The State of Retirement Research | #419 (Jean-Pierre Aubry)

0:00This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer, and Cameron Passmore, Chief Executive Officer at PWL Capital. Great to be with you again, Ben, episode 419. And this one, as we were just saying to the guests as we signed off, it really is a super interesting and fun conversation about kind of our, almost the greatest hits of things we've talked about that really

0:31get people energized and learning about. This week's guest that you found, Jean-Pierre Obrey, he's the Associate Director of Retirement Plans and Finance at the Center for Retirement Research at Boston College, which is a fascinating organization and the research they've done is so varied. So it was blocked in four different conversation topics and each one is so practical, so pragmatic, so interesting, a little bit shocking, a little bit not shocking, but to have it all wrapped up in

1:02nice, tight, completely understandable bundles from JP was a real fun, interesting interview. The reason that it comes across as greatest hits of stuff that we've talked about is that their, JP and his team are doing research specifically for improving financial outcomes for households, which is kind of what we're trying to do. So it makes sense that the greatest hits with a line there. And I think what JP brings is his own research on those topics. It's not just a summary of other stuff that we've talked about. It's a reiteration of it

1:33backed by independent research that him and his team have done. So I think that brings a really fresh angle to these topics, even if they're topics that we have covered before. It's also interesting perspective too, I think in each of the topics in terms of awareness and not just the public, but also awareness of the advisory community. There's some really interesting insights there that you learn about, for example, asset allocation. How do financial advisors impact asset allocation? One of the surprising stats, there is some sample bias here as JP talks about when he brings the stat up, but a huge portion of households do work with

2:05advisors. Their impact on asset allocation, definitely that was an interesting point. The discussion on alternative investments and public pension plans, I personally loved. That's a topic that's- That's like candy for us, right? Let's face it. It was very balanced. Yeah. And as you quite clearly said to JP, it can change. Yeah. I think that's always an important point to bring up that we can look at the last 20 years and say, all these pension funds are not very smart, but that can change in a couple of years. If, and I'm not saying it's going to happen. Everyone knows I support index

2:35funds and wish that pensions would use more of them instead of all the alternative investments that they use. However, it only takes a couple of years of a big performance swing for all the stuff that they're doing with alts to look really smart. Anyway, so we did talk about that. We also covered how inflation affects retirees and how the distribution of the inflation effect on retirees changes across different characteristics, retiree characteristics. We talked a little bit about market risk for retirees. We talked about the financial advisor piece and how financial advisors impact asset allocation, but we also talked about how individual preferences for asset

3:10allocation differ from the actual asset allocations that people have, which is also a bit surprising. Well, it was also, he talked about the asset allocation per advisor. Yes. That's another big one. If you take, I can't remember how many they had, but five different, whatever number, five different profiles call it of households with different characteristics that you would expect an advisor to give different recommendations to. The recommendations given an advisor are very flat across those five different profiles, but the recommendations from advisor to

3:41advisor are very different, which is something we've talked about in the past. It calls it an advisor fixed effect. Advisors don't do a lot of customization to individual portfolios, but the portfolio from one advisor to the next can be very, very different, which is not great, right? Because one of the things you kind of would expect is customization based on household characteristics, but advisors, as JP talks about, will tend to have their belief on sort of the optimal asset allocation and their recommendations

4:12will reflect that more so than a customization based on household characteristics. That part was also pretty shocking. Not shocking because it backs up other research, but also, I don't know, at least very interesting to see independent research corroborating something that we've talked about in the past. JP is the associate director of retirement plans and finance at the center for retirement research at Boston college. He oversees and conducts research and data collection, develops new analytic techniques for evaluating retirement plans and secures funding support. So all the research we

4:43talked about with him is research that he has done in that capacity. He's recognized as a leading expert on state and local government plans. And he's the co-founder of the public plans data, which is a database on public pension plan performance that he uses and other people have used to do research. He also studies single and multi-employer plans in the private sector, as well as state run auto IRA programs. And he's co-authored numerous studies that have received broad attention, which again is what we talked about. And he's presented to professional and academic groups. He leads CRR's retirement plan

5:17consulting unit, which supports state and localities considering policy reforms. So he's done lots of analysis in that capacity and talked to lots of different groups. It was really interesting too, to hear about some of his, because I asked him like on the public pension plans piece, you've done all his research showing that public plans are not doing a great job. How do those conversations go? And I thought he had some really interesting insights on, on that, what people say behind closed doors. Anyway, great conversation, as you said, Cameron greatest hits, but with some independent

5:50corroboration of those greatest hits from someone who's done a bunch of their own research. I followed JP for a while. Like every time he puts a new paper out, I'm going to read it. They're always quality, interesting, and practically relevant for people making financial decisions. Love it. Great setup. So you're good to go? Let's go to our episode with JP Obrey.

6:14JP Obrey, welcome to the Rational Reminder podcast. Thanks for having me. Really happy to be here. We're very excited to be talking to you. You got some really great research that we're going to talk about. To kick it off, can you explain what the mission of the Center for Retirement Research at Boston Colleges? So at the CRR, Center for Retirement Research, our mission is really to produce first-class accessible research for the policy community and practitioners in the private sector around retirement policy. It's 1998 when the center was founded. We've really built a reputation

6:45for being a kind of objective resource on all the major aspects of retirement policy. And like I said, you've done a bunch of interesting research. We're going to jump into that now. Can you talk about how investors own asset allocations compared to their desired asset allocations? So we just did a recent study on this where we looked at what individuals want to hold in terms of stock. I mean, we have this huge shift that's been happening since the 80s from defined benefit plans to the defined contribution plans. So defined benefits are kind of the old

7:20working at GE your whole life. You know, you retire after working on the line, you get payments, a check coming in the mail for the rest of your days from the employer you work with. That was the old way. The new way is the 401k system, which is basically a glorified savings account that you invest in the market. And so that has its challenges for individuals where they're trying to, depending on the market goes, how that goes, that's how their retirement goes, essentially. Well, that was not

7:51the case under the old model. When the check came, basically hell or high water, you get the same amount in the mail. So given that risk, you know, trying to understand, given the market risk in 401ks, it's really important to understand, you know, how much individuals are comfortable with and whether they are taking on the risk that is right for them. And so this research was really looking at that issue. And so what we did is we surveyed individuals with about $100,000 or more in the markets. We wanted people with money. So to save, you have to have money. They have to have assets. And so that's the

8:27population we're looking at. We asked them how much they'd like to hold in stock. What's their kind of ideal allocation? Just thought about it quickly. And on average, we saw that was around 30, high 30s, 37, 38% in stocks. That's pretty low, right? These are older individuals. I think our lowest age is 48 and it goes up to 70. So you're mixing it with people at the tail end, who may not want any risk. But yeah, that's kind of what we're seeing. There actually wasn't that much variation across age. That's the average. When you look at actual allocations in other data sets, it's closer to

9:02among the same basic population of 45, 48 to 70. You basically see holdings are closer to 45, 46, about 10% higher. And so takeaway from this was that it seems like actual allocations for individuals are somewhat higher than what their kind of pie in the sky, what their gut tells them for what they would like to hold in terms of stocks and the risk they'd like to be exposed to in the market. So what explains that difference between the actual and desired? We're still actually doing some research to try to understand that. But our hunch

9:34is that it's defaults in the retirement system, essentially. Potentially TDFs, but there are other defaults before TDFs came about. And other frictions, just the most salient investment in the lineup, maybe equity heavy, maybe an index fund, that kind of thing. And people default to those, whether explicitly or implicitly. That's where they stay. People also don't make much, aren't usually aren't too active in their retirement accounts. And so that's kind of what we think is driving some of that. Now, I think an important distinction is also that

10:07individuals on the whole have pessimistic views of what stock returns will be relative to what history has said. So there's been multiple studies over time that have confirmed this year after year, kind of repeated surveys show that at any given point in time, individuals always underestimate returns, overestimate volatility, again, relative to history. The presumption is that, or the thought we have is that maybe being a little bit higher than they would desire on their own may not be as bad

10:39as what we think, given that most people harbor relatively pessimistic assumptions about stocks. Yeah, that is really interesting. So it's like people hold pessimistic views and therefore have low ideal allocations to equities, but defaults or salience or whatever pushes people up to a higher allocation, which is probably a good thing because it's almost like de-biasing their beliefs. Exactly. But still not very much. Yeah, still not much. That's true. It's still, even in the actual allocations, it's still pretty low, even for an older investor. At least I would say it is. There can be a lot of

11:14variation around that opinion too, which we will ask about in a second. What do you see as the role of financial advisors for retirement investors? Their role is what you alluded to before. It's kind of trying to de-bias or just provide more information to help investors, retail investors, be better informed. And so what we see in our data, again, is that those that work with financial advisors are more likely to have higher allocations. They're more likely to say that working with an advisor change their opinion of stocks, they're more likely to say that it also, when they worked

11:47with an advisor, they were more likely to want to hold more stocks. So if you view that from the benefit of the doubt, and a generous view of that is that they're helping people correct their innate pessimistic biases on stocks to hold more ultimately. What's the less generous view? The less generous view that our data shows is that in many cases, we found a relationship basically between recommending higher allocations to stocks and how the advisor is compensated.

12:21Essentially, if they're compensated as the percent of assets, they're more likely to recommend higher equity allocations. The idea here is that your pile is going to grow more if you have inequities. And if you're getting the percent of that pile, you want them to be more in equities. So there is that dynamic also at play, which one is really driving the story is part to know. That is a really interesting one. And I do say this as someone who works at a firm that does charge an asset-based fee, but it's like there's a conflict there for sure. But incentives are also somewhat aligned because the pie growing bigger is yes, good for the AUM advisor, but it's also

12:53good for the client. At some level, yes. Growing the pile is the ultimate goal, but there's risk that comes with wanting to do that. And that's kind of the question, that trade-off. If there's no change in risk for growing the pile, you should put it all in red and just go for it. I think that's the dynamic and pushing a client too far relative to the risk when the downside is mostly in the client's side. That's the worry. Right. Okay. Yeah. I think on the whole, it's a positive thing. The differences between where people are and where they want to be is not huge. It's meaningful. Can't be ignored, but it's not,

13:26you know, they want 20% and they're being put to 80. Okay. So we understand now advisors are increasing equity allocations for clients, which is probably a good thing, but how much variation is there in advisors and investment recommendations given a client profile? Pretty significant. Actually, that was really surprising. So we did two things in the paper, I think you're referring to, or the research I think you're referring to, where we looked at desired allocations from the individual side and then allocations and recommended allocations from

13:56the advisor side. On the advisor side, we basically presented a survey to advisors where we provided four or five prototypical clients and asked advisors, what would you recommend for them? There was less variation than we thought we'd see across the prototypes, the archetypes, and much more variation across advisors. So for any given advisor, the difference across archetypes was very small for what we thought were very different people set it up. You know,

14:27someone who's got a DB in the 70s versus someone who's 40 and has a house. We just had what we thought were very different people. And really they didn't seem much difference other than if we said explicitly, they had a different risk profile, like risk conversion in the term of art. So this is per advisor. There wasn't much difference across the archetypes. Right. So per advisor, there's not much difference across the archetypes given the individual's characteristics, which we thought were materially different. When we set it up, we hoped that they

14:58were. The only factor that led to some variation across the archetypes was when we explicitly changed their risk aversion. And I think this is something that's very salient to advisors. Many times when they're thinking of asset allocation, they'll actually provide their clients like a little worksheet to fill out so they can understand where they are at the risk tolerance scale. And so moving that around created some changes for any individual advisor, but it was not nearly as much as we saw the kind of shifts, level shifts we saw across advisors.

15:31Can you just expand a bit on what may have explained the variation in those stock allocations? I know you mentioned compensation and specific risk commentary, but are there other factors at play here? Yeah, I'm trying to remember specifically some of the things. We looked at risk profiles, we kind of set up individuals to have essentially the same overall wealth, but for some, it would be in a DB and a little bit in a DC. For others, they would have a house and less than financial assets. And then obviously the risk profile was another aspect. But we tried to keep the overall wealth

16:03similar. It's just hard to change the composition of that wealth and to see what advisors would do. I think was the test. So it was housing, DB versus DC. I think we also had something in about whether the person wants to leave money for their child as a factor and the risk tolerance. And the other factors didn't matter much outside of risk tolerance. So that's the client level factors, which you did not see much variation across, but then there was a lot of variation. It sounds like across advisors. So each advisor... Right. So the idea is that advisors have some number they think is good for people, right? If I were to

16:35kind of summarize what I'd get out of that, is that each advisor has a number they think is kind of good for people. And regardless of the client profile or the client characteristics, they kind of stay around that number. That number can vary quite a bit. Advisor fixed effects, I think is what it's called in the research. Is that what explains the variation or are there other factors explaining the advisor to advisor differences? We didn't see much else, actually. I mean, again, the one thing we found was how the compensated effect kind of where you set your level. And a little bit about the baseline strategy,

17:05that they were using, whether it was like a total return strategy or a kind of floor strategy, which kind of promised you a guaranteed level of income. In that case, they're taking on less risk. They're trying to kind of guarantee some flow. A total return had more risk. So there were some aspects of the kind of strategy that the advisor primarily liked to use. But I kind of put that in the bucket of fixed effects. It really is what the advisor's approach is to this kind of work. Think about

17:37total return as the kind of ideal approach for their clients. And then how are they compensated showed up as well. From the client's perspective, it's like choosing an advisor is almost like choosing an asset allocation. Interesting. I hadn't really thought about it that way, but that's what our data would suggest. The advisors come to the table with their ideas about where to start the conversation. I think that most advisors probably do their best to hear what the client wants and make some adjustments. This was just a survey, not a real world client to advise or match, but it suggests

18:13that they're humans. They come to the table with their own ideas, what good investing looks like. That's where they start. It's so interesting to think about because the client will not come to the table knowing what their asset allocation should be. And so they can't really choose an advisor based on the asset allocation they think they should have. They're just going to get the asset allocation they happen to get from the advisor they happen to choose. Right. It's a funny dynamic. I mean, they might have a feeling ex post when they get there, like, oh, that's not quite what I thought I wanted once you presented me with the narrative. But I think you're right. They come to the advisor for some guidance. They don't often come with much of an idea of where they want to go.

18:48You've touched on this and maybe the question's redundant, but I want to ask it anyway. How do financial advisors' recommendations actually impact their clients' portfolios? When we asked individuals who had worked with a client, I think in our survey, just to give you a sense of the population, I think it was like two-thirds of our individuals worked with an advisor. These are people with money and assets. So this is not the general population. That number is really general population. But those who did work with an advisor, they were more likely to say that working with an advisor changed their opinion and it changed their opinion

19:20towards more stocks. That was kind of the main takeaway. So it all hangs together. What we hear from what the advisors recommend on average versus what the individuals say they want on average, how the advisors react to different clients, it all hangs together in that way. But again, I'm not sure how bad of a thing it is that they nudge clients towards more risk given that their baseline is usually guided in some extent by pessimistic beliefs relative to history.

19:50I think like you said earlier, it's probably a net good thing. There's that old paper in the Journal of Finance called Money Doctors, which basically argues that that sort of trust-based ability to get people to take more equity risk is the reason that financial advisors can command relatively high fees, even if they don't beat the market. I think there's something to that. You know, TDFs are starting to take some of that role away, I guess, that you're kind of getting the defaults that are doing that automatically for individuals. We suggest that TDFs are part of the story in our piece. Being defaulted into a TDF is still

20:23relatively uncommon. Really? Really? Most plans don't have defaults. Yeah, I mean, it's the requirement for new plans to have defaults just came about with Secure 2.0. So it's really only new plans that have to have defaults, like auto-enrollment that defaults you in the TDF. Most older individuals with a 401k or assets were in the system a long time ago. Just were, even to the extent that there was some voluntary pickup of auto-enrollment for Secure 2.0. That was minimal. And if you're an employer and giving a match, what you hope for is you giving a match and knowing the rules. Like you gave the benefit,

20:58you're lowering people's wages with the presumption that they're going to put some money. It's overall compensation for the employer. So you're saying, okay, I'm going to give you a wage with the narrative that you're going to be also getting a match for me. And so you're thinking about that whole thing. If you don't take it, you're lost. So auto-enrollment is as a significant cost to employers, because now everybody's going to be getting that match. So you don't see a lot of voluntary adoption of auto-enrollment. So the take up of TDFs was kind of more about the lineups, saliency, other things like that. And that was still pretty

21:33powerful. TDFs are still through a lot in the space as the investment vehicle of choice, even without auto-enrollment. But with auto-enrollment coming in, you know, they're going to, I think, take over the retirement space. Just for clarity, JP, can you just briefly describe what a TDF is, in case some listeners don't know? So what a TDF is, what that stands for, that acronym is Target Date Fund. And essentially what it does is it changes asset allocation over time automatically for the investor. So you just

22:06put your money in the fund. It starts off at a high stock allocation generally for younger ages. And as you age, it will decrease your allocation towards stocks and put it more towards bonds. The idea being, as you get closer to retirement, you want to take less risk on your pile. You want to know what's going to be there. You don't have the long horizon to kind of make up any losses, et cetera. There's a lot of actually like very deep and thoughtful theory behind it, economist and financial, economic and financial theory, but essentially it's what it's

22:37doing. And that's why. Usually they start off at really high, like 60 or 70% when you're young, even higher than that, going down to around 40 by the time you're 60. So based on your findings, when you boil all this down, what effect do you think advisors and TDFs have on retirement security? Generally, I think it's a net positive overall. The fact that most individuals are wary of stocks for reasons that aren't reflected in the historical data. The fact that both TDFs and advisors seem to

23:11nudge people towards more exposure is a good thing. It's going to grow the pile for individuals over time. There's really no way to save for retirement without taking some exposure to stocks. You can't invest in bonds. No one has enough money in their back pocket to invest in bonds and be able to replace the income they're earning during their lifetime and keep that same income or something close to that same income in retirement from their savings. All right. I want to move on to public pension plan investment strategy. And this is part of your research that I found you through,

23:42I don't know when, years ago and kind of started following your writing since then. This was the first taste that I got. Can you talk about how public pension plans typically approach asset allocation and maybe touch on the evolution over time, just how that's changed? This is kind of how I cut my teeth as a young researcher within public pensions. Started studying them back in 2009 before they were on the radar, I guess is the word I would use for the research media at least. But that's even before that. It was 2006, excuse me, before the global

24:12financial crisis where we started studying public pensions as a kind of undergrad RA, essentially. And so I've been studying them for two decades and following their evolution over that time. It's an interesting space because they are government entities entrusted with investing money, which is just not a place where governments usually reside. It's kind of by design in our system in America, where state and local governments in particular are supposed to be money in and money out, not holding huge pots. The kind of political risk of that, et cetera, has always been thought

24:44to be high. And we just rather not have that in our system, the way it's designed. So this is kind of an odd duck in the state and local government policy world. These seems institutional investors directly playing in the markets in a political economy. The investment evolution of public pensions have been interesting. I mean, they were basically all in bonds until the 70s. And like everyone else in America, the 80s were equity time. People had seen what had been going on with equities. They had realized that there was growth potential being left on the table.

25:14The perceived risk of equities, I think, was a lot lower then. And so they slowly shifted from basically being in not just treasuries, but mostly municipal bonds, to starting to allocate more towards equities, with the thought being that it would be cheaper. You can grow your pile faster with less money and still provide the benefits to retirees that you're promising. And that, on the whole, worked out pretty well, I would say. Republic plans did exactly what they thought. Their pile grew. And by the 2000s, they had trillions of dollars in aggregate in the markets, saved to pay retirees'

25:50benefits. You know, cops, teachers, police officers, DMV workers. And so starting in the 2000s, though, we had a series of downturns, dot-com bust in 2002, global financial crisis in 2008 and 9, blip in COVID. And so those bumps really changed how public plans started thinking about stocks in particular. What happened essentially is they shifted away from vanilla stocks and bonds,

26:20which they'd done well by up until 2000, and started shifting towards alternatives. Alternatives are basically private equity, more real estate, private, generally, commodities. I think primarily one of the initial favorites was hedge funds, which are basically more analogous to stocks, but just taking bets. The stocks will go down. It's just a little bit more of taking bets on stocks. And that part has not turned out well. Our research has shown continually that that transition, when you look

26:50at public plans, those who have made more significant shifts away from stocks, vanilla stocks and bonds, towards these alternatives, have underperformed the others. In particular, those that made shifts after the global financial crisis, which is when a lot of plans said, whoa, stocks are scary. They had seen other plans who had dipped their toe earlier, do pretty well, because these markets were nations, they were underdeveloped. So there were still opportunities. But they jumped in, you know, when the towards the tail end, I think, or tailor end of these trends, they said they jumped in after

27:252009, it really underperformed peers. And we've looked at plans against other plans. We've looked at state and local plans in aggregate against the basic index fund, which is our most recent research. And it's all ways come up the same, that it hasn't worked. They said it has worked. The gains have just been minimal. Public plans are in a position where they have to really defend why it's worth all the trouble to make its transition. These asset classes are opaque.

27:55They're difficult to explain. And they're in a political economy where transparency is king. They aren't nimble investors. They can't jump in and jump out of opportunities because, again, transparency is king. So to decide they want to make an allocation shift, they have to have five board meetings over the course of a year. By the time they make the leap, whatever they saw a year ago is no longer an opportunity. And so they just aren't, I think, well suited for this kind of nimble institutional investor game because they really aren't well suited to turn on a dime given market trends.

28:31That's kind of the story of public plans. So, you know, the shift to equities worked out pretty well since 2000. The shift away from stocks towards alternatives has not been as fruitful and has also come with lots of headaches politically for public plan investors trying to explain what's going on, because they're just such a different animal and oftentimes pretty opaque. And fees have gone up and liquidity has gone down. And, you know, when we study public plans, we actually give them a lot of credit for the things

29:02they've done right to the global financial crisis. There were lots of benefit increases in the early 2000s when the pile was growing after the 80s and 90s and stock run ups. And so they've kind of retailed the system of some of the excesses of that period. They've really tried to rectify how they fund the system. They're more conservative in how they fund and their assumptions and their benefits. In terms of asset allocation, from what I can tell, they're just actually doubling down on this approach of shifting to alternatives. And actually, recent research not done by my CRR,

29:36but used our database, the public plans database. Researcher coming out of Harvard and I think USC, they were asking the same question, like, what's driving this transition? Because a lot of it is going from stocks to alternatives, not even getting out of bonds is one more risk, but changing what your risk profile. And to do that, you have to have some really strong beliefs that like, these other things are better than stocks. That's why you'd shift. And what's driving that belief? And they provide evidence that it's primarily consultants, essentially.

30:07Yeah, I've seen that paper that it's consultants. And I think is peer effects, another big one in that paper? Peer effects too. Yeah. You know, anecdotally, I think that rings true. I mean, our system is set up where board members are not experts, they're representatives of factions, and they rely heavily on outside expertise for all the decisions actuarially. I think if you're looking towards for any of the whys around what public plans are doing in particular, it's around the professional consultants and service

30:38providers they have, because they rarely push back. They don't have the expertise to push back. It's the same as, you know, the individuals. It's like that same dynamic, but you're putting trust in them. So it's just what it is. Robert Leonard Warren Buffett's talked about that conflict with consultants for a long time now, where consultants won't command the fees that they do if they just come in and tell you to buy index funds. So there's that funny conflict there. We are going to ask more about the public plans versus index funds research, but have you also found that public plans with higher allocations to

31:10alternatives have performed worse than public plans with lower allocations? Robert Leonard Before we did this index analysis, we had done two papers that looked at the shifts in alternatives, and always looking just within public plans. So looking relative to each other, you know, who's done better or worse based on their allocation. And what we found was those that had higher allocations to, and mostly to private equity hedge funds, commodities underperformed their peers. The real driver of that was hedge funds and commodities. To be honest, the private equity

31:46basically held its own, but if hedge funds and commodities were really drags on public plan performance. And again, in particular, in terms of private equity, prior to the global financial crisis, plans that went into private equity outperformed after the global financial crisis, they underperformed. So on the whole, it's a wash for private equity. But the other asset classes, they just were basically a net negative. Can you talk about the approach you took to evaluating the performance of the pension

32:20funds relative to index funds? Robert Leonard We had to create a benchmark. We were looking at the performance of pension funds relative to indexes. We had to figure out what index are we talking about? What do we mean in terms of index funds? And so we wanted something that was somewhat representative of overall what public plans are trying to do, because we're kind of trying to present an alternative approach to see if they're doing better than that or not. At the same time, we wanted something that was salient and understandable by the public. I mean, the point of our research is for it to be accessible.

32:53So I think the tried and true, simple 60-40 allocation for stock index and bond index was kind of fit the bills, what we're looking for. Some can argue that that's not really the risk profile or the intended risk profile of pension funds, that it might be more like 70-30. And maybe you want to put in some international stocks in there, index international stocks to really kind of map what a passive index approach for public pensions would look like in aggregate

33:25and compare. But you can quibble about exactly. But 60-40 was salient and it's hard to argue with as kind of an alternative when you're saying, you know, has all this fancy stuff public plans have been doing using my hands here? Is that really done anything for you? That's what we wanted the readers to lead with. And I think when you do the other types of index allocations, you still get essentially the same story. It may not be as significant like the differences, but you still get the same story that public plans underperform relative to this index approach. But we don't want

33:58to get too caught in that world of trying to match what they're doing too much. So we looked at this 60-40, basically the Wilshire 5000 on the stock side and Barclays Ag Index on the bond side, 60-40, track that over time. Pretty straightforward. On the pension side, we have their actual returns, you know, how they've actually performed year over year for about 250 pension funds in our sample. Clearly, that's not all the cities and towns in America, but it actually is 95% of all the pension

34:32fund assets and 95% of all public sector workers are in these plans. So everything we've left out, all that little tail, they don't add up to much. There are definitely states with a bunch of small towns that have their own little pension. And that's a different analysis that might be interesting, to see how these very small plans do. But this is where everybody is, where all the money is. And when we look at how these larger public plans have performed throughout the index, no matter how we cut it, they underperformed. I think one thing we're trying to do is really

35:04look at this many different ways in terms of the time periods. I think that's one knock people always have is because of analyses. Well, if you're looking from 2009 to 2018, of course you're going to see this. If you're looking from 2001 to 2008, of course you're going to see this. There's always this idea that you're cherry picking your time period, right, for the point you're trying to make. So we wanted to avoid that. And so we did rolling periods of five and 10 years from 2001 to 2018. So we kind of got 2001 to 2005, 2002 to 2007, 2003 to 2008, and we kept doing that.

35:39So you get kind of all these five-year chunks, all these 10-year chunks. And let's see how many of them end up positive and how many of them end up negative kind of idea. And the majority of the time across all these little ranges from 2001 to 2018, all these five-year periods, all these 10-year periods, the majority of time pension funds underperformed the index. So the point we're trying to make there is, yeah, there were some periods probably here or there where pension funds outperformed, but on the whole, they've lost more times than they've won. Our call to action for

36:12public plans from that research was kind of, if you're going to keep doing this, you need to find a way to defend yourself. Like, is it worth the trouble anymore to keep doing this? You know, we've looked at all the different periods, all different times, and it's just hard to make a strong case for this complex approach that pension funds have shifted to over time. And it may not be that indexes have to be the right answer, but it's just, this is relative to, I think, more vanilla asset classes at the very least, you could still do active investment or other things.

36:42Bill Nielsen Indexes probably are the right answer though. Bill Nielsen Yeah, that debate is for a different time. But I do agree, now is a weird time and the broadest stock market. Also with some of the concentration issues, I can kind of appreciate the argument against indexes a little bit more than I used to, given the current situation. Bill Nielsen Yeah, that's fair. Is it the Nevada state pension fund? That's famously an index investor? He comes in with his ramen noodles every day, clicks one button and goes, oh, yeah, something like that. And has whatever top quartile performance relative to everybody else.

37:16Yeah. He doesn't have to defend himself in meetings. It's easy. You summarize other research in the paper. So I do just want to ask about it. How do your findings in this research compare to other research that has tried to look at how public plans or just institutional investors more generally have performed by investing in alternatives? It jives with our own work from before, showing that allocating away from vanilla spots and bonds towards alternative asset classes has been a net negative. It jives with the more recent research coming out of Harvard and USC by Emil and Julianne, tries to understand the reasons for this shift,

37:52which seems to be kind of a consultant class. And I think importantly, it pushes against the main argument whenever analysts try to look at specific periods to argue against public plan investments. One argument refuting that is always for public plans to say, hey, you're cherry picking your period. I am sympathetic to that argument. And so I think in a really important aspect of what we did was trying to look at all different periods over time, because you can always say something about

38:24a given period, the context, what's happening in the world markets. We try our best to kind of nip that in the bud with our approach. I don't think it's hard also for the average individual who kind of follows these asset classes at some level to feel this too. It's not hard to find a story of private equity not being able to offload their assets, having tons of dry powder, not finding investments of only top or top performers actually doing well. There's a drumbeat of this

38:59that I think corroborates the more in-depth academic and academic light, I guess, research. You said your sample ended in 2018? The recent research we did it ended in 2023. Okay, 2023. Since then, I mean, I'm just thinking about like out of sample for that research, I don't think things have turned around. I think it's probably gotten worse. Yeah, which is at the center why we struggle to wrap our heads around the desire to add private assets before we get lineups. I mean, I get the, you know, everyone should have access.

39:34You do this research and you show this in pretty solid analysis that's, say, hard to argue against, and you addressed, as you mentioned a couple of times, some of the common criticisms. Now the research is out there. Like, what kind of feedback do you hear from the actual people that it impacts? We are very proud of the fact that at the center, we are seen as objective. Whenever you see our name in the media quoted in Wall Street Journal or somewhere else on a minister, wherever, there's never a qualifier in front of our name, like the left-leaning, right? The right-leaning, the center,

40:04right? It's just the Center for Retirement Research. That is, we work so hard to keep that, our name, qualifier-free. And so we just kind of call it as we see it. There were years of public plans that were under serious attack for having egregious benefits. Every time there's a story of a firefighter that went on disability and they caught him on a beach, like every public pension plan should be closed down, right? You spend years kind of being the defenders saying, actually, you know what, if you look at total compensation, they get paid less in wages. That's why they get a bigger pension. They're actually getting the same money over their time. They're just getting less

40:36of it in the front end, more of it in the back end. You could kind of get that in the private sector too. We just get all wages. You could just put more of that in your bank account, but no one wants to do that, of course. And I get that. And so you could be weighted that way too. But what we found is basically the overall compensation package is the same. There are other times too, where we had to kind of step up and call it as we see it, which has given us credibility in the public plan space to say the things we're saying now. Because a union member once said, I love the center. I just don't know if they whip us or are against us. That's like two thumbs up for me. It's like, depends on the

41:10issue. And so we think the issues are wrong. So going back to what you asked about the response here, behind closed doors with investment teams, like CIOs of other pensions, what I do here is that we're asking ourselves these same questions. They're working within constraints, right? They have a board. They have other entities who want to keep costs low. So like shifting away from things that promise higher returns has a cost. So they're navigating a different landscape. But the investment officers and their teams are definitely on this and trying to figure out, is this really

41:46worth it? And how do we unwind if we want to unwind? What does the next phase look like? And also those in the investment community, I mean, especially those who have like left the space right now so they can speak more freely. I got a lot of input from those from individuals who used to be CIO, used to work investment team, but now about like, let me tell you what it's really like in these rooms kind of thing. I've had those conversations too. And those conversations are crazy. Yeah. Always. And so nothing officially from public plans generally, which I wouldn't expect. I think the crickets is like what I would hope for best. Because again, I think we've gained enough respect in the community

42:19where they were calling something like this because it deserves looking at and they kind of leave it at that. So to bring this segment home, how would you articulate the key practical takeaways from your research? So for public plans generally, I think it really righted the ship across all facets of public plan administration. The major ones for us in terms of creating a more stable system going forward, other than the investment side. This is the last element. And this one is arguably the most challenging because it will lead to higher costs, what we think probably over time, as they start

42:55really internalizing long-term expectations, shifting out of risky assets. The bottom line here is we thought retirement costed X and actually costed Y, which is bigger. And that reality takes a while to sink in. And what's really going to reflect that new cost most painfully is when they start shifting their asset allocation. I understand that. That's been our takeaway of our work since really trying to give public plans kind of the space to start thinking about this shift by continuing

43:29the drumbeat, while also giving them credit for other things that they've done, which have also been painful and costly, politically costly, has resulted in lower benefits for public sector employees, higher costs for state and local governments. I mean, these aren't easy decisions. I don't want to make it sound like they should just, like they are easy. There's lots of trade-offs. They don't work in a silo. But this is the final frontier for public plans, I think, in terms of the last steps they need to do to get their house in order for the long-term. Super interesting. It's such a hard problem because it's like, obviously, we can't predict the future. Maybe it happens that, to your point earlier about the state of the US market,

44:03maybe we do have a lost decade or more and private assets all of a sudden look really smart. We see this in Canada too, where the Canada pension plan, which is our actually funded version of social security. Sorry. They take a ton of criticism for their active management strategy, which has a ton of alternatives and has underperformed their index benchmark. I mean, there's lots of other stuff they get criticism for related to that too, but that can change in two good years for alternatives relative to public markets. And then all of a sudden,

44:34they look really smart as opposed to not so smart. It's such a hard problem. It really is. I'm glad you mentioned that too, because we often look to Canada as kind of our more sober neighbors for thoughts on how to approach this. They had made this shift and I saw the pieces when against their own indexes, which I also give them credit for reporting that and just reporting it and not hiding behind it. Well, I mentioned that they have taken criticism for other things around that. They've stopped reporting their performance against their index. They've created a new benchmark. Anyway, it's a whole thing up here.

45:05That's too bad. Yeah. So you're right. I think that's all. I think we, our former director, who's not kind of emeritus, she still writes a blog and she did one of us in Canada when they came out, performance analysis of the index to bring it back to the U S because all we do is think about ourselves, right? It was kind of like a Canada can't do it. Like they pay their investors. You guys actually pay your investment teams, real money. You're competing with the private sector in Canada and elsewhere for top notch investors where we don't do that in America for sure. You go to the public sector

45:35as an active service with a pickup. So take that for what you will, but in a world where people are playing with money and think about money, you're not giving them money. It's hard to think you're going to be getting the best of the best. That was kind of our takeaway from that. Like if Canada can't do this, we should be taking our approach as well. That's an interesting point because they do get paid very well. I mean, that's one of the things Canada pension plan investments has been criticized for is that they are paid really, really well and yet they're underperforming. So it's kind of a different angle on what she's talking about. Okay. That was an awesome discussion. I

46:08want to move on to some of the stuff you've done on retirees, starting with inflation. Can you talk about what effect inflation has on older households specifically? So I guess I should back up and say at the center, we are engaged in kind of a longish term research agenda, assessing various risks in retirement. The paper you referenced earlier about desired allocations for individuals and recommended allocations for advisors comes out of the market risk portion of that series.

46:39We've also done health risks, family risks, policy risks. So all the risks in retirement, we're kind of doing research pieces on. This piece was on inflation risk. It was particularly salient as the risk given what we went through in the wake of COVID and are still going through to some extent today or more like the repercussions of that we're still going through today. Inflation is not going up anymore, but we still have high prices relative to before COVID. People feel that. What we saw from our research, what we found is inflation is good if you're holding things like stocks and other things

47:15that go up with prices. Businesses, when inflation goes up, those things rise. It's also good when you have debt because debt payments generally are fixed. And so everything else is going up. Anything else that you own that's rises with inflation is going up, but the debt's not. So, you know, your wages are going up with inflation. People often don't think of it that way, but it's happening. Another little side note, there's a cute little research piece that looked at how people view inflation. And when it comes to wages,

47:49they see it not being driven by inflation, but only their hard work, the prices of everything else is purely inflation. The raising of your wages though, has nothing to do with inflation at all. It's just you and your hard work is what they can kill us. It's like, they just don't always appreciate the connection between all of them. And so when we look at retirees versus other cohorts, let's think about that. So retirees often have more fixed income. They don't want to hold less than equities because they want to take on less risk, which means they're not getting some of the gains that equities

48:22appreciate during inflation. They also often have less debt to pay off their house. They don't have these kind of fixed mortgage payments that are declining relative to everything else. They don't have wages, which is like the primary source of income for workers and those who aren't retired. And that's going up. So they have all these things that are actually making inflation pretty painful relatively compared to other cohorts, less equity, no wage, less debt. It sounds like a good thing, but it can be in terms of like your net gains, an inflationary period, you lose that effect.

48:53And then they have a lot of fixed income, which doesn't go up with inflation, actually decreases their value as well. If you're getting fixed income from that, it's also not going up. They're in a particularly tough spot. I think the one good thing for retirees, they have social security, which goes up with inflation. But for those who have to rely on the financial assets, right, the signals that we kind of think about when we do our research, then all these things matter much more. The fact that your bonds aren't going up, you don't have much in stocks, you don't have debt, you don't have wages. Social security is a small part of what you're relying on. That is

49:26inflation index, but it doesn't matter as much to you. So for retirees, it's tough. Inflationary periods can be tough. You kind of touched on this. Can you just maybe more explicitly talk about how the effects of inflation varies across the age and wealth distribution? The reasons I just mentioned on the age front, they have these different allocations and often less debt. So I kind of explained the age differences in the age profile just a moment ago. In terms of wealth, it's somewhat similar the way that that looks. I mean, if you have less wealth,

49:58then you are relying more on social security. That's better for you. In terms of inflation protection, not in absolute terms, what you rely on moves with inflation. If you have less wealth, then we're likely to still have debt, other forms of debt. And those two things, at least relative to inflation, make you kind of better off than the wealthy. That's a little more of a complicated narrative because having more money is always good. The wealthier individuals have more money, but in terms of how their situation changes, I guess, with inflation, their situation changes more

50:31dramatically if you're wealthy because you're relying on more non-inflation index stuff to retire. You're relying on financial assets that are more likely to be invested in bonds. You're less likely to have debt because you've paid it off and you rely less on social security. So as you go up the wealth gradient, you're also relatively more affected in terms of how your situation changes with inflation than those with less, which is a good thing. I think policy-wise, if I was thinking about who can

51:03bear periods of inflation, like who can bear some of the downside, it's those with more means. That's the reason social security is inflation index. Those that are at the lowest rung and are really relying on this. They're really relying on it. So it has to move with all the prices. That's kind of what our data show. So let's keep going on that, JP. How do households tend to respond to inflation? I think what you would expect, I think the interesting thing is kind of the magnitude. With the rise in inflation, what most individuals say is they pulled consumption forward.

51:35What that means in layman's terms, they spent more of their money right away instead of letting it stay in the bank account and buying it later, which makes sense if you think about what inflation does. If you wait, things would get more costly. So if I was going to buy something in two years and I see inflation is going up, I'm going to buy it now instead if I can at a better price. And so that was the basic trend that people saved less and consumed more in the current period if they had a belief of high inflation. What's interesting is that the amount that they pulled forward, at least over

52:10the five-year period, was essentially like an overreaction in terms of what it meant for their net wealth and income going forward. And so our behavioral data in terms of how people respond to inflation and the kind of decrease in savings and increase in consumption was basically more than they consume more than they needed to to kind of land where they would otherwise be at the end of the five-year period. So that was kind of the major takeaway. It's not surprising that people move money

52:43forward, but it was just that it was kind of an overreaction given their expectations. Robert Leonard Did inflation have an effect on household asset allocations? Robert Leonard It had some, but the takeaway was that it was minimal. I think we found a kind of think closely. I think it was a minimal effect. I'm not sure if it was even significant, but if it was, the magnitudes were so small that it was a nothing burger as a typical term. Robert Leonard And what about financial advisors' recommendations? Did they change in the face of inflation? Robert Leonard Yeah. So what we found in our research is that advisors did kind of shift a little bit more

53:14actually conservative towards kind of fixed income during inflation periods. But that was more, we found because of rising interest rates that go along with it, not really quite as like an inflation hedge. There's two things that often happen at the same time. It makes bonds more attractive. If you already hold bonds, but if you're going to go buy them, they have higher interest rates attached to them. Robert Leonard So when you reflect on this inflation research, what are your biggest takeaways on how inflation affects the retirement security of households?

53:44Robert Leonard Our main takeaway is that when you incorporate behavioral responses, it's a net negative on retirement security because people overreact. Periods of high inflation don't make retirement security any easier. Again, retirees are hit the hardest and people overreact. The net effect of inflation periods are generally, they come out the other side, less secure in retirement than before. Robert Leonard We talked a little bit earlier about the market risk research because it was related to the financial advisor questions we have. Which retirees, which group of retirees is market risk most relevant for? Robert Leonard

54:14It's most relevant for those living on, living off of it. Totally, right? It's the retirees who are retired and no longer have prospects of going back into the labor force. And that's why you see decreased allocations for stocks with higher age. There's kind of an economic theory that wages are a form of bond-like income. When you're working, you can put a bunch of money in equities because your overall portfolio, if you include wages, already has lots of bonds. And once you retire, you don't have that bond-like income and you're really exposed just to equities. And so risk is

54:51much more relevant for retirees who are living on those financial assets and trying to kind of reallocate their income flows because they don't have wages as for bond-like income is important. Robert Leonard I'm really curious, how aware are retirees of the importance of sequence of returns risk? Robert Leonard Not much. Robert Leonard That was my guess. Robert Leonard And I think we actually had a survey question in there specifically and I can't recall exactly what I know the result was that they don't have much understanding of that phenomenon and what it means. But I don't think it played a heavy part in our research because of that.

55:23Robert Leonard That makes sense for households. Do financial advisors understand the sequence of returns risk? Robert Leonard They do, actually. I think our data shows about 75%. I think three quarters of advisors understand the importance of sequence of return risk. What's interesting though, is that among, not even clients, I guess it's retail investors overall, there's actually no difference in understanding sequence of return risk whether you have an advisor or not. So even though advisors understand it, it's not clear that it's transferring at all to clients in terms of appreciating the

55:56importance of sequence of return risk, in particular when you're retired, because that's when you're withdrawing money. And it can have a significant impact whether bad returns come at the beginning or come at the end when you're pulling out money each period to pay for bills. Robert Leonard Right. We never really defined what sequence of returns risk is. But like you said, it's if you're taking money out of a portfolio and you have multiple bad years of returns in a row, that can be really damaging to the longevity of a portfolio. It is interesting though that households who have advisors don't have a better understanding of sequence of returns risk. But I guess if they're

56:29delegating that thinking, maybe it makes sense. In the end, as long as they get it right in terms of their execution, whether they only internalize the reason maybe is not as important. And hopefully financial advisors are helping them do that. Robert Leonard You talked about as your human capital, which is bond-like decreases over time, your overall risk exposure changes. How should financial asset allocation generally change over the life cycle to deal with that changing risk exposure? Robert Leonard The canonical approach, this is kind of how TDS were designed, to be candid. I mean,

57:01it should decline over time. As you get near to retirement and get older, that your risk profile should change and decrease your exposure to stocks more towards something that's bond-like. And that's again, what you see with TDS is what you see in people's actual practices, just for how they feel about the kind of exposure they want. But it's also economic theory that shows that for a life cycle model, that kind of declining exposure to risk, is that what you'd expect. Robert Leonard In your survey research, how important is input from financial advisors for people actually building

57:35out sensible life cycle allocations? Robert Leonard We don't look at that directly. What our data shows is that it helps individuals hold more in equities. I don't think it's inconsistent doing the right thing, but life cycle model. But we don't really ask directly whether an advisor kind of explains to you how your path should look over time. Robert Leonard And our final question, JP, how do you define success in your life? Robert Leonard Yeah, for me, I think success is having purpose. I am fortunate that I feel like I found that in my work. It doesn't have to be your work. I mean, I find purpose in my family, community,

58:09but I feel lucky that I've also found it in my professional life. It keeps you going. That's really important. And then having meaningful relationships as well. Longstanding friends, work colleagues, and not to tie it all back to retirement, but you need some kind of income in your life to kind of enjoy these things and to have the bandwidth to search for purpose, to have the bandwidth to have meaningful relationships. You need to have some kind of baseline security. Money isn't everything, obviously, and everyone knows that. These other things I'm talking about don't really have to do with money, but having baseline security allows you

58:44to do the things that matter in life. And so I think our work is trying to ensure that people, that policies we have and individual decisions people make, help them reach that goal. Robert Leonard Great answer. Robert Leonard That's really good answer. Money isn't everything as long as you have enough of it. Robert Leonard Yeah, this has been a great conversation, JP. Really interesting topics. Thanks for joining us. Robert Leonard It was a pleasure, guys. Anytime. Robert Leonard Awesome. Thanks, JP. Hey, everyone. It's producer Matt. Thank you so much for tuning in to this week's episode.

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