Fixed income in retirement plan line-ups: Spotlight on diversification
How can you ensure adequate diversification among the fixed income options included in plan menus?
Including both Core and Core-Plus options in retirement plan menus may pose risk for plan participants, given the fact that the risk and return profiles of these categories are so similar. Not only is the overlap of Core and Core-Plus not beneficial to participants, but there is a heavy focus within these two categories on government-related securities, which are highly susceptible to rising rates.
Government securities make up a considerable portion of the investable universe in the fixed income asset class. In 2021, the trade-off between yield and duration in these types of securities is at its weakest and potentially exposes plan participants to too much rate risk (duration) without proper compensation (yield, compared to historical norms).
To illustrate this problem, the chart below shows the change between yield and duration of the U.S. Aggregate Bond Index – the primary benchmark for intermediate term U.S. fixed income assets – from the end of 2008 to June 30, 2021:
While the Core and Core-Plus categories face the challenge of decreasing value in the trade-off between duration and yield, “we feel it is still necessary to include one – but not necessarily both – of these categories in plan line-ups,” says Damien Comeaux, senior portfolio strategist at Janus Henderson Investors. “And while their necessity cannot be denied, they may no longer be adequate as the only fixed income options in a plan; in our view, they should be complemented with strategies that may have a greater yield or return potential for participants.”
Furthermore, based on the correlation assessment, selecting one of either the Core or Core-Plus categories (noting that a Core-Plus fund typically provides greater flexibility) addresses two challenges: Firstly, it reduces the possibility of highly correlated assets in the protection-focussed portion of the line-up. Secondly, it allows plans to diversify the poor trade-off in more traditional, government-focussed fixed income by opening a slot for an additional category such as multi-sector or world bond, either of which would provide a combination of asset classes outside of primarily government-focussed securities.
“It’s important to note, however, that vigilance is required here: While categories such as multi-sector or world bond may provide diversification relative to more traditional fixed income, they are not ‘off the shelf’ options for many,” Comeaux adds, “as a result, the task of evaluating and deciding whether to include these options in a plan line-up may be challenging for DC-focussed financial professionals.”
Damien Comeaux, Senior Portfolio Strategist, Janus Henderson
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Correlation measures the degree to which two variables move in relation to each other. A value of 1.0 implies movement in parallel, -1.0 implies movement in opposite directions, and 0.0 implies no relationship.
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Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
High-yield or "junk" bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings.
A retirement account should be considered a long-term investment. Retirement accounts generally have expenses and account fees, which may impact the value of the account. Non-qualified withdrawals may be subject to taxes and penalties. For more detailed information about taxes, consult a tax attorney or accountant for advice.
Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.
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C-0821-39394 08-30-22
