large cap stocks have dominated in recent years, but we think the environment for small cap stocks has been steadily improving as the economy recovers. Historically, small cap stocks have often outperformed the broader equity market during economic recoveries. Over the long term, small caps have generated higher annual rates of return than any other U.S. equity or fixed income investment for nearly a century.

We also like dividend-yielding stocks that have the ability to provide a stream of income with less volatility. This area looks particularly appealing in the current low-rate environment when casting a wider net for income and yield. These are just a few examples of how a skilled active manger can identify areas of the market with the potential for outperformance while having the flexibility to capture the opportunities.

Keeping it professional

Monitoring participants’ equity exposure through reviewing the core investment options is a good start, but is not enough by itself. While the majority of DC participant assets are held in equities, the majority of DC participant contributions in 2020 were target date funds, according to Alight Research Insights.1 It’s therefore critical to extend that review to the equity components of the default investment option, which, per Callan, is a target date fund for nearly 90% of plans.2

The onus is on professional asset managers to make strategic and tactical asset allocation decisions for target date funds. In some cases, the pressure is better placed directly on the shoulders of professionals who can provide access to a broadly diversified portfolio within a single investment. For example, during the turbulence in the first quarter of 2020, in which U.S. equities declined 34% from Feb. 20 through March 23, most target-date funds performed in line with expectations, but outcomes varied meaningfully for those who were near retirement, according to a Morningstar analysis.3 This highlights the importance of knowing your target-date fund’s risk profile. Additionally, and perhaps most importantly, professional managers were able to take advantage of the market dip through their systematic rebalancing process.

It’s critical for plan fiduciaries to understand the following as it relates to underlying equities:

Keeping participants on course

After all the work fiduciaries put into reviewing and potentially adjusting investment menu options, participants should be made aware of their options and informed of best practices to help them keep on track. We suggest a range of communications options that will likely yield varying results.

Option 1: consistent HR/call center talking points

(minimally effective)

Volatile markets can be jarring for participants, causing some to panic and make emotional investment decisions in their retirement plans, forgetting about their long-term investment time horizons. Plan sponsors and call center support teams are often on the front line of that panic. It is important to educate employees about how to think about their 401(k) investments, the benefits of diversification and retirement planning or financial wellness tools available to them to help.

Option 2: targeted communications

(moderately effective)

Periods of uncertainty might be a good time to directly and proactively remind participants of the potential diversification benefits along with updates to the investment menu through targeted communications. Partnering with the plan administrator’s communications team, plan sponsors can launch a communications campaign to a specific segment of plan participants with tailored messaging. People learn best when they believe the information being shared is relevant to them. Targeted communications help increase the relevancy of the message compared to a broad participant notification or mailing.

Option 3: reenrollment

(highly effective)

Over-allocation to equities is a real risk in turbulent market environments. And while communications may help, we also know that many participants do not understand basic investing principles like diversification, return expectations and risk suitability. Inertia is another risk to participant behavior. Re-enrolling the plan into the QDIA may significantly help improve overall investment allocations and realize any cost savings associated with the QDIA selection (Figure 4 and 5).

FIGURES 4 and 5 Before and after re-enrollment

Looking forward

Following a tumultuous 2020, we look forward to the global economy transitioning to a period of “normalization” in 2021. Consistent with conventional retirement-planning wisdom, we believe plan sponsors should continue to remind participants to invest over longer time horizons with careful rebalancing. We do not advocate that participants time the market, which is why having actively managed, diversified investment options — either standalone or through a target date fund — on the menu can potentially provide better retirement results.

Key takeaways for plan sponsors

In this issue
Retirement An interview on retirement readiness in any market environment
Participant engagement: There are time-tested strategies that can help prepare participants for retirement.
Retirement Washington watch: shifts in retirement policy?
Fiduciary perspective: A look at legislative changes that could impact your plan participants.
Retirement Beyond better health: renewing focus on wellness
On the horizon: The physical, mental and financial toll of the pandemic continues to weigh heavily.


1 Alight, “Alight Solutions 401(k) Index™: Full Year 2020 Observations,” 2020.

2 Callan, “DC Trends Survey,” 2020.

3 Morningstar, “Morningstar’s Annual Target Date Strategy Landscape,” 2020.

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. 

Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible. 

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index. 

A word on risk 

All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income.

Please note that this information should not replace a client’s consultation with a tax professional regarding their tax situation. Nuveen is not a tax advisor. Clients should consult their professional advisors before making any tax or investment decisions.

Nuveen provides investment advisory services through its investment specialists.

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