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MFS® DC View Defined Contribution Insights April 2017 Investment Solutions Group Ravi Venkataraman, CFA Senior Managing Director Kristen Colvin, CAIA Director Peter Delaney, CFA Director Jonathan Hubbard, CFA Director Linda Nockler Editorial Director Jamie Coleman Senior Writer and Editor Bryan Potts Senior Analyst Sean Smith, CFA Analyst QuickFacts • Over the past decade, global DC assets grew at a rate of 5.6% per annum. This compares to DB assets, which grew at 2.6%, according to the latest Global Pension Assets Study from Willis Towers Watson. • Demographic shifts extend average years in retirement globally. The combination of increased life expectancies and lower average retirement age has extended average years in retirement from 13 years in 1970 to 20 years in 2014, according to the OECD’s Pensions at a Glance 2015. • OECD projections indicate room for improvement in developed market income replacement rates. In the OECD’s Pensions at a Glance 2015, projected income replacement in the United Kingdom, Australia, Canada and the United States are 38%, 58%, 43%, and 45%, respectively. The developed country average replacement rate is projected to be 63%. • Default investment options play a critical role in DC pensions. The majority of member/participant contributions to DC plans are invested in default strategies in the UK, Australia and the US. Be on the lookout for our upcoming white paper to learn more about the growth and evolution of default structures in DC globally. Global DC landscape The evolution of DC is in various stages around the world, but the overall trend continues. 2016 2010 Size of DC markets (US$) US UK CA DC market DB/DC split DC as % of GDP Average age of retirement 10% For more information, please visit our website at mfs.com/DC DC market DB/DC split DC as % of GDP Average age of retirement 20% $516 billion 82% DB / 18% DC 19.50% 64 M / 62 F 40% $6.9 trillion 40% DB / 60% DC 37.50% 66 M / 65 F AUS DC market DB/DC split DC as % of GDP Average age of retirement $72 billion 95% DB / 5% DC 4.70% 65 M / 62 F 30% DC market DB/DC split DC as % of GDP Average age of retirement 50% 60% 70% 80% $1.3 trillion 13% DB / 87% DC 109.60% 65 M / 63 F 90% % of retirement assets invested in DC schemes Sources: Investment Company Institute (4Q 2016), Towers Watson Global Pension Assets Study 2011 & 2017, OECD Pensions at a Glance 2016. Retirement outcome levers Members/participants may need to increase contribution rates to make up for lower expected market returns in the future. Target vs expected DC account balance at retirement (US$ thousands) 1,200 1,000 800 Target savings (70% replacement rate) 600 400 Projected assets (assuming lower exp. returns) 200 0 US Canada UK Australia 10.4% 9.6% 2.8% 2.3% Additional savings % to meet target This is a hypothetical example shown for illustrative purposes only. An investment cannot be made directly into an index. Target savings represents the present value of living expenses at the time of retirement using a discount rate equal to the local 7-10-year government bond return expectation based on MFS Long-Term Capital Market Expectations (LTCME). Expected account balance assumes participant contributions of 10% invested in a 60/40 relevant local equity/fixed Income portfolio over 44 years using MFS LTCMEs. See page 5 for more detailed assumptions. Regulatory timeline Regulatory trends in various markets have increased the importance of DC in retirement. Australia, Canada, United Kingdom and the United States CA Quebec Voluntary Savings Plan introduced AUS AUS Superannuation Guarantee implemented Stronger Super Reforms, which include MySuper (low cost default product) and Self-Managed Supers (SMSF) US Pension Protection Act enacted 2004 2007 2006 1992 AUS Capital Accumulation Guidelines introduced CA For more information, please visit our website at mfs.com/DC 2014 2017 Auto Enrollment legislation introduced QDIA Regulation finalized US Alberta DC legislation introduced within Employment Pension Plans Act Auto Enrollment fully implemented at 8% default rate DOL Fiduciary Rule implementation delayed 60 days to June 2017 2012 2011 Choice of Superannuation Funds Act published CA UK US UK Pension freedom and choice reform UK 2019 Super reforms including an A$1.6M transfer balance cap set to take effect on July 1, 2017 AUS Regional spotlight United States and Canada While the US and Canada share a common border, the two countries are at very different points in terms of the evolution of their respective defined contribution markets. Retirement income by source (%)1 4 Asset allocation (%)2 Other 1 13 10 35 32 10 Public pensions Private pensions 18 Other income 41 41 6 7 7 8 10 Company stock 24 Balanced/Target risk 6 9 Fixed income Cash/Capital preservation 22 Investment TDF 43 Employment 27 14 US 12 Canada US Equity Canada Sources: 1SSA Publication No. 13-11871 2015; Statistics Canada. 2EBRI Issue No. 426; Sun Life, Designed for Savings 2016. DC assets (USD billions) DC/DB split Average retirement age Average participation rate Average member/ participant contribution rate Auto enrollment utilization United States 6,965 60%/40% 65 78% 6.8% 41% Canada 72 5%/95% 65 57% 4.3% * * L imited data available. Currently only in Alberta and British Columbia. Sources: Investment Company Institute (4Q 2016); Towers Watson Global Pension Assets Study 2011 & 2017; OECD Pensions at a Glance 2015; Vanguard, How America Saves 2015; Sun Life, Designed for Savings 2016; Great-West 2015 CAP Benchmark Report. Key similarities • T hree pillar system: 1. government sponsored retirement income, 2. plans offered by employers, 3. private savings • Investment menu design: i.e., TDFs plus core menu. TDFs have grown to 22% of total DC assets in Canada and 18% in the US. • B to DC: Trend continues toward Defined Contribution D plans • Focus on retirement income/drawdown solutions Differences • egulation falls mostly under provincial R jurisdiction in Canada • Fees: Bundled pricing in Canada versus move toward unbundled/a la carte pricing in the US • ome country bias is more pronounced in H Canada, especially in fixed income • Recordkeeper: DC recordkeeping market is much more concentrated in Canada versus the US. Top three recordkeepers control 65% of the market in Canada versus 33% in the US Sources: Sun Life, Designed for Savings 2016; EBRI Issue No. 426; CAP Suppliers Report 2015; Plansponsor 2016 Recordkeeping Survey. For more information, please visit our website at mfs.com/DC Join MFS on the road MFS global DC presence — Experienced and diversified Pensions & Investments 401k Investment Lineup Summit – US Hear MFS insights about effective fund platform considerations and standards and our global perspective on developing an optimal default fund structure during a four-city tour with Pensions & Investments. San Francisco, CA 5/9 Dallas, TX 5/11 Chicago, IL 5/16 New York, NY 5/18 http://www.pionline.com/conferences MFS DC assets by asset class EAFE/Global 42% US equity 38% • US$77b DC AUM Multi-asset 10% • Client types: Corporate Nonprofit Health services & education Union/Taft Hartley Public/Local authority Fixed income 6% Regional 4% MFS DC assets by country US 71% Australia/South Pacific 14% MFS Investment Management DC Summer Solstice – Canada Plan to join your MFS and industry peers at the second annual MFS DC Summer Solstice in Toronto on Wednesday, June 21. This premier DC event will feature interactive discussions on current trends and a networking reception. For more information and registration instructions, please email Amra Jakupovic at [email protected]. DC and DB Forum – London Please join us on Wednesday, October 4, when we have a number of experts from across the industry discussing global retirement and industry trends affecting both DB and DC. These include governance, consolidation and the importance of investment returns. For more information, please email Maddi Forrester at [email protected]. For more information, please visit our website at mfs.com/DC Canada 12% • Vehicles: Mutual fund Institutional trust Commingled fund Subadvised Separate account UK/Europe 2% Hong Kong 1% As of December 31, 2016. Insights & blogs DC View: Year in Review 2016 This special edition of DC View includes a recap of significant defined contribution events throughout 2016, as well as an outline of what we expect 2017 to bring. Learn more Target date fund design and decision drivers: No such thing as a representative participant Perspectives on how participant demographics influence glide path design. Learn more The Road to Retirement Is As Important As the Destination Kristen Colvin blogs about white label portfolios as a DC menu option. Learn more Balance at retirement graphic assumptions: Target savings represent the present value of post-retirement expenditures for 20 years at 70% replacement ratio of final salary using a discount rate equal to the relevant local 7-10 year government bond return expectation. Expected balance assumes a 42-year investment horizon within the context of the MFS proprietary Participant Investment Model. Retirement age assumed to be 67, while beginning contribution age is 26. Beginning participant salary of $35,000 (at age 22); 2% annual wage growth over 44 years. The proxy portfolio is a 60/40 blend of equities and fixed income and considers MFS Long-Term Capital Market Expectations (Jan. 17) expected returns. Contributions are made uniformly over the course of a year; employer match is 50% of savings up to 6%; employee contribution of 10%. Long-Term Capital Markets Expectations methodology: We use a proprietary top-down approach by employing quantitative, country-based models as the foundation for our expectations and then integrating bottom-up fundamental views from our global equity and fixed income investment teams to inform our final expectations. Our expectations are developed across 26 countries comprising 18 developed countries and 8 emerging market countries. MFS equity market expectations are displayed in unhedged, nominal total return and are developed using a building-blocks approach. Our long-term equity model develops return expectations in two stages: years 1 through 5 and years 6 through 10. Deploying our model in two distinct stages allows us to use different parameters and assumptions for each forecast horizon. In all stages, our model estimates both a price return and dividend return, which are aggregated to a total return expectation at the country market level. The price return component is based on our expectations of future sales, margins and P/E multiples; the dividend return component is based on our expectations of future dividends, which are based on expected earnings and dividend payout ratios. Elements of market history and mean reversion are incorporated into our model in both stages. Reversion speed and target levels are calibrated based on our analysis of historical data and forward-looking expectations. The first stage of our model examines current conditions and then assumes a healthy degree of mean reversion (particularly with respect to expected margin and P/E multiple) as it estimates a market’s price and dividend return. In the second stage of the model, the mean reversion parameters are relaxed, which results in more of a “steady state”-type forecast that picks up where the first stage leaves off. It is important to acknowledge that there are a wide range of potential outcomes associated with our return expectations. Any return figure should be viewed as the midpoint in that range of outcomes. References to future expected returns and performance are not promises or estimates of actual performance that may be realized by an investor, and should not be relied upon. The forecasts are for illustrative purposes only and are not to be relied upon as advice, interpreted as a recommendation or be guarantees of performance. The forecasts are based upon subjective estimates and assumptions that have yet to take place or may occur. The projections have limitations because they are not based on actual transactions, but are based on the models and data compiled by MFS. The results do not represent nor are they indicative of actual results that may be achieved in the future. Individual investor performance may vary significantly. For more information, please visit our website at mfs.com/DC The views expressed in this report are those of MFS® and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any other MFS investment product. Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries. Issued in the United States by MFS Institutional Advisors, Inc. (“MFSI”) and MFS Investment Management. Issued in Canada by MFS Investment Management Canada Limited. No securities commission or similar regulatory authority in Canada has reviewed this communication. Issued in the United Kingdom by MFS International (U.K.) Limited (“MIL UK”), a private limited company registered in England and Wales with the company number 03062718, and authorised and regulated in the conduct of investment business by the UK Financial Conduct Authority. MIL UK, an indirect subsidiary of MFS®, has its registered office at One Carter Lane, London, EC4V 5ER and provides products and investment services to institutional investors globally. This material shall not be circulated or distributed to any person other than to professional investors (as permitted by local regulations) and should not be relied upon or distributed to persons where such reliance or distribution would be contrary to local regulation. Issued in Hong Kong by MFS International (Hong Kong) Limited (“MIL HK”), a private limited company licensed and regulated by the Hong Kong Securities and Futures Commission (the “SFC”). MIL HK is a wholly-owned, indirect subsidiary of Massachusetts Financial Services Company, a US based investment adviser and fund sponsor registered with the US Securities and Exchange Commission. MIL HK is approved to engage in dealing in securities and asset management regulated activities and may provide certain investment services to “professional investors” as defined in the Securities and Futures Ordinance (“SFO”). Issued in Singapore by MFS International Singapore Pte. Ltd., a private limited company registered in Singapore with the company number 201228809M, and further licensed and regulated by the Monetary Authority of Singapore. Issued in Latin America by MFS International Ltd. For investors in Australia: MFSI and MIL UK are exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 in respect of the financial services they provide to Australian wholesale investors. MFS International Australia Pty Ltd (“MFS Australia”) holds an Australian financial services licence number 485343. In Australia and New Zealand: MFSI is regulated by the SEC under US laws and MIL UK is regulated by the UK Financial Conduct Authority under UK laws, which differ from Australian and New Zealand laws. MFS Australia is regulated by the Australian Securities and Investments Commission. MFSI-DCVIEW-FLY-4/17 25619.22