Today’s ever-changing investing landscape requires a more flexible approach to core investment menu design.  Here, we outline a few simple approaches to consider that are working for some leading DC advisors:

  • Focus on quality, not quantity in your core menu -- make investment selection as easy as possible for participants.
  • When selecting a target date fund, look under the hood to understand how the fund is designed and whether that design is appropriate for changing participant needs.
  • Embrace a more flexible approach that moves beyond traditional options and includes a mix of both active and passive investments to help reduce costs and manage risk.

The investing landscape has gone through upheaval since the financial crisis, with the onset of routine volatility and prolonged low interest rates. As a result, retirement savers ranging from the most unsophisticated to the extremely knowledgeable have started looking for ways to better manage risk while still achieving a reasonable return.

So, how is this shift in priorities among investors impacting the core investment menu design of defined contribution plans?

DC Edge sat down with three retirement plan advisors who are considered innovators to learn about their approach to designing core menus in this new climate: Edward Lynch Jr., Managing Director and Chief Retirement Officer of Dietz & Lynch Capital; Matt Gnabasik, Managing Director of Blue Prairie Group; and Patrick Morrell, Vice President of Business Development and Investments at Ingham Retirement Group. They shared their experiences helping clients make the transition from older plans to more flexible, user-friendly ones designed to  better meet participant needs, cut costs and adapt more quickly to changing times.

Setting the foundation—consider quality, not quantity

The biggest issue plan participants face: Too many choices. To meet the needs of investors with varying levels of investment expertise and interest, many plan sponsors offer a dizzying array of investment options in their plans. But is a bigger menu better? Given too many choices, participants can quickly become overwhelmed. How much is too much, and at what point does so-called “analysis paralysis” set in?

Our three advisors agree that plan sponsors should consider offering a diverse set of high quality, cost-effective investments across a range of asset classes — including domestic and international equity, fixed income, cash and cash equivalents — to help provide flexibility and choice for participants.  But plan menus should also make fund-picking as easy as possible for participants who may not have the time, knowledge or interest to make appropriate investment decisions.

That means plans need to be designed with “the least sophisticated participant” in mind, says Edward Lynch Jr. of Dietz & Lynch. “When we think about constructing a menu, what we really think about is how we keep people from doing damage to themselves.”

Lynch encourages plan sponsors to consider using menu design to add a “qualified default investment alternative,” or QDIA, in effect making an appropriate investment decision on behalf of those participants. Once you have a QDIA in place, “You’re about 80% to 90% of the way toward a well-designed plan,” he says.

“When we think about constructing a menu, what we really think about is how we keep people from doing damage to themselves,” says Edward Lynch Jr. of Dietz & Lynch.

Matt Gnabasik agrees. “What you’re trying to balance is appropriate broad asset class representation, coupled with an appropriate mix of active and passive, without overwhelming people with too much choice.” Most of his clients now have 10 to 15 funds in their plans, down from more than 30 in the past. But it’s possible to pare the number to six or seven core options and still “create a tremendously diversified portfolio,” he says.

Gnabasik also stresses the importance of making it as easy as possible for participants to find a plan’s target date fund.  “There are reams of behavioral finance data that show that most participants are much better off in a low-cost, well-engineered target date solution than in building their own portfolio,” he says.

Patrick Morrell, Vice President of Business Development and Investments at Ingham Retirement Group, recommends offering a tiered approach, with one tier consisting of target date strategies to help meet the needs of the “do-it-for-me” participants, and a second tier of more diverse options for the “let-me-do-it-myself” segment. He coaches participants to choose their level of involvement at the outset. “Is this something that you want to be thinking about every month, or is this something where you want a professional to do it for you?” he asks. For participants who choose the self-service route, Morrell emphasizes the need for “hands-on” education to explain the options and how to use them, using both group meetings and one-on-one sessions.

When choosing a target date fund, understand its structure and the trade-offs

When choosing among target date funds, Gnabasik helps plan sponsors look under the hood of a fund, so to speak, to understand how a fund is designed and whether that design is appropriate for their participants. It’s important for plan sponsors to understand how a fund’s design could impact its performance in different market environments.  “Some trade-offs may be appropriate for me and my company, and they may be less appropriate for you and your company, and that’s the effort that’s required of the advisor, the consultant, and the plan sponsor, to determine that,” he says. Weighing target date fund pros and cons also can lead to productive conversations with clients around their expectations and concerns.

“We look at downside characteristics over multiple market cycles,” Lynch says. “A lot is focused on what happens in adverse market environments,” to help sponsors get a sense for what they could expect from a manager.

It’s essential to partner closely with clients to understand the scope and reality of participants’ needs when selecting a target date fund.  Take advantage of this visual aid to help set expectations with clients on the types of data you’ll be reviewing to pinpoint the appropriate option for their needs.

Use BlackRock’s Target Date Fund Edge Evaluator, a comprehensive and objective analysis tool, using BlackRock Solutions® analytics, to help plan sponsors make an informed target date fund decision for your plans.

Consider moving beyond traditional allocations without introducing more risk

While the direction in which most plans are moving is to simplify, advisors can add value by making sure plan sponsors understand that their menu selections will still need regular updates. As the fixed income landscape continues to shift, for example, more DC advisors are adopting flexible funds that can tap into other income sources, including high yield, inflation-protected securities and international fixed income, rather than relying on funds investing in U.S. Treasuries or the Barclays U.S. Aggregate Bond Index alone as “safe haven” options.

Gnabasik is adding multi-sector bond funds to his recommended core menu lineup, as well as more targeted fixed income exposure for select clients, including longer and shorter duration, high yield, and emerging market bond funds. He prefers a multi-sector approach to fixed income rather than more targeted products, “because most participants don’t know the difference between high-yield, treasuries, short-term or intermediate-term bonds,” he says. He typically pairs a traditional, intermediate-term bond fund with a multi-sector fund that offers exposure to different durations and credit qualities while providing the benefit of an experienced manager.

A high-quality target date fund could do the same thing, he adds. ”If you look under the hood of most well-engineered target date funds, they have very sophisticated fixed income representation that can satisfy the needs of most participants,” Gnabasik says.

Help reduce cost and manage risk by considering a mix of index and active strategies

Cost is the prevailing factor for many advisors when helping clients choose between index and active funds. “We’re not ideologues on the issue of active or passive, though we’re absolutely, ferociously focused on driving down investment cost,” Gnabasik says.  “With most asset classes, you can do quite well using passive. We typically don’t do passive in fixed income, because we do think active managers can make a difference in fixed income due to credit-quality research.  But we’re going to start considering other asset classes where it might make sense.”

Still, there are considerations beyond cost – mainly making sure that fund managers chosen by plan sponsors stick with their stated strategies. “Style purity is important for us. If you’re a fiduciary, having a manager who can go anywhere doesn’t really sit well,” he says.

Morrell also feels growing pressure on costs, and uses index funds as much as possible” But “certain plan sponsors still want an active, alongside a passive, option. We can’t get around that in some cases, but to the extent that we can, we will, because we truly feel that it’s not worth the headache to pay an investment manager to try to beat the S&P,” he says.

Our Morningstar Fund Comparison Tool can help compare index and active products side-by-side. Tools and Calculators

Understand that plan menu development is an ongoing process

Continuing to communicate with clients and providing ongoing education to participants is crucial to the success of a plan. Lynch returns to clients on a regular basis to check up on what a plan sponsor feels is working, or not working, and how participants are using the plan. “At the end of the day, it’s about how to communicate with clients in a way that they’re going to be comfortable with, even when things are not going well in the markets,” he says. “Then, they may not make a change at the worst possible time.”

Morrell offers himself as a resource to participants.  “For those who are engaged, it’s a regular conversation. It’s not over-intensive.  I’m not trying to help them get a mortgage. I’m answering some simple questions, helping them understand their portfolio, something they read, heard or received.  I’m someone they can call,” he says.

An approach that has worked well for Gnabasik is returning to his clients on an annual basis to take a comprehensive look at the entire plan as if they were starting from scratch.  “We ask, ‘If we could redesign your plan today, what would it look like?’”  That question becomes the launching-off point for recommendations for adding asset-class exposure or replacing funds, he says. “When you frame it as, ‘hey, we have this exercise where we take a look at your portfolio with a fresh set of eyes,’ plan sponsors love that.”

Many sponsors are also looking for help in communicating with participants in a way that is meaningful to them. Particularly when introducing target date funds for the first time, or with reenrollment.  Call us to learn more about how BlackRock can help you with client education.

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