State Street’s Spina Rethinks Retirement Investing

The generational shift from defined-benefit to defined-contribution retirement plans has allowed plan sponsors to manage their financial exposures, and it has also permitted a mobile workforce to accumulate retirement assets from several different employers over a career. But after only 20 years or so, it's too soon to declare the defined-contribution, employer-matched 401(k) retirement scheme a success.

"It is too early to know precisely how effective they will be," said David A. Spina, chairman and CEO of State Street (Boston, $87.5 billion in assets), speaking at TowerGroup's annual conference in May. "There is enough data to suggest to me that this approach will not produce the level of retirement income our employees expect."

Such unmet expectations, he warned, would lead to "another source of distrust - distrust of employers and of the financial system as a whole." To mitigate the potential damage, Spina proposed that the industry "rethink the entire intellectual theory and rationale of pension investing."

For starters, the concept of benchmarking against an index measured by assets has caused pension plan managers to lose sight of their ultimate goal: to ensure that a pension plan can meet its liabilities, he said. Thus, investment managers should watch the probability that a portfolio can meet its liabilities, rather than the performance of that portfolio over a benchmark, Spina suggested.

Adopting a "liability benchmarking" framework would require pension funds to adopt the use of "utility functions," which create a precise and exhaustive description of investor preferences across a range of market scenarios. Doing so would require substantial input from financially savvy consultants and fund managers, as well as robust supporting systems for tracking fund and manager performance, Spina noted.

While more complex than today's asset-liability modeling framework, liability benchmarking uses more realistic assumptions, Spina remarked. "Our industry will be challenged to deliver this, but the best funds, consultants and fund managers are already moving in this direction, albeit slowly and carefully," he told the audience.

Spina also suggested that the industry develop performance guarantees for retirement investments, in which investors trade potential upside in return for limited downside on their retirement portfolios.