Should You Offer Special Education for Sector or Specialty Funds?

Every plan and every employee population is somewhat unique, so the decision about special education should be considered by fiduciaries on a plan-by-plan basis.

By | January 08, 2014
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Demographics, menu composition and allocation patterns are important determinants of education needs. 

What types of funds are we talking about?  Primarily, we’re thinking of investments with concentration risk, such as real estate, technology, high-yield, emerging markets (EM), metals, or other funds exposed to non-systematic risk.  These sorts of funds can be beneficial building blocks in portfolio construction, but can present undesirable levels of risk when over utilized.

How do you know if you have a problem?  Most plan recordkeepers can provide reports showing allocation patterns.  A plan with high utilization of asset allocation models or with a high average number of funds per participant may be less in need of special education than one with a high number of participants concentrated in the plan’s high-volatility funds. 

One of the tools we provide to plan participants is a table showing the available menu options, ranked by volatility (we use three-year standard deviation for this purpose)—the higher on the page, the higher the historic volatility.  It’s a quick visual that helps self-allocators get an idea of where their picks lie on the risk scale.  Naturally, volatility is just one of the risks investors face, but it’s an important one because of the propensity of individual investors to make emotionally-driven decision errors.

While general education about diversification is important, we don’t want a participant to think they have successfully managed their risk by spreading their balance equally between a gold fund, a real estate fund and a technology fund. 

Another area where special education may be beneficial is with target-date funds.  It’s true they are diversified, self-adjusting and designed to be age-appropriate, but how well are their risks understood?  Ranking target-date funds on a simple, visual risk scale could be valuable educational content.