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Rich Nuzum, CFA: Lessons from Top-Ranked Political Systems
00:29:16
In this episode of the Enterprising Investor podcast, guest host Ryan Munson discusses the 2024 edition of the Mercer CFA Institute Global Pension Index with Mercer's Executive Director of Investments and Global Chief Investment Strategist, Rich...
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Hello and.
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Welcome to the Enterprising Investor, the flagship investment podcast for CFA Institute. I'm Mike Wahlberg and I'm on a break this episode. Filling in for me this round is Ryan Munson, Research Manager with CFA Institute. Enjoy the episode.
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Hello everyone.
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Welcome to today's episode of the Enterprising Investor Podcast. My name is Ryan Munson, I'm a Research Manager here at CFA Institute and I am the guest host for today and I'm joined by Rich Newsom, cfa. Rich is the Executive Director, Investments and Chief Investment Strategist for Mercer. He works with some of Mercer's largest, most sophisticated clients and is accountable for Mercer's innovation agenda, including the creation and development of thought leadership and related products and services across the firm. Over the last 30 years, Rich has provided investment advice to clients in more than 20 countries, including many of the world's largest institutional investors. He's also led Social Security and other long term savings reform projects in five countries and one state. Rich has led Mercer's work in several projects at the World Economic Forum, including work related to transformational investment and the longevity economy. Rich, thank you for joining us.
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Thanks for having me, Ryan.
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So we're here today to highlight the recent launch of the 2024 edition of the Mercer CFA Institute Global Pension Index. This is the 16th year that the index has been created and the fifth year that CFA Institute has been a partner. The report ranks 48 retirement systems around the world on the adequacy, integrity and sustainability of each system. And overall, the index underscores the growing importance of financial security in retirement, especially as populations age and economic pressures increase. So these challenges that are posed by inflation, rising, cost of living, demographic shifts are all making pension reform more urgent. And this year's special chapter of the index focuses on the transition to defined contribution savings plans and the implications of shifting the risk away from the fund and onto the individual. So Rich, with that background laid out and given your experience as president of Mercer's investment and retirement business, what are the key features of consistently highly ranked robust pension systems?
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So, as you said, Ryan, the design of the study, which evaluates across 48 countries in the 16th version. It's agnostic on underlying design and features. It focuses on the adequacy, the sustainability and the integrity of each system. However, the systems that come out highest on those measures have some common features. The eight highest rated systems, with the exception of the Netherlands, which is the highest rated system in the study, but the other seven all have a minimum safety net for people who are unlucky or unable in terms of their labor force participation throughout their careers, but a minimum safety net that's centrally funded from general government budget revenues or some other levy across the population. So a minimum safety net that's defined benefit in nature, and then an individual account savings program, what in the US we would call defined contribution, but an individual count program that provides effectively. It ends up being a career average pay type benefit, but puts the investment risk and lots of other decisions on individuals. Now, the Netherlands has been the exception. The Netherlands is the one system that rates highly, that's been defined benefit in nature. But the Netherlands society have determined through debates over the last couple decades to now move from defined benefit to collective defined contributions. So even the Netherlands moving in that direction. If we contrast that, it's worth noting that none of the G7 economies get a high rating in the study. And those economies tend to have pay as you go Social Security across the whole population. Not just the minimum safety net, but a primary pillar of savings is pay as you go Social Security plus significant use of defined benefit. And the pay as you go systems are in trouble, and we might come back to that. But the systems that are doing well, some of them are higher income countries, but they have this common feature of a minimum safety net plus an individual count system.
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Would you say that in those you mentioned the top eight performing countries, would you say that there is maybe a greater political will for this contribution throughout your lifetime to the government side of the pension savings plan?
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I think political will, it's a great term and a great question. What I can say, I think pretty definitively is because every working voter in the country has an individual count, they're focused on their retirement savings and anything to do with pension reform is front page news. So you take the Australian system, which is one of the top eight ranking systems, or the Singaporean system, which again is in the top eight. Any tweak that is proposed to the system, it gets talked about in the papers because it's going to hit every worker and every voter. It is a constant part of the political economic dialogue. What are we doing with our savings system? How can we make it better? Things like people who work in their home as caregivers, either for young children or for aged adults, tend to get missed by many pension systems globally. That tends to be a hole in coverage because they're not formally employed. There's no formal employer to remit contributions to central scheme. So what are we going to do about them is a common area of political debate. And in the countries that have this feature of a minimum safety net plus plus an individual count system that becomes front page news. Whereas in other countries where the individuals don't have an individual count balance to look at, they're not kind of self reliant for their retirement planning, they're leaving it up to the government. From time to time Social Security or long term savings reform may intrude into, into the popular discussion but for the most part those are issues other people are dealing with and people get on with their daily lives. It's not such a day to day political issue.
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So it almost creates like a sense of commonality amongst voters to potentially improve those political outcomes for, for their savings.
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Yep, everybody's in the system, everybody's kind of in the same set of rules and any proposed tweak to those rules hits directly at people's pocketbooks. So to take an example, in some countries some politicians have proposed that these systems assets should be invested more in local infrastructure or local economic development. And whatever the merits of that are, it immediately becomes a topic of intense political debate because the individuals don't view it as the government's money even though it may be in a government managed scheme. They view it as their money because they have an individual compounds.
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Interesting, interesting. So let's, let's take the more pessimistic approach if we will, looking at maybe some of the countries that aren't performing quite as well in the index. What are the common shortfalls that you see and how can governments work to address these challenges?
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So pick on the U.S. the world's largest economy. One that many of our listeners live and work in or at least are familiar with. An extremely wealthy, fast growing economy. So here's the justice position. The US stock market has led other global stock markets. The magnificent seven stocks have beat most other stocks. The US dollar by many measures is the strongest it's been since 2005 or longer. It's the global reserve currency. So strength, strength, strength, strength, strength. And the US will be the strongest performing of the G7 economies. 2024, it was in 2023 and is projected to be in 2025. And yet as you and I talk Today, half of US households have no retirement savings beyond Social Security. They don't have an ira, they don't have a DC plan, they don't have, they don't have any deed fine benefit coverage. Half of U.S. households have no savings beyond Social Security. So they're purely reliable Social Security. And the Social Security system in the US is projected to start running short of money in 2033 and to have to cut benefits back to less than 80% of what's currently paid. And while that's a well known issue, it's not one. We just had our election and in my opinion, neither presidential candidate put forward very concrete proposals for Social Security reform. It's referred to as a third rail issue. They both promised to protect Social Security, but they weren't specific about how they would do that in a system that's going to run out of money short term. And so we have this juxtaposition of huge US wealth, US economic and innovation leadership globally, and half of US households with no retirement savings. And what they are relying on, that single period of Social Security projected to run short of money. So the US Bottom line gets a C plus grade in the Mercer State Institute Global Pension Index and ranks below Median of the 48 countries we look at, it ranks 29th. So here's the world's wealthiest economy, envy of the world for economic performance, venture capital, entrepreneurship, rule of law, business environment, ranking 29th in retirement income security and failing half its population, in my opinion. Why is it so bad? Well, we have the Social Security pay as you go system. In 1960, we had more than five active workers for every retiree and we had life expectancy of 69 years of age. So if you retired at 60 or 65, you were looking at funding on average a nine year or four year retirement from Social Security and you add five active workers to support you. Fast forward to today. We're at 2.8 to 1. So less than three workers per active, sorry, per retiree. But also life expectancy has increased. So instead of 69, the average life expectancy is 79. If you're already 65, you've attained the age of 65, your life expectancy is 84. So we're trying to pay for a much longer period of retirement on a shrinking population of active employees. And by 2050 we'll be down to 2 to 1 in the US active to retiree, life expectancy will continue, presumably to lengthen. And so the challenge is getting tougher day by day. And we've had some attempts at Social Security reform, but they were in the distant past. Alan Greenspan actually chaired the effort. And we need another round where again, the projections are that we'll run short of money in 2033. So. So the US gets a low grade because half the population has nothing besides Social Security and because Social Security doesn't look very sustainable.
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I mean, going back to the, maybe the political will topic, you know, we've seen places like France and the challenges they have had in making changes to the retirement age, which is one of the inputs to solving the problem that you just laid out that the US has. Is it as simple as, you know, the countries that are underperforming lack that political will and the tie to a community and more individualism that's causing some of these challenges.
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I think in a way it's tougher in a defined benefit system or pay as you go Social Security system to achieve reform that's around how long people work. So the easy solution as an economist to longer lives, more healthcare expense in retirement, is to say to people, if you work longer, you'll have better outcomes, you'll be able to save more. And at an individual level, we know that when somebody continues to participate in the workforce, whether it's paid work or whether they're lucky enough to do pro bono charity work that they want to do and don't need to get paid for it, in either case, if you continue to participate, you have stronger mental health outcomes, you have stronger physical health outcomes and you have better social connection and less risk of participating in the epidemic of loneliness amongst the age that we see globally. So it's actually good for people to stay in the workforce. In a defined contribution system, an individual comp system, individuals will look at their financial situation, realize if I continue to work, maybe it's part time, maybe it's phased, maybe it's not what I used to do, maybe it's something I, I like doing more and it doesn't pay as much. Maybe I don't get paid at all. But if I continue to work, I'll have those better mental and physical and social outcomes and more flexibility about what retirement income I have. In a defined benefit system, you aren't leaving it up to individual choice and individual navigation. You're saying we'll change the rules. And now instead of everybody being able to retire at age 65 or age 67, we're going to push that out next years. Well, some people might have volunteered to do that if they understood the math and what that would mean for them. But when it's forced on everybody in a one size fits all notion. That's when you get demonstrations, even riots about pension reform. So I do think it's inherently tougher to reform a pay as you go Social Security system or any defined benefit system than it is to reform an individual account system because you don't have the self correction around how long and in what ways will somebody choose to participate in the workforce?
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So what's the one innovation that you're really excited about from a US perspective?
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So coming out of the Secure Acts, we have pooled employer plans in the US now which allow a professional defined contribution plan provider to aggregate and manage assets for a bunch of small employers. And I mentioned earlier that that seven of the top ranking systems have a national individual account scheme. In many cases what you have underlying that is single employer provision of DC is giving away to these multiple platforms which have scaled up to the hundreds of billions of assets. So you know, in the case of Mercer's offering in Australia, we have more than 16,000 underlying employers, more than 950,000 individuals that are contributing to one defined contribution master trust and we're able to go out and invest in private equity and infrastructure and real estate, really, really complicated assets on their behalf at low cost. And that's now happening in the US because of the combination of the secure Choice plans in 17 states that are, that are increasing the rate of formation of new plans and then these PEPs which allow a small employer to just pick a pap, contribute to that pep, have some input on some design things but it's all taken care of for them by this professional intermediary. And what we've seen in places like Australia, Hong Kong, Denmark, others that have these multiple employer DC schemes is they start out small and for small employers, but as they get bigger, larger and larger employers move into them. Until you turn around one day and these competing multiple employer DC schemes are taking care of long term savings for the entire nation and competing with each other to do a good job. So I think, I think the US is off to the races there and it's going to reduce the cost of a small employer offering a DC plan and it's going to improve massively the quality of what their, of what their employees can, can get from that. So I'm very excited about Pepsi.
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You lead Mercer's innovation agenda and you've worked on several of these long term savings reform projects. So maybe combining those two parts of your experience, how do those two directives intersect when you think about pensions and retirement? Are there Any emerging innovations that you feel will have a significant impact on outcomes for retirees and this could be at a global level or even using an individual country or market as an example.
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So there's innovations around the accumulation phase and then there's innovations around the decumulation or retirement phase. And in both cases, the digital transition in the economy, including application of AI is helping because we can mass customize advice to people and give you and I and other participants smart defaults and smart nudges around when to use those smart defaults and kind of mass customize both the investment arrangement while we're accumulating assets and then, and then the spend down menu when we think about, well, how, how are we going to navigate longevity risk and inflation risk and downside risk as we stop earning and maybe lose the flexibility to participate in the workforce as we enter that decumulation phase. So digital technology, AI technology is not replacing human advisors, but it's helping make human advisors vastly more productive. And it's helping individuals get a curated experience that brings together all of their different savings from all their different retirement plan accounts, all their different after tax savings, taking into account their housing situation, their family situation, their caregiving situation, their health insurance, and bring that together in an integrated way. And that's evolving quickly in real time. There's new digital innovation every day, but that individually customized digital consumer experience around financial advice and then the products that you make use of for savings, for investment, for insurance, that's evolving for both accumulation and decumulation. And I think there's a lot of good things happening there. I was pessimistic earlier about the U.S. i'll be optimistic for a second. Secure 1.0 and Secure 2.0 passed with bipartisan support. 17 states have instituted secure choice plans that mandate that small employers with above a certain amount of headcount in the state provide some form of retirement savings to individuals. We don't have a national mandate that for you yet, but we're, we're state by state working towards that. And in my experience most of those have passed with bipartisan support. So long term savings reform is actually something that we get done in the US with bipartisan support. We have in the past. We're, there's, there's proposals now and the, the individual congressmen who've helped deliver that have changed over time and yet we continue to see bipartisan efforts in this direction. The U.S. in my opinion, needs to expand coverage. And so 73% of workers in the U.S. have access to a D.C. plan at work. Only 52% participate, in my opinion. We have to get the other 27% covered, and then we have to do things to make it possible or more likely that more people choose to participate because otherwise they're not going to have good retirement outcomes and they will fall back on the state and charity and family for support in retirement, which is not a great outcome.
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Right. So you mentioned AI and the opportunities for personalization there, and I think that that's a really interesting point. One thing that we've seen in other research, not necessarily just looking at pensions, is that institutional investors love AI because it makes their jobs slightly easier. But retail investors are less trusting of AI generated results or advice. How do you see that playing out as we think about, you know, bridging that gap between the people who aren't participating in the available DC plans and especially at the decumulation phase when they're starting to withdraw? Is AI become like a supplemental tool for an advisor to actually help them service their clients? Or does AI do you think AI will eventually get to the point where individuals are using it and making decisions based on that? How can AI in the industry build trust in those tools?
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So we see AI and digital transformation happening in every stage of the value chain for retirement and savings advice and delivery, and some concrete places where I think most individuals are already benefiting from AI. You know, you go back 10 years, if you wanted to find out your account balances across your different accounts, you actually need to call in and speak to a human being, and you need to do it during their business hours. So most of us have more time if we're not working nights, we have more time at nights or on weekends to deal with our financial situation than we do during working hours. And the ability now to go online and do that quickly, anonymously, you know, at your time of your own choosing, that then improves flexibility. Even if. Even if you don't get to the point where you're automating the feeds so that everything's brought together for you. And you and your financial planner can look at that, or you can look at that if you're doing your own financial planning at the next stage. For somebody who's in a human financial planner, the productivity that AI and Robo brings where. So if I was working as an individual financial planner maybe 10 years ago, I could handle 40 individual accounts at a given level of service. Now with AI and Robo, I can handle several hundred because the AI and Robo is telling me, well, something's changed in Ryan's situation. He's just got married, had a child. Something's happened there. Now's the time to call up Brian and help him with his financial situation or at least ask if he needs help. And if you allow your advice provider to use AI to big brother you a bit, which gets it in the trust issue. But for example, my banker can see what deposits are being made into my bank account and we'll call up and ask me, do you need any help around that? Or they'll see what I'm doing with my housing situation. You know, I'm currently running. I used to own and ask if I need any help around that. And done in the right way. Those are, those are good things. They're offering help when you need it. And pre AI, pre digital, they would have had to guess, you know, they might have had me on their call sheet for once a year call. Hey, Rich, do you want to review your financial situation now? They're doing it around either key life events or things happening with financial data that they can see. When you change jobs, when you ultimately retire, those are key moments. How are you going to roll over your investments if you retire? What are you going to do with that now that you don't have the flexibility to continue to work? You're no longer in accumulation phase, you're flipping over into decumulation. So when you have big decisions and having your advisor again, if you allow them to have your financial data at their fingertips so you don't have to aggregate everything and get it to them. And maybe you forget something or you get on the call and they're like, well, what about your Social Security benefit? You don't have your last benefit estimate from the Social Security Administration. You got to go out and get it and have a different call and reschedule. I mean, just the productivity aid is real. You raised at the start AI for investment decision making. We do see more than 80% of investment managers trying to integrate AI into parts of their investment process. I'm not aware of any institutional quality investment managers that are giving up the reins to AI. Everybody's got humans looking in on top of the AI, trying to understand what the AI insights are and benefit from those, but also avoid hallucinations. And it's still garbage in, garbage out on the data. If the data is not clean, the AI will pick out the anomalies and tell you, maybe you can trade on this. And a lot of times when humans look in there, they realize, okay, that's a fat finger error by somebody further back in the chain. That's just not clean data. That's an anomaly. If we train on that, we're going to get crushed in terms of our performance because it's actually a bad signal. If the data had been correct, the AI signal would have been right. But the AI is kind of what the AI is flagging up is there's data problem, not an arbitrage opportunity in many cases. So it's cyborg, it's not AI instead of humans, it's not in the terminat science of cyborgs, but it's a friendlier cyborg where you're combining the best of humans and the best of AI and digital to achieve better outcomes. So right now the productivity enhancement of AI is very real. The potential improvement in decision making I think is still in front of us.
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Sure, we at CFA Institute we call that AI plus hi. So it's the artificial intelligence plus human intelligence that can actually use that application in the right way to achieve better outcomes.
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I love that. And one saying we have in our work with employers is it's not AI that's going to take your job, it's the human being across the street from you that makes better use of AI that's just going to take your job.
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Yeah, well said. So maybe staying on the investment side for a little bit. As a charter holder, you have a relatively unique position and perspective into the role that investment managers and practitioners play in improving pension system coverage and sustainability. So in your opinion, what role do charter holders and practitioners play in improving pension outcomes for retirees and advocating for pension reform?
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Well, I'll go back to the strength of the US economy and again I was pessimistic about the US earlier or made some critical comments, but the wealth that the US economy generates ongoing basis gives us an opportunity to address this and the growth. And that's coming because capitalism works really well in the US And a lot of that's because CFA charter holders are working in various parts of the value chain to direct capital to the highest expected return risk adjusted meta fee opportunities. So the vibrancy of the US venture capital sector, the vibrancy of private equity. As I travel around the world, Ryan, I meet with ministers of finance of different countries and I'm trying to get them to use Mercer to advise on their sovereign wealth funds or their Social Security funds. They almost always flip the table on me and ask for my opinion on hey, how do we get more foreign direct investment into our country? How do we get more entrepreneurship? How do we create a venture capital ecosystem similar to what the US has and I won't give all the answers now, but a lot of that is just CFA charter holders and other smart investment professionals running around. And we're trying to, on a daily basis individually, we're trying to make money for our clients and help our clients achieve their investment objectives. But by doing that really well in aggregate, we actually make the economy work really well. And I've seen that throughout my career that when capital is directed towards more productive things, labor benefits, because it goes to the highest and best use, the economy performs better, the government has more tax revenues under any given tax system and you have more money available to address long term savings. So I think CFHR holders and other investment professionals make the economy work better and that creates wealth that can do with retirement, health care, education, safety, just, just the long list of development priorities we have globally. One of my favorite charts is from the World bank and it shows the proportion of the world's population that lives in poverty. And at the end of World War II it was about 60% of the world's population. Today it's down to 8% and it's pretty much a straight line down. It's actually accelerated in terms of decline since the global financial crisis. So to me that's capitalism and free trade and globalization working. And CFA charter holders are doing a lot to make that engine work on an ongoing basis and help our politicians and other policymakers understand the investment and economic implications of their considerations and decision making.
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I mean, that's a quite an inspirational viewpoint especially for our audience. So I think on that we can call it there. I really appreciate your comments today, Rich. Really enjoyed the conversation. I think this partnership between CFA Institute and Mercer has been tremendous and I look forward to seeing future editions of the index come out. That's all the time we have for today's episode of Enterprising Investor. Thank you all for joining us and thank you for the opportunity to guest host.
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Thank you Ryan. Thanks for having me on.
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Ryan was speaking today with Richard Newsom, Executive Director Investments and Global Chief Investment Strategist for Mercer. I'm Mike Wahlberg and this has been the Enterprising Investor.
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SA.