Ben Rizzuto: Hi, I’m Ben Rizzuto, and you’re listening to Plan Talk, from Janus Henderson Investors.

Many of you may be as addicted as I am to WORDLE. If you haven’t played it, the object of the game is to figure out what the daily five-letter word is. You get six guesses, and the game tells you if you have the right letter, the right letter but in the wrong space, and if a letter isn’t part of the word.

Every day I go onto the WORDLE website and try to figure out the word in as few guesses as possible. Some days, however, the word is less obvious than others. I stare at the screen and try to figure out what letter goes in which space and many times I have no idea, so I just guess.

Plan sponsors these days are playing a similar game when it comes to plan menus. There are several ways to fill in the spaces, but what is going to be the right answer for today? Plan sponsors also have the added difficulty of not only having to think about today’s answer when it comes to investment options to offer participants, but what the answer is going to be tomorrow and years into the future. Plus, even though WORDLE keeps it to five-letter words, a plan’s core menu can have more or less options. The average these days is around 20, but a core menu of 21 – or 15 or 25 – could work for today and tomorrow.

Along with that, recent research has provided a differing view that I fear may lead to plan sponsors not knowing what to do and just staring at their screens with no idea how to fill in the spaces.

Today I’d like to go over some of that research and then provide some ideas on how you might parse this information and construct plan menus for today and tomorrow.

The first major piece of news was the recent ruling from the Supreme Court on the Northwestern University 403(b) lawsuit. Many thought this case’s trip to Washington DC would lead to a groundbreaking ruling; however, it was simply remanded back to a lower court. While the ruling was not earthshaking, it is important, and I do think that there are a couple items from it that plan sponsors would be wise to heed.

First, the judgement reminds us of the landmark Tibble v. Edison case and of a plan sponsor’s continuing duty to monitor and possibly remove investments. The judgement also notes that this continuing duty to monitor covers ALL the investments in the plan menu. To most, this seems pretty common sensical, but if we think about this from the standpoint of a 403(b) plan like Northwestern, which has hundreds of options, you can see how this idea may become a bit more applicable.

While many of you may not deal with plans with hundreds of investment options, there is the thought that this decision and the ongoing fiduciary pressure advisors and plan sponsors face could lead many to consider decreasing the number of investment options in the core menu. In fact, on a recent webinar, I heard a couple experts hammer home the ideas that “each and every fund in a plan menu needs to be reviewed” and that “plan sponsors need to sharpen their focus on fund review and risk analysis.”

Along with that, the practical question of if investment committees read every page of a fund prospectus came up. If, for example, a prospectus is on average 50 pages long, the time needed to read through such a document in order to have a thorough understanding of an investment increases substantially with every added investment.

Based on those three ideas, many would say, “Let’s reduce the number of funds in the plan menu so that we can do the appropriate level of due diligence.”

That’s on one side of the coin. However, on the other side I’ve seen research asking the question of whether plan menus are set up for the long term and if there are other funds and assets classes which should be considered for inclusion.

The main reasons for these considerations would be due to the changes we are seeing in long-term capital market assumptions, which include lower returns and less yield from equities and fixed income funds. Along with that, many do not feel retirement plan investment menus have been created with retirement in mind, nor do they consider that retirement plans have become decumulation vehicles rather than just accumulation vehicles.

The other thing we know is that as participants get older, they have more financial capital, they have more responsibilities, they just have more going on, so they are more likely to work with a financial professional. And in many cases, they will then work with that financial professional to put together an asset allocation within their employer’s retirement plan. In fact, Prudential recently showed that the percentage of participants who use “professionally managed” options such as target date funds or managed accounts decreases from over 80% for participants in their 20s to only 36% for participants in their 60s.

So, what I see based on these trends is plan sponsors being pulled in two opposing directions: They are facing heightened scrutiny and facing the increased threat of fiduciary liability suits, which may prompt them to consider offering fewer plan menu options, but then the needs of participants, the markets and plan sponsors’ own concern for the wellbeing of participants may be prompting them to consider offering more options in the plan menu.

And while there is no way to figure out what a PERFECT plan menu looks like, I’d like to take some of the research we’ve seen recently and see if we can meld it into the average lineup of today in order to improve things.

Now, recent research has shown that the average number of funds in a plan’s core menu is somewhere around 20, not taking into account the plan’s target-date fund series.

And this would include funds like a Large Growth, a Large Value. Possibly a Small Blend, a Mid-Cap Growth or Value fund. Possibly a Foreign Large Growth fund, Core-Plus Bond investments on the fixed income side. Maybe even a Diversified Emerging Markets fund, a Money Market fund, and of course, Stable Value fund. So with that as our foundation, let’s start and look at the equity side of the ledger.

Now, as I mentioned, most plans offer participants the ability to allocate to value and growth funds in large cap, mid cap, and maybe even small cap asset classes, and they can do this both domestically and sometimes internationally. Of course, being able to have that exposure to both is important for diversification purposes and that actually became evident in over the past two years. During the COVID-19 lockdown from March to October 2020, growth stocks outperformed value stocks significantly. For example, large growth was up 26.1% while small value was down 4.9%. However, in November after vaccines were announced through the end of 2021, small value was up 53.7% whereas large growth was up 39.2%. What’s more, the volatility between U.S. growth and U.S. value increased significantly and the relative performance between the two flip-flopped every couple of months. Along with that, and while not as stark, we saw a similar relationship between international growth and value.

The question for plan sponsors is, how can participants intelligently allocate between growth and value over the long term? And how can we make sure they don’t chase performance, especially during periods of increased volatility? Plus, this difficulty gets exacerbated when we move to international equities, which participants may be less equipped to allocate to. This may be a reason to consider blend as a way to provide professionally managed allocation services to participants on a long-term basis. Plus, by including a blend fund, a plan may be able to rid itself of its value and growth options, thus decreasing its due diligence process by one fund.

Next, let’s move onto inflation, and as we know inflation has reared its ugly head of late, and more and more participants have lost purchasing power in their retirement savings because of it. Now, one of the main asset classes many point to as an inflation hedge is real estate, but less than 40% of plans offer participants a real estate or global real estate fund.

Historically, inflation and listed REITs have been positively correlated as inflation expectations rise, as have valuations for REITS, particularly in times of improving economic growth. For example, when the economy is growing and inflation is high, REITS have outperformed equities, commodities and bonds. Now, in this case we’re defining high inflation as an amount over the long-term U.S. Fed target of 2.0% and growth by using the U.S. ISM purchasing manufacture and non-manufacturing blended index. This sort of environment occurs about 48% of the time. 43% of the time, however, we’ve had growth and low inflation, and in these periods REITs and equities have outperformed both bonds and commodities.

Other evidence for the value of real estate comes from David Blanchett at Prudential, who recently showed that asset classes like real estate or other types of real assets could provide participants with significant excess return.

The point is this: real estate funds provide diversification and an inflation hedge for participants. Plus, I think people have a better grasp for real estate than they do for other inflation hedges like commodities or TIPS.

Moving over to the fixed income side of the ledger: fixed income exposure is something that increases as investors age and become more conservative. Also, with retirement plans becoming more of a decumulation vehicle for participants, the fixed income options offered must become a greater focus. Now, you may remember that Janus Henderson and the American Retirement Association conducted research a couple years ago which showed that equity funds outweigh fixed income funds in the plan menus three to one. Along with that, we found that the average retirement plan menu offers its participants only three to four fixed income funds, those being stable value, money market, bond index, and possibly an intermediate core bond fund.

So, with that said, where can improvement be made? As one can see from the types of fixed income funds currently offered, most plans have the short-term low-risk to intermediate-term moderate-risk portions of the fixed income spectrum covered. While that may have been sufficient over the past few decades during a bond bull market, the current environment, which offers lower yields and a greater need for income, may now require plan sponsors to look further out on the fixed income spectrum.

Based on the inflation fears that many have these days, TIPS or inflation-linked bonds could be a worthy addition. Not only do these make sense in the current inflationary environment, but research has shown that they can provide better yield and return than other types of fixed income funds.

The question once again is, how well can the normal participant allocate to TIPS?

Because of this, I think funds that offer more flexibility and allow participants the ability to gain exposure to different fixed income asset classes may be helpful for all involved. For example, we see increased interest in multisector bond funds as they can provide exposure to high yield, collateralized debt, asset backed securities and other types of fixed income securities in one package.

Not only that, but they provide a way to solve the current yield vs. duration puzzle that many are faced with. This puzzle has been created since many of the types of fixed income securities offered in core or core plus funds offer very little yield and have higher durations. Remember, the higher the duration, the more risk one is having to take on to receive a security’s stated yield and thus the more sensitive it will be to interest rate changes.

In research that we’ve done at Janus Henderson, multi-sector income funds may be able to provide an answer to this puzzle as they offer a 12-month yield of approximately 3% with a duration of only 1. Compare that to something like intermediate government bonds that offer a 12-month yield of just over 1% but a duration of approximately 3.

Not only that, but a multisector bond fund will be able to be more flexible over time in order to manage duration risk and change allocations in order to provide participants with the income and total return that they need as they age.

So those are a few ideas and, based on my count, that would possibly add three additional funds to a plan’s menu. While that is the case, remember we didn’t discuss rationalizing a plan menu. That could lead to deletions and an overall reduction of funds that an investment committee would have to review. As part of that process, I would encourage plan sponsors to look at the correlation between funds [and] consider if funds overlap from the standpoint of market capitalization, holdings or other types of exposure. That review and rationalization is part of a solid fiduciary process. Sure, it may not lead to the removal of funds and it may mean that there is more analysis involved with plan investments, but I think we can all agree that if our goal is to make sure participants are better prepared for retirement, this may now be what is needed.

So, just like WORDLE, there are thousands of five-letter words, and the combination of letters we select are going to create different answers and are going to have different meanings for those who are part of a plan. Our job is to figure out which letters are going to provide the best answer for participants today and tomorrow.

Finally, the Janus Henderson research I referenced in this episode will be available in the show notes, so be sure to check that out. And as always remember that we have our own channel these days for this podcast, so be sure to subscribe to Plan Talk with Ben Rizzuto. Until next time, thanks for listening.

¹ “Personalized Retirement Income Solutions to Play Central Role in Retiree-Friendly DC Plans.” Cerulli Associates, June 22, 2021.

² Fidelity 2021 Plan Sponsor Attitudes Survey