Advisers should continue to advocate for conservative investment options in their plan sponsor clients’ defined contribution (DC) retirement plans, experts say. While use of a conservative fund as a default investment has grown less prevalent under the Pension Protection Act—replaced in many plans by far more aggressive target-date funds or asset-allocation portfolios—this does not mean conservative options should be dropped entirely.
“We believe conservative options have a place in retirement plans, even as the QDIA [qualified default investment alternative], for a number of reasons—the most important being that participants really struggle with seeing negative returns on their statements,” says Tim McCabe, senior vice president and national sales director, retirement, at Stadion Money Management in Watkinsville, Georgia. If a plan uses a conservative, balanced fund as the QDIA, participants stay invested, McCabe says.
Following the market crash of 2008, for example, “many participants converted to cash and didn’t get back into the market until 2012—missing the market run up,” he says.
Another consideration advisers should keep in mind when reviewing conservative options in today’s market environment, McCabe says, is that “with six-plus years of significant market gains, now is a really good time to have conservative options in a plan.” He is not predicting a market crash, but he warns the Federal Reserve has indicated it will raise interest rates either as early as this summer or as late as the fall to reflect the market recovery, which could impact the value and volatility of some bond funds. “In a rising interest rate environment, bond funds can lose their value as quickly as equity funds,” he says.
Conservative options do have a place in retirement plans, agrees Winfield Evens, director of outsourcing investment strategy with Aon Hewitt in Chicago. “You want enough options in the lineup so that participants can diversify their risk,” Evens says. Advisers definitely should consider conservative funds, he says. “They have a role in a portfolio, and are likely to become of more interest as the Baby Boomers continue to age.”
Retirement plans have traditionally offered either money market funds or stable value funds as conservative options, Evens says. However, in the past few years, advisers have become twice as likely to recommend stable value funds as money market funds, he says. This is because, due to the low interest rate environment, money market funds have been delivering 0% performance net of fees, while stable value funds, which have an insurance overlay, have been delivering between 100 and 200 basis points, he says.
However, with money market reform causing the funds’ net asset value (NAV) to float—and stable value funds becoming more expensive over time, some retirement plans have been “looking at hybrid solutions, like short-term and ultra-short-term bond funds with various durations,” says Lorie Latham, DC investment director at Towers Watson in Chicago. “We could see plan sponsors embrace other types of short-term instruments in the coming 12 to 18 months—even unconstrained bond funds or multi-manager bond funds,” she says. “They provide an improved risk/reward trade-off.”
Next on the scale from most moderate to least moderate conservative choices would be intermediate bond funds that track a broad bond benchmark, Evens says.
The next tier is balanced funds and managed accounts, Evens says, followed by target-date or lifecycle funds. Advisers need to be especially careful when analyzing target-date funds (TDFs), McCabe says. “Some TDFs for those in their 50s—even those in retirement—have as much as 50% to 60% of the portfolio in equities, partly because the funds are benchmarked against the S&P and we have been in a bull market,” he says.
Target-date fund glide paths should become more conservative for those closer to, or in, retirement, Latham agrees. This is particularly important since 85% to 90% of plan sponsors are using TDFs as the QDIA. “That is where the vast majority of assets are going,” she says.
Other conservative choices advisers might consider recommending are Treasury inflation-protected securities (TIPS), Evens says. Latham believes real estate investment trusts (REITs) and diversified real return options could play a role in fund lineups, either on their own or integrated in a TDF. McCabe even believes that some large-cap value equity funds could qualify as conservative options.
As to how many conservative options advisers should recommend to a plan, McCabe says, “There needs to be at least several—perhaps three or four—including a money market fund, a short-term bond fund and some type of high-grade government bond.”
And as to how advisers should work with sponsors on selecting the right conservative choices for their plan, McCabe says it starts with “the investment policy statement, which will be their guide for the quality of investments. They need to be near the top of their peer groups, have a significant track record of at least five or 10 years and charge reasonable fees. That will shake out the list, and an adviser or consultant can help them narrow down the choices.”