While declining interest rates were driving strong bond fund returns, another trend was shaping today's defined contribution plan menus — the trend toward streamlined menus. These trends reinforced each other. With limited shelf space and strong fixed-income returns providing the safety, diversification and return that participants had come to expect from their bond funds, few plan sponsors saw any reason to expand their fixed-income selection. They were free to focus elsewhere, particularly on their second- and third-tier equity fund choices.
If rates do rise, or any of the other headwinds we mentioned challenge returns, today's bond fund choices might fall short of participant expectations — a particular concern for participants in or near retirement relying on consistent bond fund returns as the foundation for retirement income. As we see it, plan sponsors have three potential choices:
Keep the status quo, double up on education.
A plan sponsor might be able to justify making no change to its bond fund menu by doubling up on participant communications efforts to ensure participants understand the fixed-income choices that seemed safe in the past might not be safe in the future. The problem is that while some participants will get that message, many may not. And many who do get the message might wonder what to do as an alternative.
Expand the fixed-income menu.
On the face of it, it might make sense to offer a broader menu of fixed-income funds. Funds can be introduced to address a wider range of credit quality, geographic regions, strategies and so on. For participants with the knowledge to make intelligent selections, this might be a welcome development. But most participants may lack the in-depth investment knowledge needed to choose wisely. For many, adding choice may add confusion.
Reinvent the bond fund with a multimanager structure.
The third choice is to not simply prepare for immediate headwinds, but for the long haul and the new, highly uncertain reality. This can be done through a multimanager structure that incorporates a mixture of fixed-income strategies and allows plan sponsors to allocate among them as circumstances dictate. The overall investment objective of the fixed-income strategies could be to provide appropriate risk adjusted returns, rather than simply tracking the Barclays Aggregate index.