Market offers 401(k) plans lesson on company stock

Updated with correction.

The rampant ricocheting of the stock market recently has given defined contribution researchers, consultants and executives another opportunity to preach the value of diversification and issue warnings about an overreliance of employer stock in participants' 401(k) accounts.

The experts' concerns are highlighted by discomfiting activity in financial markets. For example, the CBOE volatility index in August recorded the biggest one-month increase in its history; the third-quarter results for the Wilshire 5000 Total Market index were the worst since the third quarter of 2008; and the third-quarter performance of the Dow Jones Industrial Average was the worst since the third quarter of 2011.

However, DC executives acknowledge a few months of market volatility and sinking stocks won't lead to quick changes by plans or participants in an industry that is slow to transform.

Changes have come steadily over the years as many DC plans reduce — or even eliminate — the impact of company stock. A steady diet of participant education plus plan design changes — such as capping amounts of company stock in participant accounts or freezing the amount of company stock available to DC plans — are among the most practical ways to let participants invest in company stock without going overboard, the experts say.

“Companies have been trying to limit their exposure over the last 10 years,” said Mike Alfred, CEO and co-founder of BrightScope Inc., a San Diego-based company that provides financial data services and rates 401(k) plans based on total plan costs, company contributions, account balances, salary deferrals and participation rates.

In most cases, a 10% allocation to company stock is enough, Mr. Alfred said. An exception, he added, might be startup companies and fast-growing technology companies for which the issuance of company stock — in retirement plans or as stock options — is in keeping with their employees' appetite for risk-taking.

Company stock in DC plans “is mostly a legacy issue,” said Holly Verdeyen, director of defined contribution investments for Russell Investments, Seattle. “If you started (a DC plan) today with a blank sheet of paper, it's likely company stock wouldn't be involved.”

When talking to clients, Russell Investments officials don't recommend a specific amount for a company stock allocation, “but we say 20% to 25% in general is the limit, absent special circumstances,” she said.

For example, the $3.1 billion Procter & Gamble Co. Savings Plan allocated 37.7% of the plan to company stock for the fiscal year ended June 30, 2014, according to its most recent 11-K filing. There's also the $12 billion Procter & Gamble Profit Sharing Trust and Employee Stock Ownership Plan, of which 87.5% of net assets available for benefits is allocated to P&G common stock and an ESOP convertible preferred stock, according to the latest Form 5500 filing.

“The (overall) exposure to P&G stock is too risky for the average participant,” said a recent analysis by BrightScope. “In an era where most employers have moved away from loading their employees up with their own stock, P&G likely views the plan as a way to provide their employees with ownership interest in the company.”

BrightScope praised P&G for offering a “well-designed lineup and low fees” but said the company should find ways “to reduce its employees' exposure to P&G stock to reasonable levels.”

Over the past five years — as of Oct. 1 — Cincinnati-based P&G's stock gained about 29%, well below the S&P 500 index gain of 64%.

P&G declined to comment, as did representatives of several other companies contacted by Pensions & Investments that have significant allocations of company stock in their DC plans, according to P&I research data, the most recent 11-K statements and Form 5500s.

These plans are: the $12.9 billion Honeywell International Inc. Savings and Ownership Plan (29.8% company stock); the $19 billion Chevron Corp. Employee Savings Investment Plan (46.7%); General Electric Co.'s $27.5 billion GE Retirement Savings Plan (35.5%); the $7.6 billion Target Corp. 401(k) Plan (28.3%); and the $35.2 billion Wells Fargo & Co. 401(k) Plan (30.2%). Data for all of these plans are for the year ended Dec. 31, 2014.

Stock performance among these companies was mixed during the five-year period ended Oct. 1. For example, Chevron was down 6.8%, while shares of Wells Fargo and Honeywell substantially outperformed the S&P 500.

Among client DC plans that offer company stock, data from Fidelity Investments, Boston, shows an almost steady decline in the average company-stock asset allocation to 14.6% as of June 30 from 19.9% as of June 30, 2007. For Fidelity's largest DC plan clients — those with $100 million or more in assets — 29.2% offered company stock compared with 38.8% 10 years ago.

The reasons for paring the company stock presence are varied but “fiduciary concern is always at the top” of considerations, said Jeanne Thompson, a vice president at Fidelity Investments, referring to fears of lawsuits over falling company stock prices.

She said sponsors use multiple strategies to reduce the impact of company stock in retirement plans such as offering company stock through an employee stock ownership plan outside of the retirement plan, putting a cap on stock in participants' retirement accounts and limiting the amount of new contributions to company stock a participant can make. Liquidating company stock in retirement plans has not been common among clients, she added.

T. Rowe Price Group, Baltimore, has 146 record-keeping clients offering company stock, and 31% took steps last year to address large allocations to company stock, said Francisco Negron, head of client services for T. Rowe Price Retirement Plan Services.

The most frequent strategy is restricting new contributions or transfers into company stock funds, he said. Other policies include reviewing investment policy statements, hiring third-party administrators to supervise company stock in the DC plan, placing a cap on company stock in a participant's account and highlighting the risk via more education and communication.

Plan executives, he added, try to balance concerns about risk with concerns about appearing to be too paternalistic. “They are sensitive about trying to seem that they are limiting what they want participants to do,” he said.

Company stock is experiencing a reduced role among Vanguard Group Inc. DC plan clients. For example, 18% of participants had more than 20% of company stock in their retirement accounts in 2005, said Jean Young, senior research analyst with the Vanguard Center for Retirement Research, Malvern, Pa. By 2014, that level had fallen to 8%. “You are simply not compensated for the risk in holding company stock,” she said.

Based on Vanguard research, the offering of company stock via a corporate match “is definitely a driver” among participants' overallocating company stock in their retirement accounts, she said. A Vanguard research report published in December showed that when a plan offers an employer contribution in company stock, 56% of participants hold more than 20% of company stock in their retirement accounts. When the plan offers an employer contribution in cash, 15% of the participants have accounts with more than 20% in company stock.

To illustrate the risks of holding too much company stock in retirement accounts, Russell Investments recently published a research report comparing the volatility of the Russell 200 index with the average volatility of each stock in that index. Last year, the volatility for the index was 7.9% while the average volatility of each stock in the index was 18%.

In every year from 2005 through 2014, Russell found similar results. “The numbers speak for themselves,” said Mark Teborek, senior consulting analyst, in an interview, commenting on a research report that noted participants frequently allocate too much to company stock.

Despite stock market volatility, company stock still remains a selling point for many DC plans.

Company stock “has been and should continue to be an important and useful plan design option for sponsors and participants,” said Tony Verheyen, executive director of the Plan Sponsor Council of America, Chicago. It gives employees “an ownership interest” in their employer and can serve as a way to retain and recruit employees, he added.

Mr. Verheyen acknowledged the risks of excessive allocations to company stock, noting that “many but not all” employers have used plan design changes and participant education “to help employees understand the pros and cons of a concentration of wealth tied to the company's performance.” n