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JP Morgan: Flexibility in DC Investing Now Essential

Investment Management

Given that strategies that worked for DC plans in the past may be less successful in the future, it will be critical to incorporate forward-looking market views to keep participants on track, the firm suggests in a new paper. 

In “What our Long-Term Capital Market Assumptions Mean for Defined Contribution Plans,” JP Morgan’s Jared Gross and Emily Cao explain that factors, such as asset allocation, manager selection, performance and fees, were less meaningful in a period of sustained strong investment returns. “We shouldn’t be surprised, therefore, that simplistic allocation models and passive strategies were able to thrive in an era when their lack of sophistication made little difference,” they note. 

With stocks and bonds unlikely to deliver the same level of returns going forward, the JP Morgan executives contend that DC plan investment strategies need to adapt, noting that the continued use of static allocation models biased toward historical market performance will likely miss out on opportunities. 

As for how DC plans can enhance their investment flexibility, Gross and Cao suggest that one approach is to “make room for disciplined, strategic allocation changes based on long-term forecasts.” They submit that two primary pathways for implementing such changes:

  • within the target date glide path, through its structure and execution; and
  • through the selection of the core menu options—including any white label options.

“Combining this strategic flexibility with active management at the funds level, where appropriate, would allow for a nimble response to changing markets. That combination may be critical to maintaining returns at levels that would support the future retirement of today’s participant population,” Gross and Cao write. 

In pointing to the firm’s Long-Term Capital Market Assumptions (LTCMAs) as a way to guide asset allocation, the two executives observe that their most recent LTCMAs suggest that relying on more static and passive strategies is likely to produce lower returns and higher volatility relative to historical levels—and not just in the short term but over a longer horizon. 

As such, aligning DC plans with this anticipated lower-return environment should involve all elements of the plan, they suggest. 

Plan Sponsor Steps

The steps that plan sponsors should consider implementing through their plans’ TDFs and core menus include: 

  1. replacing static passive TDFs with hybrid or active strategies that incorporate flexibility in glide path implementation and active management;
  2. evaluating equity exposure in TDFs designed for older participants who are closer to retirement, while diversifying fixed income and embracing active management to increase yield and avoid unattractive risks; 
  3. seeking diversification in active equity across cap-weighted market benchmarks (e.g., international, emerging markets) as well as sectors with high concentration (e.g., growth); 
  4. offering active options across key market sectors within the core menu to provide participants with choices beyond passive cap-weighted strategies; and
  5. within white label options, exploring:
    1. adding emerging market strategies to international equity sleeves;
    2. diversifying away from traditional core fixed income strategies and toward active core-plus, multi-sector and unconstrained strategies; and
    3. shifting away from TIPS for inflation protection and diversify toward real assets, given the risk from rising rates.