Designing a Plan Investment Menu in Unprecedented Times
Art by Lars Leetaru
In the 2010s, defined contribution investments were treated to an unprecedented market run. Not even a global pandemic, so it seemed for a time, could halt growth. That finally changed last year, when rising inflation and the commensurate interest rate hikes helped lead to 401(k) accounts falling by double digits and plan sponsors and participants looking to advisers for answers.
For retirement plan advisers like Jim Sampson of Boston-based Hilb Group Retirement Services, the occasion served as a reminder of why his firm had been putting conservative options in plan menus like TIPS, for Treasury Inflation-Protected Securities.
“I remember for years and years, clients saying to us, ‘Hey, why do we have this TIPS fund in here? It’s always negative, and no one’s got any money in it,’” Sampson recalls. “I would say to them, ‘Well, if we ever have any inflation, that’s going to be what protects you.’ …. Now all of a sudden, people are saying, ‘Oh, that’s what that thing is in there for!’”
The TIPS example is something that retirement advisers operating as 3(38) and 3(21) fiduciaries reiterate when it comes to designing long-term DC plan menus. In short: Keep it simple, conservative and ready for anything.
“I would have to say, as it applies to us and the way we construct lineups, we’re pretty boring, and I’m OK with it,” Sampson says. “The more stuff that’s crazy, or new or different that we throw at people, the more we confuse them—so I’m less focused on offering people some new thing than I am in trying to get them to save more.”
Long-term planning, however, does not mean advisers aren’t adjusting to the major changes that have taken place in the market in recent years. Advisers and asset managers say they have been taking actions such as recommending more conservative target-date funds to near-retirees; adding real asset funds for exposure to things like commercial real estate and commodities; and derisking fixed-income offerings, as higher interest rates can provide solid returns for the first time in more than a decade.
Getting Real
Sean Bjork, president of Bjork Asset Management, also puts himself in the “boring” camp of investment menu design. Even so, rising inflation has prompted him to work with plan sponsors to add investments that hedge against rising costs by giving them exposure to currencies, real estate and commodities.
“Within the context of the lineup, real assets have become a little more front-of-mind after being something of a backburner item for a long time,” Bjork says.
The Northbrook, Illinois-based adviser said he will recommend funds such as a State Street real asset CIT and a Cohen & Steers real asset fund, which have exposure to investments that grew counter to the market drop in 2022. Bjork notes that these are used as sleeves within a plan for moments such as the current one, as, historically, equities and fixed income have outpaced inflation.
The real asset funds, while considered “other,” are overall pretty conservative and “not taking a bunch of menu space,” Bjork says. “Overall, we’re very boring and very vanilla. If the [Department of Labor] says that a plan should exercise extreme caution, we do not see that as an invitation to begin exploring.”
From Safe to Safer
When interest rates were low, investment menus may have included riskier fixed-income options to capture growth, notes Steven McKay, head of global Defined Contribution Investment Only and institutional management at Putnam Investments. Now, with higher interest rates, many advisers and consultants have been looking to derisk the fixed-income portion of portfolios, according to the asset manager.
“Going back three to five years, they had fixed-income strategies that were taking on a little more risk to capture yield,” says Boston-based McKay. “Now, you can get that in high-grade corporate credit, so there is a lot of derisking going on in fixed income.”
McKay does note, however, that in defined contribution investing, the long-term strategy still works best, and a hike in interest rates should not be considered a reason to overhaul your investment menu. Putnam has had a long history of offering stable value funds in DC plans, he says, as they protect against downturns in the market and preserve capital for participants.
“You need to take a long-term, historical perspective and not try and chase short-term rates,” he says.
Nearing Withdrawal
The long-term view can be hard, of course, when you are near retirement and see a double-digit drop in your 401(k) savings. Robert Massa, managing director of retirement for Qualified Plan Advisors in Houston, says during the decline in 2022, he focused on participants close to retirement age who were in shorter-dated TDFs.
“I look at the one-year trend line on those short-dated funds,” he says. “I don’t want a lot of deviation for someone that is close to retirement. … We are trying to protect that population because they don’t have that time to recover.”
Massa says plan sponsors should be aware of their population and, if they have a lot of employees at 55 or older, they should have an investment menu that can protect them from short-term market volatility. The sequence of return risk, in which a participant starts withdrawing amid negative returns, is important to consider, and an older participant may be better off in a stable value fund, as opposed to a more volatile TDF.
“What I always explain to my fiduciaries is that every participant is different,” Massa says. “You can have three participants with the same risk tolerance and three different asset allocations. The equities could be different, the bonds could be different. The key is to have the right options for each.”
Massa says he recommends educating the retirement plan committee on these issues, especially for near-term retirees, so the right options can be included in the investment menu. Just providing blanket TDF options will not customize plans to the level necessary to protect everyone.
“We know retirement plans are great and TDFs work well,” he says, “but they are not customized. I compare it to hammering a nail in with a sledgehammer instead of a finishing hammer—you can do the job, but it’s not as efficient for every person.”
The Second Journey
Sampson of Hilb says one tactic he has used for years is to offer a core bond fund-plus, which adds real asset exposure such as real estate to a fixed-income portfolio. As a plan menu generally has only a few slots for fixed-income options, that gives diversity beyond just bonds, which, as the Silicon Valley Bank collapse showed, can be devastating when interest rates rise and bonds lose value.
“I’d like to say we planned for things like [rising interest rates],” Sampson says. “We didn’t plan for exactly what happened, specifically, but we always plan for the possibility that something like that could happen. … But we at least wanted to have people have options if something like this came up.”
Sampson says he keeps in mind the financial crisis of 2008, when people near retirement were seeing losses of 40% or 50% in their retirement savings accounts.
“Oftentimes it was somebody who doesn’t follow this stuff and was probably defaulted into the option,” Sampson says. “I have a really hard time saying to somebody, ‘I defaulted you into this because we were trying to take care of you, and look how we screwed your life up.’ That is a conversation I never want to have with an employee.”
One focus area for Hilb in recent years is working with plan sponsors to trim back the investment menu options, as opposed to adding options. He believes simplifying with the right products will ultimately lead to the best nest egg for participants once they reach quitting time.
“Retirement might be the end of one journey, but it’s the start of another,” Sampson says. “My goal is to get you to the finish line in the best position possible, so when you hit the starting line of the next journey, you can be ready.”