Exhibit tier passive core mutual funds

Retirement plans are regulated under the Employee Retirement Income Security Act of 19741 and the Pension Protection Act of 2006,2 which set minimum standards for most private pension plans to provide protection for individuals. Tese acts defne the necessary fduciary, reporting, disclosure, minimum benefts, and minimum funding requirements for pension plans.

Defned contribution retirement plans are retirement plans in which an employee (often in conjunction with their employer) contributes to a retirement savings account; upon retirement, the employee can withdraw the accumulated funds—with any earnings from their investments— from the account. Te retirement beneft is not fxed in advance; rather, it depends on the amount contributed to the retirement account over time and how much the account has earned.

Another option for retirement savings are defned beneft retirement plans. In these pension plans, employers make predetermined monthly payments to a retired employee using a formula based on that employee’s earnings history, tenure of service, and age. Te retirement beneft, therefore, is not directly dependent on an individual’s own contribution to a retirement plan and the investment returns on those contributions. Te employer bears the risk of meeting the retirement benefts under defned beneft plans, whereas the worker bears the risk under defned contribution plans.

Historically, corporate and government retirement plans were predominantly defned beneft plans. With the introduction of 401(k) plans in 1978, however, corporations gradually moved to defned contribution plans. Government-sponsored retirement plans were much slower to make the transition. Investments in defned contribution and beneft plans in the United States totaled more than $15 trillion in 2016, with about $7 trillion in defned contribution plans, $3 trillion in private defned beneft plans, and the remainder in public defned beneft plans.6 Assets in private defned beneft plans fell from 80% of private retirement plan assets in 1975 to less than 40% in 2016.7

part of a large, professionally managed diversifed portfolio (most mutual funds hold hundreds of securities) that can be easily bought and sold.

Bond

Source: Investment Company Institute, “2017 Investment Company Fact Book,” p. 28.

Equity

Source: Investment Company Institute, “2017 Investment Company Fact Book,” p. 159.

Figure 3: Average Asset-Weighted Expense Ratio by Type of Fund

	1.0%
	0.8%
	0.6%
	0.4%
	0.2%
	0.0%
		Equity			Hybrid

Figure 4: Average Asset-Weighted Expense Ratios for Active vs. Index Funds, 2016

0.8%

Once employees became eligible for the retirement plan, Northwestern automatically made contributions to their retirement plan equal to 5% of their eligible earnings every pay period. For the most part, “eligible earnings” meant an employee’s base salary. Employees could also make voluntary additional contributions to their retirement plans that were matched by the university. If an employee made a voluntary contribution of at least 1% of his or her eligible earnings (but not exceeding 5%), the university made a matched retirement contribution equal to 100% of the employee’s contribution. Finally, employees could make voluntary supplemental retirement contributions* (contributions in excess of 5% of their eligible earnings) up to the federally mandated limit.† Northwestern did not match these voluntary supplemental retirement contributions. All contributions to an employee’s retirement plan below the federally mandated limit were made on a before-tax basis.17

*Northwestern employees were able to make supplemental contributions to their retirement plan prior to becoming eligible to participate in the retirement plan. Furthermore, if they ceased to be eligible to participate in the retirement plan, they could continue to make contributions.

In the summer of 2016, Northwestern introduced a new investment structure for its retirement plans. A committee of Northwestern faculty and administrators (the Northwestern University Retirement Investment Committee) put together a list of 24 core funds among which Northwestern employees could allocate their retirement savings, including a selection of US equity and bond funds and international equity funds. Tese were not just Fidelity funds, but also funds managed by Goldman Sachs, Vanguard, Met Life, and others. Tese 24 core funds were split across a three-tier investment structure that provided employees fexibility to choose investments based on their investment style and preference. In addition, a fourth tier provided access to many more funds, but these were not evaluated by the investment committee.

• Te Tier 1 investments were target retirement date mutual funds. A target date fund is a mixture of stocks and bonds, both US and international, in which the percentage of stocks versus bonds varies depending on the investor’s age. Te younger a person is, the higher the percentage of stocks in the fund. As the person’s target retirement date becomes closer, the fund manager adjusts the asset allocation mix to make it more conservative. Target date funds are a good investment choice for someone seeking a diversifed mix of stocks, bonds, and short-term investments in one investment option or who does not feel comfortable making asset allocation choices over time. Te list of Northwestern’s nine available target retirement date funds and their fees is presented in Exhibit 1.

sponsor. Tier 4 provided Northwestern employees with access to thousands of mutual funds from hundreds of mutual fund companies. Te university neither evaluated nor monitored these investments. It was the employee’s responsibility to ensure that the investments they selected were suitable for their situation, including their goals, time horizon, and risk tolerance.

Mansueto, launched its mutual fund database in 1986. Te frm provided information on some 525,000 investment oferings around the world, including stocks, bonds, mutual funds, and exchange-traded funds. Te company also ofered investment management services.

Using the Morningstar database, Alice could look up the historical performance of a fund, its fees, the assets under management, the Morningstar Rating™, the capital asset pricing model’s alpha and beta, fund management, main holdings, the Morningstar Category™ or management style, an analyst report (if the fund was followed by a Morningstar analyst), and much more. Te Morningstar data for Northwestern’s Tier 2 and 3 funds is presented in Exhibit 4 and the defnitions for the Morningstar Categories in Exhibit 5.

Alice remembered that the Sharpe ratio was used to compare the risk-return trade-of between well-diversifed portfolios; the portfolio with the higher Sharpe ratio yields the better return per unit of risk. Terefore, she felt the Sharpe ratio could be a useful metric in selecting the optimal mix of mutual funds.

In general, she felt that saving for retirement was a low priority for her right now—retirement seemed far enough down the road that she could worry about it later. She found the additional 5% matching by Northwestern enticing, but she was not sure she wanted to set aside that much toward her retirement at this point, especially since her husband already had a 401(k) account at his job. Should she just not save for retirement right now?

*Togetthelongesthistoricalrecordforeachmutualfund, itwasnecessarytousediferentshareclassesacrosstime for some mutual funds. For example, the historical record for one of Northwestern’s funds, the American Funds NewWorldFundClassR-6, wastakenfromadiferentclassofthefund, its InstitutionalClass, becausetheR-6 did not have a complete historical record. Note that although the two funds held the same investments, they did nothavethesamereturnsbecausetheyhaddiferentfeestructures.

Exhibit 1: Tier 1 Target Retirement Date Core Mutual Funds

Tese investment funds seek to provide for retirement outcomes based on quantitatively measured risk. Tey allocate assets among a combination of equity and bond index funds and money market funds in proportions based on their specifc comprehensive investment strategy.

Exhibit 2: Tier 2 Passive Core Mutual Funds, Strategies and Objectives

who is willing to accept the generally greater volatility of investments in smaller companies.

characteristics. These characteristics include industry weightings and

Exhibit 4: Morningstar Data for Tier 2 and 3 Core Mutual Funds

growth rates and price. Stocks in the top 70% of the capitalization of the US equity market are defined as large cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate. These portfolios tend to invest across the spectrum of US industries, and owing to their broad exposure, the portfolios’ returns are often similar to those of the S&P 500 Index.

Mid cap growth Some mid-cap growth portfolios invest in stocks of all sizes, thus leading to a mid-cap profile, but others focus on midsize companies. Mid-cap growth portfolios target US firms that are projected to grow faster than other mid-cap stocks, therefore commanding relatively higher prices. The US mid-cap range for market capitalization typically falls between $1 billion and $8 billion and represents 20% of the total capitalization of the US equity market. Growth is defined based on fast growth (high growth rates for earnings, sales, book value, and cash flow) and high valuations (high price ratios and low dividend yields).

Small cap blend Small-blend portfolios favor US firms at the smaller end of the market-capitalization range. Some aim to own an array of value and growth stocks while others employ a discipline that leads to holdings with valuations and growth rates close to the small-cap averages. Stocks in the bottom 10% of the capitalization of the US equity market are defined as small cap.

Exhibit 5 (continued)

Short-term is defined as 25% to 75% of the three-year average effective duration of the MCBI.

Foreign large Foreign large-blend portfolios invest in a variety of big international stocks. Most of these blend portfolios divide their assets among a dozen or more developed markets, including Japan, Britain, France, and Germany. These portfolios primarily invest in stocks that have market caps in the top 70% of each economically integrated market (such as Europe or Asia excluding Japan). The blend style is assigned to portfolios where neither growth nor value characteristics predominate. These portfolios typically will have less than 20% of assets invested in US stocks.

Exhibit 6: Historical Monthly Returns for Tier 2 and Tier 3 Core Funds

See Exhibit 6 in the Exhibits Excel file .

11 Ibid., p. 11.

12 Ibid., p. 113.

17 Northwestern University Human Resources Department, “Northwestern UnVoluntarySavingsPlanSummaryPlan Description,”efectiveJanuary 1, 2011, hr/benefts/retirement-plans/Retirement_SPD.pdf.