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Defined Contribution

4 ways to prepare
your core menu for change

Anne Ackerley |Nov 6, 2017

No matter how well-designed a defined contribution plan may be, shifting demographics, emerging economic trends and evolving participant demands can create unexpected risks that challenge retirement goals.

When it comes to retirement investing, we know change is inevitable. Most of the plan sponsors we speak to would rather get ahead of change than be forced to react to it. The question is how to get ahead? Based on conversations with plan sponsors and our own analysis, here are four ways to prepare for potential change:

1. Rethink downside diversification

A participant in mid-career who began saving in 1992 will have seen 59 negative periods for the S&P 500 Index, with dips as low as -40.9%.1 It’s almost certain she will see more during the final 15 to 20 years of her career. That may be why 76% of plan sponsors agreed that downside protection is more important than outperformance for core menus, according to our 2017 DC Pulse Survey.

The problem is that many of the traditional style box options intended to provide diversification may no longer be up to the job. We have seen numerous plans with multiple equity options that have substantially similar risk and return profiles that offer little diversification benefit. We need to rethink sources of downside protection. One approach, especially for participants in late career or retirement, is through factor-based minimum volatility strategies that seek market-like returns with less risk.

2. Identify growth opportunities

Ninety-one percent of plan sponsors are concerned about industry forecasts for an extended period of lower market returns, once again according to the 2017 DC Pulse Survey. Ninety percent are concerned that their core menu does not provide options with sufficient return potential to help participants meet their goals.2

Plan sponsors may wish to consider both cap-weighted and smart beta indexes. For plan sponsors seeking outperformance within a familiar index approach, diversified multi-factor smart beta strategies offer a rules-based, low cost way of seeking alpha at market risk levels. These strategies typically begin with a cap-weighted index and tilt the exposure toward factors that are established drivers of return such as quality, value, size and momentum.

3. Fixed income is getting
increasingly complicated

Fixed income may never have been simple, but funds that track the Bloomberg Barclays U.S. Bond Aggregate served plan sponsors well in the past. Rising rate expectations and potential increased volatility may call for a fresh approach.

Introducing a degree of active management may add the flexibility to help steer through potential hazards while seeking to retain the risk profile of traditional fixed income investments. Depending on a plan sponsor’s comfort level, options can range from total return strategies that permit some leeway around duration and credit quality, to unconstrained strategies that seek to manage risk in pursuit of return.

4. Make sure the plan
is ready to respond

Many legacy menu options may no longer meet participant needs. The same may be true of many of the policies governing plans and the implementation structures within them. Outdated policies may delay or prevent a plan sponsor’s ability to respond to change. We recommend considering at least three key potential updates:

  • Analyze investment mandates and, if necessary, set new benchmarks to allow, for example, smart beta, factor and active fixed income strategies.
  • Adjust investment policy statements to allow for white label fund structures. With an increasingly complex investing environment, white label core building blocks may allow for seamless transitions between investment strategies as markets evolve. They are also an ideal way to include highly sophisticated solutions within participant investments.
  • Allow plan flexibility for retired participants. This would be necessary before considering retirement income strategies so that retiring participants have more choices once they stop working and have additional time to consider their alternatives.

Evaluating your core menu

It is tempting to make adjustments piecemeal, but we believe participants will be better served by stepping back and doing a holistic review. Three crucial considerations are:

  • Review: Run an analysis to see how your participants are actually invested and whether your core menu is delivering the right level of diversification and return potential.
  • Replace: Consider updating investment menus by replacing existing options and mapping participants to more effective strategies.
  • Reenroll: Or, alternatively, you may seek to conduct a reenrollment to more fully unwind issues created by legacy funds, outdated plan design and participant inertia.

That way, plans can bring some of their top thinking and latest insights about diversification, growth, income and more into alignment, implement changes efficiently, and reset the core menu to help stay ahead of these inevitable shifts.