May 30, 2013

Poor Diversification Is Failing 401(k) Savers: Clear Path

‘Style box’ limits put DC investors ‘at a significant disadvantage’ to broadly diversified DB plans, says BNY Mellon Retirement’s Capone

The U.S. and Canadian defined contribution systems are failing 401(k) retirement savers on a number of counts, including a lack of diversification and an overdependence on the “style box” investment design, warns a defined contribution industry report from Clear Path Analysis released Thursday.

The North American DC marketplace may be maturing, but its continued reliance on U.S. securities shows a lack of diversification that is harming investors, especially as the U.S. markets struggle against the current low-interest rate environment, concludes the “DC Retirement Plan, North America 2013” report from London-based Clear Path Analysis.

According to Robert G. Capone, executive vice president of BNY Mellon Retirement, who is quoted in the report, great disparities continue between investment opportunities and resulting performance of both DC and defined benefit (DB) plans—and the underlying asset class exposures “factor prominently” in the results.

“DB plans have significantly more exposure to nontraditional, out-of-the-style-box investment categories,” says Capone in the report. The paper examines the evolution of target-date fund structures as they move away from traditional, U.S.-reliant investments into “out-of-the-box” investment categories.

Style Boxes a Disadvantage: BNY Mellon Retirement's Capone

“We believe the limitations placed upon DC investors by the ‘style box’ investment design so prevalent in DC plans puts the DC investors at a significant disadvantage to the more broadly diversified DB plan,” Capone says.

Clear Path publishes reports on industry issues written by a cross-section of experts in the financial services, investments and pensions sector. The second annual online DC Retirement Plan report offers thoughts from U.S. and Canadian DC plan managers and finance directors, including Capone, Klinger Cos. CFO Robert DeSmidt, Thomson Reuters employee benefits vice president Marco Diaz and Transamerica Center for Retirement Studies President Catherine Collinson.

The average DB plan has outperformed the average DC plan by more than 180 basis points since 2006, according to the report, which concludes that DC plans must evolve like their DB counterparts and consider more non-style-box category funds.

Capone speaks of a “home bias” in DC plans, pointing to the combined U.S. equity and U.S. fixed-income allocations at approximately 80% for DC to just over 60% for DB plans. “Most importantly,” he notes, “when it comes to truly low-correlated, nontraditional diversified categories, the average DB allocation has nearly 20% allocation to a combination of alternatives, real assets and emerging markets whereas the average DC plan has minimal exposure to these investment areas.”

Solution Is Education

DeSmidt of Klinger Cos. agreed, saying: “We would certainly agree that there tends to be a bias towards home country equities and that a lot of investors just don’t have a broad enough holding to really get proper diversification.”

The solution, according to Patrick Baumann, assistant treasurer of Harris Corp., is to do a better job of educating retirement plan savers about investment classes.

“We need to determine and explain to our plan participants the benefits in bringing new asset classes, such as improving the potential risk-reward payoff, providing more diversification and moving the efficient frontier further out,” Baumann said.

Read Better Employee-Benefits Communication Means Happier Workers at AdvisorOne.

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