Janus Henderson’s Portfolio Construction and Strategy (PCS) conducted an assessment of the key challenges of fixed income in retirement plan lineups. Here, Senior Portfolio Strategist Damien Comeaux discusses how to address the potential for overlap, particularly in the Core and Core-Plus categories.

In 2020, Janus Henderson partnered with the Plan Sponsor Council of America to better understand the fixed income universe within the plan lineup world. According to our research, equity options outnumber fixed income options in plans by approximately three to one. Furthermore, the average number of fixed income options recommended to plan sponsors is three – total.

In addition to the study, Janus Henderson’s Portfolio Construction and Strategy (PCS) team developed a diagnostic report specific to retirement plans that provides a comprehensive analysis on the risk and reward of fixed income investments in plan lineups. In our conversations reviewing this diagnostic report with DC-focused financial professionals, we identified four areas we believe are the most crucial to consider in order to avoid the complications of implicit and unintended risk.

We cover each of those challenges in detail in our four-part blog series. Here, we explore the potential for overlap and discuss how to address the issue through specific due diligence measures.

Comparing Core and Core-Plus Risk and Return Profiles

Overlap is a phenomenon that can occur in both the equity and fixed income spaces. Unfortunately, in fixed income specifically, overlap presents itself in two critical categories: Core and Core-Plus. These categories form the basis for the traditional fixed income exposures of a plan lineup; they are the anchors of the allocations and are needed to diversify and limit the risk presented by equities, especially in times of crisis. These are “sleep at night” investment categories.

It perhaps makes sense, then, that many lineups the PCS team has reviewed have both a Core and a Core-Plus option in the plan. Why not attempt to be as safe as possible in fixed income by using both? The logic certainly seems appropriate on the surface, but upon further investigation, there is additional risk by having both a Core and a Core-Plus manager present. Despite the inclusion of off-benchmark sectors in the Core-Plus category relative to the Core category, the risk and return statistics are extremely similar:

Source: Morningstar, as of 6/30/21.

 

To address the overlap challenge, evaluating potentially duplicative exposures created by the inclusion of both a Core bond and a Core-Plus bond fund in a plan lineup is a good starting point.

Understanding a fund’s correlation to equities is critical as well. While these diversifying categories will naturally take on higher correlation to equities, based on typically lower exposures to government securities (again, as intended), it is important to consider funds with a reasonable correlation to equities as acceptable and those with very high correlations to equities as unacceptable.

Our goal in presenting these insights is to ignite conversations that help construct the best lineup possible for participants. We think such due diligence measures can help effectively diversify fixed income lineups while maintaining a risk/reward profile that plans – and their participants – have come to expect from fixed income.

In our next post in this series, we look at the challenge of diversification.