Retirement planning is the primary goal of retail investors. In fact, 47% of respondents to the CFA Institute 2022 Investor Confidence Study indicated that saving for retirement was their most important investment goal.
However, the conventional path to retirement savings, the traditional portfolio of stocks and bonds, is not as effective as it once was. Weaker diversification, declining real returns and rising inflation present major challenges for both defined benefit and defined contribution (DC) pension funds. As funds struggle to meet their return targets, investors are calling for them to provide access to new and potentially riskier products. Fund managers must weigh these demands in the context of their fiduciary duty, or duty of care, obligations.
With these challenges in mind, for better or worse, or at least until regulators weigh in, many pension funds are exploring allocations to cryptoassets.
So what does this mean for the future of trust in the financial services industry?
Slower wage growth, an aging population and lower investment returns have been identified by the Mercer CFA Institute Global Pension Index as critical threats to the future sustainability of pension funds. Asset owners know the headwinds they face: Only a small percentage believe they are very likely to meet their annual return target over the next few years.
How likely is it that you will achieve your current target performance over the next three years?
That means benefit cuts are not off the table. Of state-sponsored corporate and defined benefit plans, 60% say they are likely or very likely to have to adjust benefits downward in the next 10 years.
Plan participants depend on payments from retirement funds. That pension funds may reduce their expected expenses creates a deferred confidence deficit, which could undermine faith in the entire retirement funding system.
To address the potential return gap and cover unfunded liabilities, pension funds have diversified into digital assets and their supporting infrastructure. According to the trust survey, 94% of state and government pension plan sponsors said they invest in cryptocurrencies, along with 62% of corporate defined benefit plans and 48% of corporate DC plans.
The crypto market has had a turbulent history, especially lately. Volatility has been the norm, with rising peaks giving way to extreme declines and vice versa.
When crypto was near its all-time high, studies showed that a small allocation to digital assets as part of a diversified portfolio could increase returns, improve Sharpe ratio and reduce portfolio drawdown. Of course, in the midst of the latest crypto crash, these conclusions may no longer be workable.
Given the risk of direct investments in digital assets, funds such as CalPERS and CDPQ have allocated capital to crypto-adjacent assets, seeking to capitalize on popular momentum around cryptocurrencies and the potential of blockchain technology while avoiding volatility from day to day of cryptographic direct investment.
DC’s plans have also dipped their toes into space. Fidelity Investments plan participants will be able to invest up to 20% of their portfolios in cryptocurrencies.
So how does the demand for crypto look? It skews towards younger investors, with 59% of those aged 25-34 saying they currently own cryptocurrencies. As digital natives become a larger proportion of plan participants and have more assets, the pressure on plan sponsors to provide access to digital products will only increase.
Percentage of those investing in cryptocurrencies by age group
But skepticism about expanding access to cryptocurrencies and derivatives is widespread. The US Department of Labor registered its ambivalence in response to Fidelity’s inclusion of cryptocurrency in its 401(k) offerings, stating:
“Assets in retirement plans, like 401(k) plans, are essential to financial security in old age, covering living expenses, medical bills and more, and should be carefully protected. It’s that’s why plan fiduciaries, including plan sponsors and investment managers, have a strong legal obligation under the Employee Retirement Income Security Act to protect retirement savings.
Warren Buffett, meanwhile, has described cryptocurrencies as speculative assets and predicted that “cryptocurrencies will have a bad ending.”
Pension funds face an unenviable choice: chase higher returns (and more volatility) or not return at all. Fund inflows are not matching expected outflows and plan participants have a growing appetite for new alternative investment products. So how can the industry respond to these challenges and maintain customer trust?
Pension plan sponsors want to adopt new products early. In fact, 88% said so in the trust survey. But if these products are unregulated and their long-term performance is unknown, plan sponsors must assess whether they can be safely incorporated into portfolios without jeopardizing the confidence of plan participants or the viability of their savings for retirement.
As fiduciaries, pension plans must take a long-term view of investment growth and carefully consider and responsibly manage any allocations to new asset classes. They must communicate to plan participants the risks associated with these new asset classes, including crypto, to ensure that investments align with client goals.
To continue to increase investor confidence in financial services, retirement planning must be supported by robust due diligence. Pension funds and their participants must understand and believe in the products they are investing in. Without this standard, the trust deficit will only grow.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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Ryan Munson
