Plan Sponsors: Are the International Markets Giving

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Plan Sponsors: Are the International Markets Giving Your 401(k) Participants Heartburn?

March, 2016

Lost in all the attention the poor start of the S&P 500® index has received this year (down 4.96% in January) are the struggles of many international equity markets. In fact, during January the MSCI EAFE®, an index widely used to measure the stock market performance of the most developed foreign countries, was down 7.23%. Looking at the 12-month period from February 1, 2015, through January 31, 2016, the disparity in performance compared to the S&P 500 was even more staggering. While the S&P 500 managed to stay relatively flat (down only .67%), the MSCI EAFE® fell a whopping 8.43%. Even patient 401(k) participants who take a long-term perspective must be wondering about the viability of international investing. For the three-year period from February 1, 2013, through January 31, 2016, the MSCI EAFE® returned a mere 0.68% and for the five-year period from February 1, 2011, through January 31, 2016, the MSCI EAFE® did only marginally better returning 1.59%. Even after January’s setback, the S&P 500® handily outperformed the MSCI EAFE® with a three-year return of 11.30% and five-year return of 10.91%.

Matt Sommer, CFP®, CFA® Vice President and Director, Retirement Strategy Group Janus Capital Group

Despite the recent disappointing performance, the benefits of adding foreign equities to a domestic portfolio are well documented. For starters, foreign companies are some of the fastest growing in the world. In 2001, the U.S. accounted for 33% of global GDP, but by 2014, the U.S. represented just 22% (The World Bank, GDP in US Dollars). Second, international investments have shown the ability to improve risk-adjusted returns. Since 1970, a globally balanced portfolio that included developed-foreign market stocks has returned about the same as the S&P 500®, but with significantly less risk. The standard deviation for the global portfolio was approximately 10% less.

S&P 500® 100%

MSCI EAFE® - 100%

Balanced - 70% S&P 500®/30% MSCI EAFE®

Annualized Returns

10.26

8.79

10.15

Standard Deviation

16.34

17.02

14.59

Sharpe Ratio

0.37

0.28

0.39

1970-2015

Continued to next page.

Plan Sponsors: Heartburn (continued) Finally, international investors may stand to profit through exposure to foreign currencies. Since the U.S. dollar moves in the opposite direction as foreign currencies, when the U.S. dollar declines, returns may be boosted. Of course, the opposite is true when the U.S. dollar appreciates. For these reasons, international investment strategies remain a popular offering in most 401(k) plans. In Deloitte’s 2015 Annual Defined Contribution Benchmarking Survey, 88% of plan sponsors surveyed offer an actively managed global or international equity option and 62% offer a passive option. Astute investment committees recognize that different asset classes are likely to do better than others at various points in time. This premise, which forms the basis of Modern Portfolio Theory (MPT), recognizes that over the long-term a diversified portfolio will reduce the risk of owning a poor performing investment, asset class or part of the world. In fact, diversification may even increase returns. Where MPT shows its cracks, however, is when we introduce behavioral finance and the emotional bias of loss aversion. This bias claims that individuals tend to feel the pain of losses twice as much as the pleasure of gains, and therefore, are prone to selling their out-of-favor investments at the worst possible time—after they have already declined in value. This behavior is exasperated in a 401(k) because the panicked participant fails to take advantage of another investment truism – dollar-costaveraging. The question facing plan sponsors, therefore, is how to provide 401(k) participants who elect to construct their own asset allocation, instead of using a target-date or risk-based alternative, the benefits of international investing while tempering the urge to sell during periods of extreme volatility? A relatively new investment strategy catching the attention of investment committee members is a “managed” or “low” volatility approach. These investments can take many different forms but strive to provide something close to equity-like returns while assuming less risk. These strategies are not likely to keep pace with a sustained bull market, but they are designed not to go down as much during market corrections. Lower spikes and shallower troughs may provide a smoother ride for participants and have less ground to make up when market conditions improve. For a plan’s most aggressive core menu options, such as foreign large-cap blend, a managed volatility approach may offer sponsors and participants a reasonable compromise. The Janus subsidiary INTECH has more than a 25-year history of providing investment management services to institutional clients including pensions and Defined Contribution plans. The INTECH managed volatility process is designed to adjust to the changing risk environments by taking the least risk necessary to outperform. For example, in a low volatility environment, the process focuses on returns through high active weights. In a high volatility environment, the process brings volatility down with lower standard deviation or lower beta stocks. Generally, INTECH is seeking to produce the best risk-adjusted return for a given level of volatility in the market. Different from traditional managers, INTECH does not use fundamental data in constructing their portfolios. Instead, they combine stocks with high relative volatility and low correlations. The INTECH International Managed Volatility fund targets up to 45% less volatility than the MSCI EAFE Index. Plan sponsors concerned about their international investment’s recent performance might ask their consultant about whether a managed volatility approach would better meet the needs of participants. If helpful, our retirement and investment professionals will be happy to discuss these exciting new alternatives with you in more detail. S&P 500® Index measures broad U.S. equity performance. MSCI EAFE® (Europe, Australasia, Far East) Growth Index is a subset of the Morgan Stanley Capital International EAFE Index and contains constituents of the Morgan Stanley Capital International EAFE Index which are categorized as growth securities. The index includes reinvestment of dividends, net of foreign withholding taxes. The information contained herein is for educational purposes only and should not be construed as financial, legal or tax advice. Circumstances may change over time so it may be appropriate to evaluate strategy with the assistance of a professional advisor. Federal and state laws and regulations are complex and subject to change. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of the information provided. Janus does not have information related to and does not review or verify particular financial or tax situations. Janus is not liable for use of, or any position taken in reliance on, such information. INTECH, an indirect subsidiary of Janus Capital Group Inc., is an investment adviser registered under the Investment Advisers Act of 1940 utilizing a mathematically-based, risk managed investment process that attempts to capitalize on volatility in stock price movements. INTECH is affiliated with Janus Capital Group Inc. and its subsidiaries and affiliates. These subsidiaries and/or affiliates include Janus Capital Management LLC and Perkins Investment Management LLC. Past performance cannot guarantee future results. Investing involves risk, including the possible loss of principal. . Janus is a registered trademark of Janus International Holding LLC. © Janus International Holding LLC. Janus Distributors LLC C-0116-109641 02-15-17

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