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RETIREMENT
INSIGHTS
Focus your aim
Innovating the defined contribution
core menu to help increase the odds
of participant success
ABOUT
CROSS-ASSET SOLUTIONS
FROM J.P. MORGAN
The Global Multi-Asset Group (GMAG) is part of the Global Investment Management Solutions
Group, which oversees more than $134 billion in multi-asset solutions worldwide.1 GMAG
leverages its specialized investment expertise, together with the vast resources of J.P. Morgan
Asset Management and its partners and affiliates, to provide customized solutions across asset
classes for institutions, third-party intermediaries and individuals. GMAG blends its experience
in capital markets investing, strategic and tactical asset allocation, portfolio construction
and risk management with one of the industry’s broadest product offerings to develop and
implement optimal portfolio solutions for a wide range of client needs.
1
As of September 30, 2014.
FOREWORD
The defined contribution (DC) industry has introduced numerous advancements to help
participants achieve stronger retirement funding levels. One critical area of DC plan design,
however, continues to fall short in meeting the needs of the vast majority of participants: the
core investment menu.
In the past, most plan sponsors relied on expanding core menu investment line-up choices to
help participants better diversify their retirement portfolios. A growing amount of evidence,
though, shows that this approach has not consistently delivered better investment results and
may actually have been detrimental to participant success. In fact, our research has found that:
•
The existing core menu model is not serving most participants’ best interests. Many
participants are overwhelmed by too many investment choices. This has resulted in
greater inertia and frequently poor investment line-up usage. For example, the average
participant invests in only 3.3 funds, even though the average DC plan includes 20
different investment options.2 This lack of diversification has increased participants’
exposure to extreme investment performance, particularly on the downside.
•
A more effective core menu simplifies participant decisions while ensuring expanded
diversification. J.P. Morgan introduced Core Menu InnovationSM, which streamlines
the core investment line-up to three easy-to-understand choices: a diversified equity
portfolio, a diversified income portfolio and a diversified cash alternatives portfolio.
These professionally managed strategies provide sophisticated diversification across
traditional and extended asset classes to help ensure participant portfolios are better
structured to potentially deliver more consistent and efficient investment results.
•
This new approach can help improve investment outcome potential for a greater
number of participants. A rigorous analysis of how these Core Menu Innovation
portfolios are likely to interact with real-world participant usage shows improved risk/
reward characteristics and potentially stronger investment performance through a wide
range of possible market environments.
Core Menu Innovation helps make it easy for participants to construct institutional-quality
portfolios that exhibit greater return efficiency while maintaining a level of control over their
asset allocation profiles. By replacing complex and often redundant line-ups with these three
simplified, highly diversified choices, plan sponsors can help participants make smarter
investment decisions that can lead to higher expected investment results.
For more information about Core Menu Innovation or any of the other topics covered in this
paper, please contact your J.P. Morgan representative.
Sincerely,
2
Anne Lester
Katherine Santiago, CFA
Managing Director
[email protected]
Executive Director
katherine.santiago
@jpmorgan.com
Source: J.P. Morgan retirement research data as of March 31, 2014.
J.P. MORGAN ASSE T M A N AG E ME N T 1
TABLE OF CONTENTS
3
Overview
5
The DC disconnect
8
Rethinking the core menu
11
Better investment building blocks
13
Smarter diversification, stronger outcomes
17
A more complete plan line-up
19
Conclusion
2 FO CU S YOU R A IM
OVERVIEW
Despite 30 years of innovation and insights, DC plans and participants still
struggle with a perplexing fundamental problem. Since their introduction,
DC plans have morphed from supplemental investment offerings into the
cornerstone of the country’s retirement system beyond Social Security.
Yet the fact remains that most plan participants are largely unprepared
to make the effective investment decisions required by these primarily
self-directed retirement programs.
Inadequate levels of retirement savings is one distinct and persistent problem. Setting
that aside, the crux of the issue is that participants find it difficult to achieve adequate
diversification and appropriate asset allocation. By far the most significant DC
investment advancement to date has been the introduction of professionally managed
target date funds and other types of qualified default investment alternatives (QDIAs),
which simplify the asset allocation process into one efficient investment choice.
Given the expanding body of research illustrating that participants often make bad
investment decisions on their own, most plan participants are probably best served
by a target date strategy. Core menu line-ups that include target date strategies can
also be effective. Unfortunately, many participants who invest in core menu options
make choices that do not provide adequate diversification and/or do not appropriately
match their risk tolerance. As a result, the retirement security of millions of Americans
is threatened.
J.P. Morgan’s Core Menu Innovation offers plan sponsors and their advisors a
practical solution to help overcome this challenge. We think plan sponsors should
aspire to move as many participants as possible into a target date strategy to help
increase the odds that more participants will receive adequate levels of income
replacement in retirement.
Core Menu Innovation provides an effective way to offer flexibility to those who
continue to desire a more active role in their investment choices, while helping to
mitigate many of the common investment mistakes participants tend to make.
J.P. MORGAN ASSE T M A N AG E ME N T 3
In this paper, we examine:
• How current core investment line-ups are failing to address
participant needs
CORE MENU INNOVATION
THE CONCEPT:
• Why Core Menu Innovation offers better investment choices
for participants who prefer a more active role in
determining their asset allocation and risk profile
• Consolidate the entire core menu into three easy-tounderstand investment portfolios: diversified equity
portfolio, diversified income portfolio and diversified cash alternatives portfolio.
• How successful implementation can deliver a more complete
plan line-up
• Each provides a single entry point into a broadly
diversified portfolio of underlying traditional and
extended sectors within the specific asset class category.
By applying the sophisticated investment thinking behind target
date strategies to the core menu, plan sponsors can help ensure
that participants’ portfolios are better structured to achieve
potentially more consistent and efficient investment results.
• Underlying allocations are professionally managed to
optimize asset class-specific portfolio efficiency and
systematically rebalanced to maintain proper risk/
reward characteristics.
PARTICIPANT BENEFITS:
• Simpler and smarter investment choices
• Better diversification with access to institutional-
quality strategies
• Higher probability of better investment outcomes
• Potentially greater engagement
PLAN SPONSOR BENEFITS:
• Open architecture
• Fee transparency and parity
• Manager risk reduced and brand bias eliminated
• 404(c) protection
4 FO CU S YOU R A IM
The DC disconnect
The history of DC investing is marked by enhancement and change, as plan sponsors, regulators and investment
managers have introduced ongoing refinements to help participants make better retirement savings choices.
Through the years, three types of participants have emerged, each taking a different approach to investment
decision making. The industry has responded to the particular needs of the three segments with specific offerings.
The three types of participants:
• Participants who struggle with granular investment choices
and prefer professional management
• Participants who value professional oversight but prefer a
level of control
• Self-directed participants who are well versed in investing
and prefer significant flexibility and choice
Most participants fall into the first two groups, with only 1.1%
considering themselves self-directed. This extremely small
segment accounts for a modest 2% of overall DC assets and is
usually best served by self-directed brokerage accounts that
offer a high degree of autonomous investment selection. For
the remaining 98% of assets, participants are normally
investing in either professionally managed investment solutions
or selecting individual strategies from a core menu to build
their own portfolios. A growing body of research, however, has
highlighted two major weaknesses with this approach.
Though both plan sponsors and participants lack confidence in
participants’ ability to invest effectively, 80% of DC assets reside
in do-it-yourself core menu options (Exhibit 1, next page). Most
DC product innovation has centered on participants who favor
professional management by introducing professionally managed,
asset allocation solutions such as target date strategies. These
offerings provide a viable way to invest assets more efficiently
and do not require extensive investment knowledge.
We believe, however, that adoption rates for these solutions have
remained too low. Though more than 70% of plans now offer
target date funds, according to a report from the Investment
Company Institute (ICI) and Employee Benefit Research Institute
(EBRI), as of year-end 2012 only 41% of participants invested in
target date funds. This relatively low share mainly reflects the fact
that the industry has generally taken a more passive approach to
incorporating these innovative investment vehicles into existing
plan line-ups.3 Often only a select group of participants—those
who have been defaulted into a 401(k) through an automatic
enrollment program—are proactively placed into these strategies.4
This covers a relatively small population.
Typically participants can actively select a target date fund as
an investment option from the core menu, but most fail to do
so either due to inertia or a general lack of understanding
about the benefits of these strategies. Based on the low level
of target date adoption by participants, it is clear that too few
of the participants who admit they need and prefer
professional investment guidance are taking advantage of the
solutions the industry has developed to address this very issue.
Although core menus support the bulk of DC assets, most have
not been constructed to foster optimal investing based on realworld participant behaviors. A large part of this problem can
be attributed to how core menus have evolved over the years.
When DC plans were first introduced, they initially offered
participants a selection of only three to four institutional
portfolios. The tremendous growth in 401(k) plans during the
late ’80s and ’90s, however, prompted participants to start
demanding more investment choices, often in the form of
commercially branded mutual fund products. Plan sponsors
responded to this by steadily adding new options to their core
menus and transitioning from institutional separate accounts
to more retail-oriented mutual funds. By 1998, the average
plan had expanded to 10 fund choices, and this figure has
climbed to an average of 20 funds today, with some plans
offering in excess of 50 different investment options.4
3
4
Source: Hewitt, 2013 Hot Topics in Retirement.
Source: PSCA’s Sixth Annual Survey of Profit-Sharing and 401(k) Plans, 2013.
J.P. MORGAN ASSE T M A N AG E ME N T 5
EXHIBIT 1: THE LACK OF CONFIDENCE IN PARTICIPANTS’ ABILITY TO ALLOCATE...
Plan spo nso rs
Pl a n p a rtic i p a n t s
Participants’ confidence in knowing how to best allocate 401(k)
contributions across investment options
Note: Total n = 1,009. Totals may not equal
100% due to rounding.
Source: J.P. Morgan Plan Sponsor Research,
2013.
Note: Total n = 796.
Source: J.P. Morgan Plan
Participant Research, 2013.
Intuitively it may seem that greater choices should help
participants achieve better investment results, but in practice
the opposite has proven to be true. Many of the expanded
fund options are more redundant than additive from a
diversification standpoint.
In addition, mounting industry research has illustrated that menu
proliferation has largely confused and overwhelmed participants.
Regardless of their degree of investment knowledge, they must
now select from an increasingly complicated fund line-up.
The ingrained structural problems with today’s typical core
menu become painfully obvious when evaluating the second
segment of participants, those who value professional
management but prefer to maintain a level of control. As a
group they have been unsuccessful in building their
retirement portfolios. Research has identified these problems
for the broad universe of participants:
• Most remain underdiversified. The average participant
invests in just 3.6 funds, regardless of line-up size.5
• Most have skewed risk exposure. Many participants
congregate inadvertently at the extremes of the risk/reward
spectrum by making random fund selections, chasing
returns and/or concentrating exposure in investments that
are misaligned with their risk profile.5
• Most fail to make any portfolio adjustments over time.
Participants rarely move into new line-up additions, and
only 7% rebalance their portfolios in any given year.5
J.P. Morgan retirement research data as of March 31, 2014.
6 FO CU S YO U R A IM
18%
Asset allocation strategies
2%
Brokerage
80%
Core menu
76%
Not confident
Plan sponsor confidence that majority
of participants have the appropriate
asset allocation
5
W h e r e p a r t i ci p a n t s ’ a s s e t s r e s i d e
24%
Highly
confident
33%
Highly
confident
66%
Not confident
DOES NOT ALIGN WITH HOW INVESTMENT DECISIONS ARE MADE
Source: J.P. Morgan Retirement Plan Services, 2013.
These types of poor investment decisions have had a direct
negative impact on the portfolio returns for many participants
in our second segment: those who value professional
management but prefer a level of control. There is both
notably lower performance as well as increased risk of more
extreme outcomes.
CHOICE OVERLOAD
Behavioral research shows that although most people are
attracted by the idea of having more choice, they actually
prefer less. In fact, research has revealed that too much choice
often leads to inaction.
In one famous study, an alternating assortment of 24 and
six jam samples were offered in a gourmet market.6 The
larger selection drew in 60% of customers, with the smaller
attracting only 40%. In both cases, customers sampled an
average of two jams. Only 3% of those presented with the
24 options decided to buy a jar, while 30% selecting from
the smaller group made a purchase—a full 10 times higher
response rate.
A similar dynamic can be found in DC plans that offer excessive
core menu options. Too much investment choice risks
overwhelming participants, who often simply decide to make
no choice at all.
6
Source: Iyengar, S.S. and M.R. Lepper. (2000). “When choice is
demotivating: Can one desire too much of a good thing?” Journal of
Personality and Social Psychology, 79, 995–1006.
However, median annualized performance for target date fund
users was 14.2%, compared to 13.6% for the other group of
participants. The bottom performance range was significantly
worse for the non-target date fund participants, at an average
negative return of -2.2% per year vs. a positive average annual
return of 8.5% for the target date fund group.
Such performance disparities have sparked greater awareness of
the structural vulnerabilities of the current core menu model. In
response, some plan sponsors have begun implementing a degree
of menu consolidation in the hope that it will help promote better
participant investment decisions. Nevertheless, we believe that
greater efforts must be made to further strengthen the core
menu model. Indeed, we think the industry has an extraordinary
opportunity to reframe the core menu in a whole new light.
E X HI BI T 2 : A NNU A L I Z E D F I V E - Y E A R S R E TU R NS :
HI G HS , L O W S A ND M E D I A N BY I NV E S TM E NT S TR AT EG Y
30
27.7
25
Rate of return (%)
We recently evaluated five-year performance for more than
770,000 participants based on whether they were invested in
target date funds or constructing their own investment
portfolios from core menu line-ups (Exhibit 2). When assessing
these results, plan sponsors concerned with providing the
broadest participant base with the strongest performance
potential should focus on participants who fall at median
return levels or below. This represents 50% of each group, a
sizable portion from a fiduciary perspective. On the upside,
top performing participants in this group achieved
substantially higher returns during the period, delivering an
average 27.7% per year compared to the highest 19.8%
annualized return for target date fund users.
20
19.8
15
14.2
13.6
10
5
8.5
0
-2.2
-5
-10
Target date fund users
Do-it-yourselfers
Source: J.P. Morgan retirement research data.
*Rates of return are standardized using the interquartile methodology.
The analysis measurement period is December 31, 2008 through December
31, 2011. The above data represents an analysis of 515,634 participants’ rate
of return. It does not represent the returns of any individual product or
portfolio. Exclusive reliance on the above is not advised. This information is
not intended as a recommendation to invest in any particular manner.
Rate of return for the measurement period is aggregated by investment
strategy and calculated for active participants using the Modified Dietz
method and is based upon volatility between the highest rate of return and
lowest rate of return associated with each investment strategy among such
participants. Historical rate of return is not a guarantee of and may not be
indicative of future results.
Services associated with the identified investment strategies were available as
of the last day of the measurement period but may not have been available
throughout the measurement period. Target date fund users are participants
with at least 70% of their account balance invested in target date funds as of
the first and last day of the measurement period. Do-it-yourselfers are those
with less than 70% of their account balance invested in another investment
strategy as of the first and last day of the measurement period and includes
those using online advice services, if applicable.
J.P. MORGAN ASSE T M A N AG E ME N T 7
Rethinking the core menu
Any discussion about the design of a more effective core menu must start by defining the overarching goal plan
fiduciaries hope to achieve with their investment line-ups. At a high level, most would probably agree that the menu
should help participants capture solid investment returns while narrowing the range of extreme investment outcomes.
This requires the line-up to:
• Provide participants with adequate investment
diversification choices across asset classes
• Deliver these strategies in a way that cultivates
constructive investment behavior and helps protect
against improper usage
When evaluating how best to accomplish these objectives, it is
important to assess what drives portfolio returns. Investment
performance is generally derived from two sources. “Beta”
represents the return that reflects an investment’s sensitivity
to market risk. “Alpha” refers to return generated by portfolio
manager’s skill. Since beta, in essence, represents market
exposure, it plays the larger role in providing adequate
diversification, since diversification is principally about
spreading market risk.
FOCUSING ON THE BIG PICTURE
Core Menu Innovation helps plan sponsors and participants
spend time and energy on areas that can change potential
investment outcomes in a meaningful, positive way. It helps
them avoid getting distracted by the details of navigating a
complicated plan line-up.
Two primary issues truly drive retirement funding success:
• Getting participants to save more
• Making those assets work more efficiently
By presenting participants with three core menu investment
choices, plan sponsors can focus education and communication
efforts on fewer, more powerful messages, such as how to save
enough and how to develop the right allocation strategy.
In practice, market exposure is typically proxied by a broad
market index, such as the S&P 500 Index or the Barclays
Capital U.S. Aggregate Bond Index (Barclays Agg), although
most investments exhibit sensitivity to more than one type of
market exposure. Equity and fixed income classifications are
perhaps the most common way to group investments, but subasset classes and various investment styles may also introduce
distinct market exposures.
One of the principal limitations of the existing line-up
structure is the fact that many participants remain overly
exposed to too few asset classes, and are inadequately
diversified within asset classes, despite the fact that most
plans offer a wide assortment of investment choices. This
makes many participants vulnerable to sub-par performance,
a challenge further complicated by the often duplicative
nature of most expanded line-ups.
A portfolio that includes a diverse set of market exposures can
benefit from a broader range of return streams, which helps
expand investment potential and also limits the possible
damage that might be inflicted by any one market’s negative
returns. Hence, effective market exposure diversification is
crucial to the concept of portfolio efficiency, which measures a
portfolio’s expected performance compared to its expected
risk level. The right mix of various market exposures can
increase portfolio efficiency, and as portfolios become more
efficient, they generate stronger risk-adjusted performance.
For example, a menu that offers multiple large cap equity
strategies with different investment styles and managers may
appear diversified because it expands investment choice.
But these different strategies do not expand market exposure.
The average participant invests in just three or four
investment options.
8 FO CU S YO U R A IM
As noted earlier, if most or all of those options end up having
similar asset class exposures, the investment risk can be
considerable. Accordingly, it seems prudent to embed a broader
E XH IB IT 3: A SIMP L IF IED, Y ET MORE S OPH I S T I C AT ED CO R E M E NU
Current model: 13 funds
Core Menu Innovation model
• Large cap growth
• Large cap value
• Large cap core – passive
• Large cap core – active
• Mid cap growth
• Mid cap value
• Small cap growth
• Small cap value
• International developed
large equity
• REITs
• U.S. aggregate bond – passive
• U.S. aggregate bond – active
• Money market or stable value
Diversified equity
portfolio
Diversified income
portfolio
Diversified cash alternatives portfolio
Broadly diversified
across equity sub-asset
classes, geographies and
investment styles
Broadly diversified across
capital structure and
geography, anchored in
high-quality investment
grade bonds
Money market or
stable value
Source: J.P. Morgan Asset Management.
Information is hypothetical and shown for illustrative purposes only.
set of asset allocation exposures into the investment selection
process as do-it-yourself participants construct their portfolios.
Furthermore, an effective core menu must be modular in
nature, but it should be far less complicated to use than the
current configuration. The industry has been much too
optimistic about the average participant’s ability to grasp
differences between relatively nuanced strategies such as
large, mid and small cap funds, even if these distinctions are
very apparent to anyone with an investment background.
However, a participant who prefers some level of control over
investment choices is likely to understand the basic
differences between broader asset class categories such as
equities, fixed income and cash alternatives.
Because plan sponsors make such pragmatic assessments in
structuring their core menus, J.P. Morgan developed its Core
Menu Innovation. It is a straightforward solution that applies a
deep understanding of retirement trends and real-world
participant 401(k) usage to plan line-up design. This
evolutionary new approach entails complete line-up
consolidation into three institutional-quality investment
portfolios (Exhibit 3):
• A diversified equity portfolio
• A diversified income portfolio
• A diversified cash alternatives portfolio
By streamlining the core menu (for example, from 13 fund
choices to three highly diversified investment options), plan
sponsors can help make certain that do-it-yourself
participant portfolios are more likely to generate stronger
investment results.
The improved choice architecture of Core Menu Innovation
offers a number of strategic benefits:
• It is easy to understand and simple to use. Participants
need only select from three basic investment options to
maintain an active role in determining their asset allocation
and risk profiles.
• It automatically invests participant assets more efficiently.
Each Core Menu Innovation portfolio incorporates broad
diversification across traditional and extended asset classes,
which significantly enhances risk-adjusted return potential.
• It is more consistent. Systematic rebalancing maintains
proper risk/reward characteristics within each portfolio.
J.P. MORGAN ASSE T M A N AG E ME N T 9
With this consolidated menu of equity, fixed income and cash
alternatives, participants experience a single entry point for
each primary asset class, while instantly gaining access to
multiple underlying sub-asset classes. This optimizes
participant decision making to focus on asset allocation
choices rather than the minutiae of individual fund selection.
These three highly diversified portfolios significantly reduce
the risk that participants might experience extreme negative
returns through improper usage of a more expanded fund
line-up. Each Core Menu Innovation portfolio automatically
diversifies return streams within its respective asset class.
For that reason, participants can effectively control their
exposure to the broader equity, fixed income and cash
alternatives categories without also having to worry about
investment decisions related to market capitalization,
geography, investment style and other fund choices that
usually fall outside most participants’ comfort zones.
10 FO CU S YO U R A IM
A MORE PRUDENT FRAMEWORK
Plan sponsors are increasingly under scrutiny to ensure they
fulfill their legal obligations for the prudence and suitability of
participant investment decisions. Core Menu Innovation can
help support these responsibilities by providing participants
with access to professionally managed diversified portfolios
where the focus is on making simpler decisions at the asset
allocation level, rather than the individual fund level.
This can potentially help position participants to attain better
investment outcomes. From a fiduciary perspective, anything
that facilitates improved investing with accessible and easily
understood options makes a positive contribution.
The open architecture aspects of Core Menu Innovation also
offer plan sponsors greater control when they want to quickly
make a change in their underlying strategies. This can help
ensure a higher level of compliance with investment policy
statements, while avoiding the adverse participant reactions
that often accompany individual fund line-up adjustments.
Better investment building blocks
J.P. Morgan has developed the following Core
Menu Innovation strategic asset allocations:
Diversified equity portfolio
38% U.S. large cap equities
12% Multi-cap equities
9% U.S. small cap equities
A CONCEPT WITH BROAD APPLICATIONS
Though the current Core Menu Innovation model consists of
just three portfolios, the concept can be applied to a wide
spectrum of investment challenges as the DC industry evolves.
One example is inflation protection. Plan sponsors might want
to provide participants with a professionally managed portfolio
designed to provide a reliable stream of real returns through
changing inflation cycles, an issue particularly important for
those closer to retirement.
6%REITs
22% International equities
13% Emerging market equities
Benchmark: MSCI World Index
Diversified income portfolio
68% U.S. aggregate bonds
8% U.S. investment-grade corporate bonds
16% U.S. high yield bonds
6% EMD
2% EMD local
Benchmark: Barclays Capital
U.S. Aggregate Bond Index
Diversified cash alternatives portfolio
100%Stable value/
Money market fund
Benchmark: Three-month U.S.
Treasury bill
Charts are shown for illustrative purposes only. May not add to
100% due to rounding.
Each Core Menu Innovation portfolio seeks to outperform its
respective benchmark on a risk-adjusted basis. Given these
strategies’ expansive diversification characteristics, we selected
two of the industry’s broadest indices to measure performance:
the MSCI World Index vs. diversified equity portfolio and the
Barclays Agg vs. diversified income portfolio.
In both cases, the J.P. Morgan strategies include an even wider
range of asset class sub-segments than those tracked by their
indices. This high degree of institutional-quality diversification
is designed to increase the portfolio efficiency of each asset
class, by lowering the amount of risk required to generate the
return expectation of each asset class.
This level of diversification would generally be out of reach for
participants drawing from a typical investment line-up. With
Core Menu Innovation, however, this sophisticated approach
becomes widely and easily accessible.
For example, the Core Menu Innovation allocations offer the
flexibility to include strategies found in many institutionally
managed defined benefit (DB) plans that may be additive to
expected performance but problematic as standalone DC
menu options. We have included a number of these extended
sub-asset classes in our strategic asset allocations, such as
emerging market equity and REITs in the diversified equity
portfolio and high yield bonds and emerging market debt in
the diversified income portfolio.
These asset classes have historically demonstrated lower
correlations to the more traditional sub-asset classes that
form each portfolio’s core holdings. Although these sub-asset
J.P. MORGAN ASSE T MA N AG E ME N T 11
classes may be volatile on their own, controlled exposure to
these investments as part of a comprehensive allocation
strategy can potentially help enhance return and reduce
overall risk.
We also based our allocations on J.P. Morgan Asset
Management’s 2015 Long-Term Capital Market Return
Assumptions. These assumptions are used by many
institutional investors, who employ them to develop and
support their anticipated return assumptions for financial
reporting purposes.
In our judgment, using these assumptions will provide a far
more realistic framework for performance expectation when
compared with historical returns. Any portfolio based strictly
on historical returns might be skewed by the extreme market
environments that occurred over the past 25 years. What
worked well from an investment perspective in the late 1990s
was vastly different than what proved successful in the wake
of the financial crisis. The most successful strategy in the
years ahead may be a different approach altogether. Markets
are continuously evolving and an asset allocation strategy
most likely to deliver the strongest investment outcomes must
be designed to address this reality.
12 FO CU S YOU R A IM
THE LIMITATIONS OF INDEXING
Similar to the target date fund concept, Core Menu Innovation
is designed to optimize diversification in a manner well
beyond any one market index. Even the broadest stock and
bond indices have significant shortcomings in terms of subasset class exposure.
Indices are designed to provide backward-looking snapshots
of the size, structure and performance of various markets.
They are not designed to improve forward-looking
investment outcomes.
Index allocations deliberately seek to mirror the market’s
fluctuations, not improve upon them. In fact, indices often
consist of outsized exposure to some market segments and
may completely exclude others. Systematically improving
risk adjusted return potential requires active management.
Smarter diversification, stronger outcomes
To test how well these Core Menu Innovation portfolios might
stand up to the stresses of real-life retirement investing, we
subjected each to a rigorous statistical simulation that
projected the investment outcomes of 10,000 participants at
age 65, covering a wide range of scenarios that might be
experienced over a lifetime of investing. Each participant
began with a $40,000 annual salary and ended with a
$72,000 annual salary over a 40-year time horizon.
The potential outcomes were quite varied because we included a
diverse assortment of possible market environments from strong
rallies to market crashes. Drawing on behavioral trends we
identified in earlier research, we also included a broad range of
participant saving patterns, from investors who contributed
consistently and left accounts untouched, to those who saved
more erratically, borrowed and/or made early withdrawals.
When compared to the MSCI World Index, the diversified
equity portfolio delivered better outcomes for all participants.
It outperformed the S&P 500 for participants at both the top
and the bottom range of returns—at the 5th, 25th and 50th
percentile of returns.
Of particular interest to plan fiduciaries, the diversified equity
portfolio provided much stronger returns for participants
unlucky enough to fall in the bottom two quartiles of returns,
either as a result of difficult markets or poor saving and
spending behaviors. The diversified income portfolio delivered
similar out-performance. It provided significant investment
HO W TO R E A D THE BO X - A ND - W HI S K E R S CHA R T
As expected, the optimized J.P. Morgan portfolios delivered
higher long-term, risk-adjusted performance relative to each
respective benchmark (the diversified equity portfolio analysis
included the widely used S&P 500 Index for comparison as
well). This trend of improved performance with more limited
downside exposure was consistent across the various market
environments and participant investment behaviors used in
the simulations (Exhibit 4).
5th
25th
50th
75th
95th
The box marks the range of the 25th, 50th
(median) and 75th percentile outcomes,
from top (best) to bottom (worst). The
whiskers reaching out from the top and
bottom of the box show the range up to the
5th and down to the 95th percentiles of the
distribution of outcomes. As the dispersion
of returns increases, the “box-and-whisker”
becomes more elongated.
E XH I B IT 4 : RANGE O F EX PEC T ED AC C OU N T B AL AN C ES A T R E TI R E M E NT
Projected outcomes – Equities
2,500
Projected outcomes – Income
1,000
2,280
900
1,946
2,000
800
1,824
736
1,500
1,000
500
—
[000s]
[000s]
700
1,181
496
765
1,056
469
701
1,013
455
283
272
266
SmartAllocation Equity
MSCI World
S&P 500
677
645
600
500
400
577
386
476
512
344
423
300
200
271
242
SmartAllocation Income
Barclay Agg
100
—
Source: J.P. Morgan Asset Management’s 2015 Long-Term Capital Market Return Assumptions. MSCI World index allocations were replicated by custom calculating
forward-looking statistics and simulations using 52% U.S. Large Cap and 48% EAFE Equity hedged. In these simulations, 5th and 25th percentiles indicate worst
outcomes statistically, 50th median indicates mostly likely scenario and 75th and 95th are best-case scenarios.
Note: These numbers are inflation-adjusted. See important Capital Market Return Assumptions disclosure on last page.
J.P. MORGAN ASSE T MA N AG E ME N T 13
outcome improvement for all participants and especially
helped to increase return expectations for participants in
the lower percentiles.
While this standalone performance is compelling, it is even
more critical to assess how these portfolios might work
together, since do-it-yourself participants will employ them to
construct their own customized asset allocations. To help
quantify if various combinations of these portfolios would help
participants secure stronger outcomes, we re-ran the
simulations with three frequently used types of allocations
(Exhibit 5, next page):
• A 60/40 portfolio of 60% diversified equity and
40% diversified income
• A 40/60 portfolio of 40% diversified equity and
60% diversified income
• A 1/n portfolio, which allocates an equal amount of
assets in each investment option offered: equities,
income and cash alternatives
All of the participant-driven portfolio combinations exhibited
consistently stronger risk/reward characteristics compared to
equivalent benchmark allocations. These improved investment
profiles would be expected, since each Core Menu Innovation
portfolio automatically provides participants with optimized
asset class-specific diversification. Of note, our analysis
demonstrated that increasing allocations to the income and
cash alternatives portfolios proved extremely effective in
dialing down expected risk, without curtailing relative return
advantages. Our analysis underscored the effectiveness of the
Core Menu Innovation model, which offers participants three
portfolio options (equities, income and cash alternatives) that
can be selected based on a participant’s individual risk
tolerance. The benefits of tightly controlled exposures to a
broad set of sub-asset classes are firmly entrenched within
each portfolio.
14 FO CU S YOU R A IM
The inference of this model for plan fiduciaries is an ensured
degree of relative portfolio efficiency, regardless of how
participants mix the equity, income and cash alternatives
portfolios together. Even if participants suboptimally allocate
assets among these three choices, they will still gain exposure
to a more limited range of downside risk. It is doubtful that a
similar observation could be made about a line-up with 18-plus
fund choices because the variability in underlying allocations
would simply be too great to predict consistent success.
This inherently greater portfolio efficiency of the Core Menu
Innovation model is expected to deliver stronger investment
outcome projections for the vast majority of participants
across all three portfolio combinations, while minimizing
downside risk (Exhibit 6, next page). In both the 60/40 and
40/60 portfolios, there was consistent—and often dramatic—
improvement at the 5th, 25th and 50th percentiles for the
Core Menu Innovation blends. This pattern remained
consistent with the 1/n Core Menu Innovation mix as well.
While there was improvement at the median percentile, it was
more muted than the increase noted in the other portfolio
mixes due to the stabilizing nature of cash in both the
participant portfolio and the blended benchmark.
Plan fiduciaries are undoubtedly concerned about increasing
investment success for the greatest number of participants.
For that reason, they should especially focus on the
consistently stronger performance across these various Core
Menu Innovation combinations at the median and lower
percentiles. These segments face the greatest risk of falling
short in accumulating enough to retire safely, due to bad
investment decisions or challenging economic climates. The
Core Menu Innovation portfolios help better protect these
groups on the downside while still delivering compelling
performance for participants in the higher projected ranges.
E XH IB IT 5: C O MBININ G C ORE MEN U I N N OVAT I ON POR TF O L I O S
OFFER S A HIGHL Y DIVERS IF IED AS S ET C L AS S MI X
60 diversified equity/
40 diversified income portfolio
EXHIBIT 6: RANGE OF EXPECTED ACCOUNT BALANCES AT
RETIREMENT FOR PARTICIPANT-DETERMINED PORTFOLIO
COMBINATIONS
60/40 portfolio projected outcomes
$1,600
1%
2%
6%
3%
1,400
23%
1,365
1,151
1,200
1,110
7%
5%
4%
13%
8%
[000s]
1,000
27%
800
883
600
477
781
650
444
590
400
200
—
40 diversified equity/
60 diversified income portfolio
760
436
308
294
290
60 div equity/
40 div income
60 MSCI world/
40 agg
60 S&P 500/
40 agg
578
40/60 portfolio projected outcomes
5%
41%
15%
$1,200
5%
1,000
4%
2%
800
9%
5%
[000s]
1%
4%
10%
600
1,077
910
763
454
590
420
400
200
1/n portfolio
—
13%
1%
2%
5%
3%
Equities
$900
600
500
400
U.S. large cap equities
U.S. aggregate core bonds
300
U.S. multi-cap equities
200
U.S. small cap equities
U.S. investment grade
corporate bonds
REITs
U.S. high yield bonds
International equities
EMD
Emerging markets equities
EMD local
Cash alternatives
Source:
J.P. Morgan. Hypothetical information shown for illustrative purposes only.
415
527
292
289
40 div equity/
60 div income
40 MSCI world/
60 Barclays agg
40 S&P 500/
60 Barclays agg
743
727
825
700
23%
Cash alternatives
658
310
800
4%
Fixed income
534
1/n portfolio projected outcomes
[000s]
33%
4%
3%
2%
7%
669
883
615
390
493
567
369
463
559
364
272
260
258
Diversified 1/n
1/n MSCI world
1/n S&P 500
456
100
—
Source: J.P. Morgan.
Results are based on analysis derived from J.P. Morgan Asset Management’s
2015 Long-Term Capital Market Return Assumptions.
See important Capital Market Return Assumptions disclosure on last page.
See page 11 for a complete breakdown of the 60 diversified equity/40 diversified
bond, 40 diversified equity/60 diversified bond and diversified 1/n portfolios.
J.P. MORGAN ASSE T MA N AG E ME N T 15
Given this data, it seems evident that Core Menu Innovation
provides a statistically sound line-up structure that delivers
efficient diversification and facilitates positive participant usage.
Based on our analysis, this smarter core menu approach:
• Consistently optimizes investment outcome potential.
The broader diversification characteristics of the three Core
Menu Innovation portfolios helped produce higher account
balances in our simulations, while narrowing the range of
extreme downside performance.
• Helps make do-it-yourself participants better investors.
The streamlined Core Menu Innovation structure made it
easy to assemble institutional-quality portfolios that
captured greater risk/reward efficiency, regardless of how
participants might combine the equity, income and cash
alternatives portfolios.
• Focuses participants on the right risk levers. Varying
exposure to the equity, income and cash alternatives
portfolios provided an effective and clearly defined means
to customize portfolio risk/reward characteristics, in
contrast to the haphazard approach required by more
complicated line-ups.
By simplifying participant investment decisions while
broadening diversification, the Core Menu Innovation model
provides a prudent framework for do-it-yourself participants
to engage in an efficient and effective asset allocation process.
This optimal convergence of participant behavior and portfolio
structuring offers a strong set of core menu offerings that can
help plan sponsors successfully increase participants’ odds for
retirement funding success.
16 FO CU S YOU R A IM
A more complete plan line-up
Core Menu Innovation helps close the substantial gap between
fully bundled target date funds and the current “go it alone”
aspect of most current investment line-ups. Offering
professionally managed asset class-specific portfolios presents
do-it-yourself participants with a practical modular solution
that allows investment choices while facilitating stronger riskadjusted return potential over the long term. In conjunction
with a target date fund offering and a self-directed brokerage
account, the addition of a set of Core Menu Innovation
portfolios can help plan sponsors offer participants three
compelling investment tracks from which they can choose
based on their particular needs (Exhibit 7, next page).
In our participant focus group research, we tested various
approaches to core menu reconfiguration. Participants
consistently told us that Core Menu Innovation, compared with
other approaches, was the easiest to understand and the most
likely to help them engage with their plans. These quotes
highlight the common themes we heard again and again:
• “I like it. I had too many options before. It’s something
different, something new that’s easier for the investor.”
• “It’s been thoughtfully planned for me.”
• “I was overwhelmed with too many choices in the past.”
• “It gives you a place to get started.”
That sentiment is captured in this particular quote:
“It doesn’t change what I’d do initially, but it makes me feel
better knowing that I could go there if I wasn’t happy with the
performance I was getting with the packaged investments.”
Engaging in a plan re-enrollment is the most effective way
to implement Core Menu Innovation. This implementation
approach is used by many plan sponsors when making
substantial investment menu changes to their plan. During
the re-enrollment process, participants are informed of the
new investment options and given the opportunity to make
new investment elections. If they do not make an active
election during the designated election window, their existing
assets and future contributions will be defaulted into the
plan’s QDIA, usually a target date fund. The plan sponsor may
receive ERISA fiduciary safe harbor protection for the assets
that are defaulted into the QDIA.
This approach will ultimately move more participants into
target date funds, while offering an improved core menu for
those who desire to retain control over their asset allocations.
It also effectively recalibrates the line-up to help plan sponsors
lead participants to the investment solutions best designed to
meet their specific needs. After the re-enrollment, this
streamlined investment structure can help focus new
participants on determining their investor type to decide which
investment approach makes the most sense for their situation.
• “This is great. They’ve simplified it by only having three
options. Yet it speaks to every different kind of investor.”
A few did say the strategy felt like a loss of choice, but those
concerns dissipated when participants were informed of the
diversity of investment styles and managers encompassed in
each portfolio.
When a plan sponsor based its communications on the
premise that participants are not losing choice but rather
gaining better access to choice, it helps place the Core Menu
Innovation concept in the context of participants’ overall
investment strategies. Additionally, offering a self-directed
brokerage account for participants who want complete control
over their investments also proved reassuring, even though
most will never use this option.
J.P. MORGAN ASSE T MA N AG E ME N T 17
E XH IB IT 7: BUIL DING T H E RIGH T PL AN L I N E-U P
If participants prefer ...
A ready-made solution
They can choose their own mix
More investment options
• Feel uncertain about investing
terms and concepts
• Take the time to check their
investments every few months
• Thoroughly understand different
types of investments
• Lack the time or interest to study
investment details
• Feel comfortable with stock market
terms, but don’t study day-to-day
changes
• Enjoy taking time to regularly
study the stock market
• Take comfort from having access
to professional expertise
• Prefer to balance choice with ease
• Consider investments outside the
retirement plan when forming an
investing strategy
They may want to consider ...
Choosing the target date fund closest
to their expected retirement year
2015
Selecting a mix from the plan’s three
core investment options
Diversified equity portfolio
2020
Exploring the range of choices
available in a self-directed
brokerage account
Mutual funds
Individual stocks
2025
2030
2035
2040
Diversified income portfolio
2045
2050
2055
Diversified cash alternatives portfolio
Target date funds are funds with the target date being the approximate date when investors plan to start withdrawing their money. Generally, the asset allocation
of each fund will change on an annual basis, with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value
of the fund[s] is not guaranteed at any time, including at the target date.
18 FO CU S YO U R A IM
CONCLUSION
Core Menu Innovation represents J.P. Morgan’s best thinking on how to measurably
move the needle toward a more financially sound retirement for participants making
their own investment decisions. Plan sponsors are searching for ways to consolidate
investment line-ups and increase participant engagement. Core Menu Innovation takes
those efforts to the next level, simplifying participant choices while providing access to
the professionally designed asset allocation and sophisticated diversification solutions
found in many professionally managed defined benefit plans.
There is a remarkable power in the simplicity of just three core menu options. Although
the concept is simple, the logic behind it is quite advanced. These institutional-quality
equity, fixed income and cash alternatives portfolios firmly root increased portfolio
efficiency into do-it-yourself participants’ asset allocation choices.
Our research has shown this approach to be conducive in significantly improving
investment outcome potential, both by generating higher expected risk-adjusted
performance and encouraging more beneficial investment behavior. By streamlining
the investment line-up with fewer but smarter investment options, plan sponsors can
help participants make better investment decisions and place a greater number of
people on a more secure retirement savings path.
THE TARGET DATE FUND ADVANTAGE
We believe target date funds remain the best choice for most participants because
many find it difficult to articulate their risk preferences. For these investors, there is no
substitute for a well-designed glide path.
Core Menu Innovation replicates many diversification benefits of the target date fund
experience at the asset class level; however, the concept is more closely related to riskbased strategies, given that these portfolios’ risk/reward characteristics remain static.
Core Menu Innovation should not be viewed as a true unbundling of a target date
fund’s asset classes. In addition to broader asset class allocation shifts, most glide
paths also include changes within each asset class as retirement approaches. These
are not reflected in a Core Menu Innovation portfolio. Some target date funds also add
exposure to assets that sit outside the equity, fixed income and cash segments, such as
inflation-protection strategies.
J.P. MORGAN ASSE T MA N AG E ME N T 19
20 FO CU S YOU R A IM
The projections utilized throughout, based on J.P. Morgan Asset Management’s 2015 Long-Term Capital Market Return Assumptions, are provided for illustration/
discussion purposes only and are subject to significant limitations. “Expected” or “alpha” return estimates are subject to uncertainty and error. For example, changes
in the historical data from which it is estimated will result in different implications for asset class returns. Expected returns for each asset class are conditional on an
economic scenario; actual returns in the event the scenario comes to pass could be higher or lower, as they have been in the past, so an investor should not expect to
achieve returns similar to the outputs shown herein. References to future returns for either asset allocation strategies or asset classes are not promises of actual returns
a client portfolio may achieve.
Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making a decision. The model cannot account
for the impact that economic, market and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual
portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact the future
returns. The model assumptions are passive only — they do not consider the impact of active management. A manager’s ability to achieve similar outcomes is subject
to risk factors over which the manager may have no or limited control.
RISKS ASSOCIATED WITH INVESTING IN THE FUNDS. This document is intended solely to report on various investment views held by J.P. Morgan Asset Management.
Opinions, estimates, forecasts and statements of financial market trends that are based on current market conditions constitute our judgment and are subject
to change without notice. We believe the information provided here is reliable but should not be assumed to be accurate or complete. The views and strategies
described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not
intended to be, and should not be interpreted as, recommendations. Indices do not include fees or operating expenses and are not available for actual investment.
The information contained herein employs proprietary projections of expected return as well as estimates of their future volatility. The relative relationships and
forecasts contained herein are based upon proprietary research and are developed through analysis of historical data and capital markets theory. These estimates
have certain inherent limitations, and unlike an actual performance record, they do not reflect actual trading, liquidity constraints, fees or other costs. References
to future net returns are not promises or even estimates of actual returns a client portfolio may achieve. The forecasts contained herein are for illustrative purposes
only and are not to be relied upon as advice or interpreted as a recommendation.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than original cost. Past
performance is not a guarantee of future results.
Cash alternatives are not federally guaranteed and may lose value. Cash alternative portfolios have interest rate, inflation and credit risks that are associated with
the underlying assets owned by the portfolio.
Bonds have the same interest rate, inflation and credit risks that are associated with the underlying bonds owned by the portfolio. Interest rate risk means that as
interest rates rise, the prices of bonds will generally fall, and vice versa. Inflation risk is the risk that the rate of return on an investment may not outpace the rate of
inflation. Credit risk is the risk that issuers and counterparties will not make payments on securities and investments held by the fund.
The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or
unpredictably. These price movements may result from factors affecting individual companies, sectors or industries selected for the fund’s portfolio or the securities
market as a whole, such as changes in economic or political conditions. Equity securities are subject to “stock market risk,” meaning that stock prices in general (or
in particular, the prices of the types of securities in which a fund invests) may decline over short or extended periods of time. When the value of a fund’s securities
goes down, an investment in a fund decreases in value.
Certain underlying funds of the target date funds may have unique risks associated with investments in foreign/emerging market securities and/or fixed income
instruments. International investing involves increased risk and volatility due to currency exchange rate changes, political, social or economic instability, and
accounting or other financial standards differences. Fixed income securities generally decline in price when interest rates rise. Real estate funds may be subject to a
higher degree of market risk because of concentration in a specific industry, sector or geographical sector, including, but not limited to, declines in the value of real
estate, risk related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by the borrower. The fund
may invest in futures contracts and other derivatives. This may make the fund more volatile. The gross expense ratio of the fund includes the estimated fees and
expenses of the underlying funds. A fund of funds is normally best suited for long-term investors.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than original cost.
Past performance is not a guarantee of future results.
All case studies are shown for illustrative purposes only and should not be relied upon as advice or interpreted as a recommendation. They are based on current
market conditions that constitute our judgment and are subject to change. Results shown are not meant to be representative of actual investment results. Past
performance is not necessarily indicative of the likely future performance of an investment.
We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the
purchase or sale of any financial instrument. This material has been prepared for informational purposes only, and is not intended to provide, and should not be
relied on for, accounting, legal or tax advice. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted
as a recommendation.
J.P. Morgan Funds are distributed by JPMorgan Distribution Services, Inc., which is an affiliate of JPMorgan Chase & Co. Affiliates of JPMorgan Chase & Co. receive
fees for providing various services to the funds. JPMorgan Distribution Services, Inc. is a member of FINRA/SIPC.
J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include, but are not limited
to, J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc.
© JPMorgan Chase & Co., January 2015
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