Inflation spurs DC plan advisers to drill down on investment menus

As fears of inflation and recession rise amid a growling bear market, many employers are asking themselves the same question: Are they providing the right investments in the retirement plans they're offering their employees?

"Anytime you're in a volatile market period, plan sponsors and clients start to question everything," said Emily Wrightson, a principal at CAPTRUST Financial Advisors LLC in New York. "They question 'does our lineup make sense, does it have the right target-date series, are things too aggressive, are they too conservative.'"

Ms. Wrightson and other retirement plan advisers said that while proper plan investment menus were designed to withstand all types of market conditions and should already offer the mix of investments participants need to navigate inflation and whatever else the market throws at them, plan sponsors nonetheless are concerned. They're worried about potential holes in their menus and whether existing funds in different asset classes are still the right ones for their participants.

Plan sponsors are "revisiting the reasons" why they selected the funds they have and making sure they're still comfortable with those reasons, Ms. Wrightson said.

Still, most plan sponsors — despite lingering concerns — are sticking to their investment menus, a fact that retirement plan advisers say reflect forward-thinking plan design.

Investment menus that were built "pre-COVID, pre-bear market and pre-rising rates," were built to have diversification options that have given participants "places to go" to protect themselves with funds like stable value, fixed-income options and a mix of passive and active investments, said Joe DeBello, a managing consultant in the retirement and wealth division of OneDigital Investment Advisors in Orlando, Fla. OneDigital has $103.7 billion in assets under advisement.

"As long as you're diversified, you're not going to necessarily feel the full brunt of what's happening to the market today," he said.

Nevertheless, while OneDigital's plan sponsor clients are not making any menu changes, the firm is "talking and fielding questions about inflation, rising-rate-sensitive funds," he said.

One of the biggest questions for plan sponsors is whether they should continue using stable value funds instead of money market funds in their plans. In the near-zero interest-rate environment that investors have had for the last 15 years, stable value funds have provided a greater return by and large than their money market peers, but now with rising rates, the situation has reversed, Mr. DeBello said.

In a rising-rate environment, money market funds typically perform better because they are more sensitive to rate increases and capture the increase in yield quicker than a stable value fund, he explained.

"We've largely not seen sponsors make decisions around that and we as a firm haven't made decisions to move away from what has been the historical norm of using stable value in lieu of money market in the majority of our plans," Mr. DeBello said.

Many plan sponsors are also asking about Treasury inflation-protected securities, or TIPS, and whether to add them to their investment menus. Greg Mykytyn, senior vice president with Commerce Street Peak Advisors in Dallas, does not favor adding TIPS as a stand-alone investment option since most participants don't know what they are or how they work.

"We try to build a fund menu not for savvy investors but for rank-and-file employees," Mr. Mykytyn said.

Mr. DeBello also does not favor adding TIPS as a stand-alone option, saying that plan sponsors should not make decisions on an investment menu based on what his firm believes are short-term economic trends.

A TIPS fund could be a "great short-term investment" but since 401(k) plans are long-term investment vehicles, plan sponsors should avoid "knee-jerk reactions to what's going on in the market," he said.

CAPTRUST's Ms. Wrightson also generally counsels plan sponsors to stay away from stand-alone TIPS funds because participants could get a "false sense of an inflation hedge."

Participants tend to assume TIPS provide immediate inflation protection and that they won't lose money, but "that's not necessarily the case," she said, adding that TIPS funds as defined by the Morningstar U.S. Inflation Protected Bond Universe were down -6.81% in the first half of the year.

CAPTRUST has more than $450 billion in AUA.

Ellen Lander, founder and principal at $1.4 billion Renaissance Benefit Advisors Group LLC in New York, also advises clients to steer away from TIPS even though "they look really good now," she said.

Ms. Lander recommends that plan sponsors instead think about adding a fixed-income or core-plus bond fund and find a manager "who is nimble and flexible enough to be able to move in and out of TIPS" for participants, she said.

Retirement plan advisers also encourage plan sponsors to look to their target-date funds to secure the inflation protection their participants may need as target-date funds often include TIPS and other inflation-protection investments, such as commodities.

Kameron Jones, a vice president with NFP Retirement Inc. in Newport Beach, Calif., for instance, is a "big believer" in offering inflation hedges within target-date funds, which he says is better than having participants try to build portfolios on their own.

Having professional managers of a target-date fund choosing what percentage of a participant's allocation goes toward inflation hedges, such as TIPS and commodities, is "hugely important" because those asset classes are "hard for participants to understand," Mr. Jones said.

It's also critical, he added, that plan sponsors know whether their target-date funds have exposure to TIPS and commodities and how much that exposure is.

NFP has about $50 billion of assets under management in its wealth management business and over $400 billion of assets in its retirement business.

Plan sponsors are directing a great deal of attention to target-date funds not just because they may offer inflation hedges. Some sponsors are questioning whether their target-date funds have the right glidepath and if they still make sense, retirement plan advisers said.

Some plan sponsors, for instance, have started to explore custom target-date solutions with some form of embedded lifetime income annuity feature.

"They're seeing the value in driving that underlying investment selection while also enabling participants to access or convert a portion of their savings into an income stream within the target-date to protect and secure that income against market volatility," CAPTRUST's Ms. Wrightson said.

Ms. Wrightson reported that several large plan sponsors with more than $1 billion in assets are either in the process of implementing custom target-date funds with an embedded annuity option or talking about doing so next year. Ms. Wrightson declined to name the plan sponsors.

With rising inflation and market instability, plan sponsor interest in guaranteed income products, including those embedded in target-date funds, will grow, OneDigital's Mr. DeBello said.

"We're going to continue to see volatility. It's only going to amplify the conversation around guaranteed income products," he said.

With two major shocks to portfolios in 24 months, Mr. DeBello added, "you're seeing plan sponsors starting to say 'enough is enough. We can't keep having these 20% to 30% drops in the market for our participants.'"

Plan sponsors are also having conversations with their retirement plan advisers about their value funds and which of the two fund types — those buying undervalued stocks or those paying dividends — make more sense in a rising-rate inflationary environment, Renaissance's Ms. Lander said.

Right now, those with a dividend-income approach are "holding up better in this market," she said.

Ms. Lander is reminding plan sponsors about the large-cap value investment strategy they have in place and encouraging them to consider adding a dividend-paying large-cap value fund if they don't already one, she said.

Other plan sponsors have expressed concerns about their long-term and intermediate bond funds and the duration of those bonds, Commerce Street's Mr. Mykytyn said.

"They want to be in funds that have a lower duration on bond funds," he said, explaining that long-duration bonds are not going to do well in a rising interest-rate environment.

Well aware of geopolitical risk, plan sponsors are also talking to retirement plan advisers about their non-U.S. equity funds, advisers said.

Renaissance's Ms. Lander, for example, is urging her clients to look very carefully at their non-U.S. selections and if "they're shocked at what they're seeing" in terms of exposure to countries such as Russia or China, they might consider adding a more defensive fund, she said.

Ms. Lander emphasizes to clients that non-U.S. funds be added and not replaced to prevent participants from locking in losses in Russia- or China-heavy funds that are down.

Participants can use the more conservative fund for new money but leave what they have in the old one until the market corrects, she said.

The 20% that went to the old fund can now go into the more conservative fund, she said.