Conservative Investments Still Have a Place in Retirement Plans

When retirement plan sponsors consider investment choices for their lineups, they need to consider conservative options to enable participants to diversify their risk, experts say.

“We believe conservative options have a place in retirement plans, even as the QDIA [qualified default investment alternative], for a number of reasons—the most important being that participants really struggle with seeing negative returns on their statements,” says Tim McCabe, senior vice president and national sales director, retirement, at Stadion Money Management in Watkinsville, Georgia. If a plan uses a conservative, balanced fund as the QDIA, participants stay invested, McCabe says.

Following the market crash of 2008, for example, “many participants converted to cash and didn’t get back into the market until 2012,” he says. The downside is they missed the market run up.

Two other considerations plan sponsors should keep in mind when considering including conservative options in a retirement plan or as the QDIA in today’s market environment, McCabe says, is that “with six-plus years of significant market gains, now is a really good time to have conservative options in a plan.” In addition, the Federal Reserve has indicated it will raise interest rates either as early as this summer or as late as the fall, which will drive down the price of bond funds, he says. Lower bond prices result in higher yields.

Conservative options do have a place in retirement plans, agrees Winfield Evens, director of outsourcing investment strategy with Aon Hewitt in Chicago. “You want enough options in the lineup so that participants can diversify their risk,” Evens says. Sponsors definitely should consider conservative funds, he adds. “They have a role in a portfolio, and are likely to become of more interest as the Baby Boomers continue to age.”

As to what conservative options are available, retirement plans have traditionally offered either money market funds or stable-value funds, Evens says. However, in the past few years, advisers have become twice as likely to recommend stable value funds as money market funds, he says. That is because due to the low interest rate environment, money market funds have been delivering 0% performance net of fees, while stable value funds, which have an insurance overlay, have been delivering between 100 and 200 basis points, he says.

However, with money market reform causing the funds’ net asset value (NAV) to float—and stable value funds becoming more expensive, some retirement plans have been “looking at hybrid solutions,  like short-term and ultra-short-term bond funds with various durations,” says Lorie Latham, DC investment director at Towers Watson in Chicago. “We could see plan sponsors embrace other types of short-term instruments in the coming 12 to 18 months—even unconstrained bond funds or multi-manager bond funds,” she says. “They provide an improved risk/reward tradeoff.”

Next on the scale from most moderate to least moderate conservative choices would be intermediate bond funds that track a broad bond benchmark, Evens says.

The next tier is balanced funds and managed accounts, according to Evens, followed by target-date or lifecycle funds. Sponsors need to ask their advisers to be especially careful when analyzing target-date funds (TDFs), McCabe says. “Some TDFs for those in their 50s—even those in retirement—have as much as 50% to 60% of the portfolio in equities, partly because the funds are benchmarked against the S&P and we have been in a bull market,” he says.

Target-date fund glidepaths should become more conservative for those closer to, or in, retirement, Latham agrees. This is particularly important since 85% to 90% of plan sponsors are using TDFs as the QDIA. “That is where the vast majority of assets are going,” she says.

Other conservative choices plan sponsors may consider are Treasury Inflation-Protected Securities (TIPS), Evens says. Latham believes Real Estate Investment Trusts (REITs) and diversified real return options could play a role in fund lineups, either on their own or integrated in a TDF. McCabe even believes that some large-cap value equity funds could qualify as conservative options.

As to how many conservative options a plan might include, McCabe says, “There needs to be at least several—perhaps three or four—including a money market fund, a short-term bond fund and some type of high grade government bond.”

McCabe says plan sponsors should start with “the investment policy statement, which will be their guide for the quality of investments. They need to be near the top of their peer groups, have a significant track record of at least five or 10 years and charge reasonable fees. That will shake out the list, and an adviser or consultant can help them narrow down the choices.”