“Insights on Investing: Fixed Income Options Within DC Plans,” a study from Prudential’s investment-only defined contribution (IODC) unit, contends that today’s equity-heavy investment menus in defined contribution (DC) plans may not be up to the task of helping participants build and protect an asset base that will generate retirement income.
One way to help participants have a successful retirement is strengthening the lineup of fixed-income offerings in the menu, Prudential’s study said.
According to the nonprofit Plan Sponsor Council of America, the average DC plan has 18 offerings in its investment menu, but only two or three are fixed-income funds. According to Prudential’s report, about 56% of funds offered in DC plan menus are equity funds, followed by balanced funds (20%) and fixed-income funds (12%). The most common fixed-income offerings are domestic bond funds.
“There’s a need to enhance the fixed-income awareness,” Mike Rosenberg, head of Prudential’s IODC unit, told PLANSPONSOR. “Make sure the fixed-income buckets are not forgotten, because they do play a really important role.”
A survey of plan sponsors found that fewer than 30% of plans offer high-yield bond funds or global bond funds as stand-alone menu options. However, more than 50% of sponsors said they would consider these asset classes appropriate as stand-alone menu options.
Many sponsors have limited the overall growth of their investment menus in recent years, believing that too many choices can overwhelm participants. While Rosenberg said he agrees that too many choices can cause participant inertia, there are ways to add fixed-income options without overwhelming participants.
Plan sponsors can simplify menus by offering a limited number of packaged portfolio products. For example, a plan sponsor might offer one fixed-income fund-of-funds rather than multiple, individual fixed-income funds. That fund-of-funds could include a higher number of fixed-income funds than is typically found in DC plans today, the study said.
”You can create a fixed-income bucket that can combine a number of complimentary strategies,” Rosenberg said.
If the number of investment offerings is a concern, a plan sponsor could consider shrinking the number of equity funds, and increasing fixed-income offerings, he added.
Prudential’s study suggests three types of fixed-income funds that could be particularly helpful in meeting the evolving needs of retirement plan participants: high-yield bond funds, global bond funds and floating rate income funds.
The investment rationale for high-yield bonds is compelling for retirement investors, Prudential’s study said, because it includes the typically high levels of current income these bonds could generate, their efficiency in generating attractive levels of return for the risks they carry, and their potential to outperform other fixed-income investments in a rising interest rate environment.
Global funds may be ideal for investors seeking to add geographic diversity to a domestic portfolio, or to take advantage of attractive investment opportunities without limiting themselves to U.S.-based investments, the study said.
The main benefit of floating rate loans is that they usually outperform other fixed-income securities during periods of rising interest rates, according to the study.
Prudential’s report is available here.