A vast majority of defined contribution (DC) plan participants face an investment menu with at least 16 fund options, according to a recent SEI report, and many are forced to choose from 36 funds or more. At the same time, the average workplace retirement investor uses less than five funds while participating in a DC plan, SEI says, setting the stage for participant confusion and inertia in the face of complicated core fund lineups (see “PSNC 2014: Investment Diversification”).
While it’s important to offer participants the opportunity to diversify retirement assets, an overly complicated fund lineup can make it challenging for even well-informed investors to choose appropriately, SEI says. Workplace investors often struggle to choose among funds in the same asset category or options that utilize similar investment strategies, researchers explain, so in most cases a simplified and streamlined fund lineup is best.
SEI finds the disparity between offerings and participant demand is driving sponsors to consolidate the number of funds offered in the core lineup. Sponsors are also seeking customizable, multi-manager funds that can add to diversification while limiting the choices faced by participants. One in five plan sponsors polled by SEI say they plan to consolidate the number of funds in the core plan lineup sometime in the next 18 months.
A somewhat larger number of sponsors (32%) plan to add exposure to non-traditional asset classes in the near term, SEI finds. While interest in alternatives is growing, certain challenges associated with alternatives—such as lack of liquidity and strategic complexity—make it unlikely that plan sponsors will offer such funds as standalone options within the overall core lineup. Instead, sponsors appear to be interested in adding alternatives as a component within broader, multi-asset funds, such as target-date funds (TDFs) or real asset funds (see “Tide is Shifting Toward Custom TDFs”).
SEI finds that the proliferation of mutual funds and the ability to easily add these funds to DC investment menus has resulted in the high number of options currently available to the average participant. Just 33% of sponsors surveyed reported having less than 15 funds on their core menu. In many instances, plans were found to offer duplicate asset classes or similar investment strategies from different investment management firms. Most sponsors (81%) have also adopted a series of five or more TDFs in recent years, a move that has only increased the overall number of funds available to participants, SEI says.
One notable conclusion drawn from the research is that a high number of funds rarely results in better retirement outcomes, SEI explains. The report authors point to outside research that suggests participant outcomes can actually decline as a function of the number of funds on the core menu. SEI says plan sponsors can typically offer a lot fewer funds than they are today while still effectively covering the full range of asset classes sought by retirement investors.
An example of a simplified lineup would include the following asset classes, SEI says:
- Large cap U.S. equity;
- Small/mid cap U.S. equity;
- International equity, including developing markets;
- Fixed income, including emerging market debt, high yield, structured credit, etc.;
- Real assets, such as commodities, real estate investment trusts, direct real estate, etc.; and
- A target-date series.
By streamlining the menu to include one or two funds in each category, much of the unnecessary complexity in retirement plan menus can be abated, SEI says.
SEI researchers urge plan sponsors to consider their fiduciary duty to offer an effective plan investment menu—and the fact that more choice isn’t always better in the retirement planning context. In fact, less than one-third of those sponsors offering 16 or more funds said that a good measure of investment success is to “evaluate if project participant income replacement ratios are being met at retirement.” SEI says it appears a number of plan sponsors are not only offering a high volume of funds, but are doing so with only minimal focus on whether or not those funds are contributing to the goal of providing adequate retirement income.
Researchers contend that the plan sponsor’s fiduciary prudence could potentially be called into question if participants are offered an overcomplicated fund lineup. In addition, an oversaturated plan lineup could make it even more difficult for plan sponsors to meet oversight and due diligence requirements prescribed by the Employee Retirement Income Security Act (ERISA).
SEI finds the complexity of due diligence, especially for those plans with bloated investment lineups, is driving more sponsors to seek 3(38) investment fiduciary support. In fact, nearly half (42%) of the sponsors surveyed said they would consider delegating investment manager selection and oversight to a discretionary 3(38) investment fiduciary. Of that group, 40% said they would delegate the entire investment menu to outside oversight, while about a third said they would use “broad multi-manager options within a simplified investment lineup.”
The full report, “Sponsors Focus on Simplifying Investment Lineups for Participants,” is available here.