The Investment Menu Trends Sponsors Are Talking About

Plan sponsors are coming to appreciate that a smaller investment menu does not necessarily imply a less sophisticated menu. 

Attila Toth, partner and co-founder of Portfolio Evaluations, Inc., noted that defined contribution (DC) plan investment lineups are shrinking. “Behavioral finance shows that when participants are given fewer options, they are more engaged,” he said, moderating a panel at the 2016 PLANSPONSOR National Conference in Washington, D.C.

Jim D. Edwards, principal and financial adviser with CAPTRUST Financial Advisors, said there are four major trends in DC investment menus:

  • Simplification and careful consideration
  • More passive or index option
  • TDFs are still popular
  • Use of institutional share classes

According to Edwards, plan sponsors are removing ancillary funds, such as real estate investments.

John Doyle, senior vice president, Defined Contribution, American Funds, added that simplification includes consolidation, or white labeling. He finds that plan sponsors don’t mind being disruptive when changing plan menus. “They want participants to be better engaged and want to help them make better decisions,” he said.

Michelle Rappa, managing director and head of DCIO marketing at Neuberger Berman, added that plan sponsors are trying to be smarter about strategies. She explained that white labeling provides simpler options, while helping participants diversify investments. For example, a core fixed income fund would include different types of bond and Treasury inflation protected (TIP) investment. An international fund could include value and growth investments as well as small-cap and large-cap investments.

“Committee members should always ask, ‘Why would we use this fund, and would I put all my money in it?’” according to Edwards. He added that committees shouldn’t base their decisions on one participant’s or a few participants’ request. As an example, he mentioned socially responsible investments (SRI), which can also be referred to in many other ways.

Doyle pointed out that SRI investments should be a true opportunity to outperform other funds. Rappa noted that SRI appeals to certain demographics and is more common in certain geographic locations.

NEXT: Addressing fees

“With everything going on in the press and courts, plan sponsors better understand what to look for in share classes, how to price plan investments and how to determine gross versus net costs,” said Doyle.

Rappa said there is a move toward more transparency and guidance to help participants understand fees and revenue sharing. Edwards added that plan sponsors are asking who should pay for fees, how they should be charged to participants and how revenue sharing should be allocated. He noted that more plan sponsors are turning to institutional share classes, and his firm encourages plan sponsors to have a fee policy statement.

Toth noted that collective investment trust (CIT) minimums are falling, so many plan sponsors will see CITs available for them. According to Rappa, very large plans are moving to CITs, as they are totally transparent and only have investment fees.

However, Rappa and Doyle both pointed out that CITs are not always the cheapest option. “Think about the strategy you want, the costs of each option and which one works,” Rappa said.

“Plan sponsors should use the same level of due diligence for CITs as for mutual funds,” Edwards added.

NEXT: Money market funds, SDBAs and managed accounts

Doyle noted that plan sponsors are looking at money market fund reform, saying they need a stable net asset value, and moving to government money market funds. However, more are looking to switch to stable value funds. “Money market funds are still returning nothing. It’s an opportunity to learn about stable value funds and the risks they have that money market funds don’t,” he said. Toth said it is not an opportunity, but a requirement.

According to Edwards, there is a fiduciary risk in holding money market funds that are returning basically zero, and with fees, participants may have negative yields. Doyle believes the industry will see a stable value revitalization.   

Rappa noted that many DC plan sponsors are using three-tiered investment menus—target-date funds, a core menu and self-directed brokerage accounts (SDBAs) for participants who are questioning why certain funds are not included in the investment menu.

However, Rappa suggested plan sponsors put a limit on how much can be invested in SDBAs. Doyle explained that some plan sponsors are backing away from SDBAs altogether because they see participants buying shares that are more expensive than those in the plan menu. “Who is responsible for that?” he queried.

In addition, the Department of Labor (DOL) wants to take a closer look at SDBAs. Doyle thinks the DOL wants plan sponsors to stop offering them. “It is still on the DOL’s agenda,” he noted.

Finally, Doyle noted his firm is seeing more use of managed accounts. Edwards said participants are looking for advice.

However, Doyle warned that many participants are not sharing the information they need to make the most of managed account offerings, which diminishes their value. He suggested that plan sponsors can get more value by offering target-date funds as well as managed accounts.