Plan sponsors and participants are unenthusiastic about bond funds as defined contribution plan investment options.
Despite recent emphasis to participants on the importance of diversifying plan accounts, little attention is being paid to bonds.
A majority of plan sponsors don't offer an actively or passively managed bond fund. A typical intermediate- to long-term bond fund was offered for participant investment by only about one-third of plans (31%) surveyed recently by Hewitt Associates L.L.C., Lincolnshire, Ill. Bond options of other durations were offered even less frequently: diversified fixed income by 19%, short-term bonds by 16% and bond index funds by just 9% of plans.
Even when bond funds are on the investment map, plan participants have voted their disinterest with their dollars. When offered, intermediate- to long-term bond funds attracted only 10% of participant-directed assets, according to Hewitt's findings. Diversified fixed-income options attracted 16% of employee money.
Part of the reason for the low use of bond funds, consultants said, is the continued popularity of pooled guaranteed investment contracts and stable value funds. While consultants are divided as to whether GICs and synthetic GICs function as a true substitute for bonds, Hewitt's data show plan participants and sponsors remain loyal to the stable value/GIC option.
"They don't gain enough on the yield curve to make the move to a bond fund from a GIC option worth the increase in volatility," said Betsy Vary, an investment consultant with Buck Consultants Inc., New York. "Sponsors find that the small, incremental gains they might get with bond funds are not worth it when they lose the comfort zone afforded by the book value of a GIC or stable value option. That book value component, guaranteeing a set benefit, is very important to participants."
Bonds are just too hard for a sponsor to explain to participants, said many consultants. Ricardo Reinking, a Hewitt consultant, said he has seen some interest lately in intermediate government bond funds as options by the treasury and finance staffs accustomed to using bonds as an integral part of defined benefit plan management. But the staff, familiar with the tenets of defined benefit portfolio management, back off the notion of adding a bond fund "when they realize the difficulty of communicating how a bond fund works and what place it should have in the asset allocation of a participant," said Mr. Reinking.
"Employees just don't understand bonds. They read 'fixed' income and think fixed means guaranteed," said Gary Blank, president of Retirement Plan Consulting, San Francisco.
"Bonds certainly have a place from an investment analysts' point of view in DC portfolios, but you have to weigh this against the difficulty of explaining them and their potentially dangerous, from the standpoint of the participant, volatility. I just don't see much of any interest from clients in adding bond funds," he added.
Murray Becker, president of Becker & Rooney, a subsidiary of Kwasha Lipton, Fort Lee, N.J., and a proponent of stable value funds, said: "Plan participants just don't understand bond funds and don't want to. All this talk about efficient frontier theory may not apply to many DC plan investors. They are not looking at their 401(k) fund as a long-term investment. They think of it as an emergency fund for college, a house purchase - shorter-term needs that are much better met by a GIC or stable value fund, which provides a guaranteed benefit.
"It's a lovely product; you can count on investment gains of 6% to 7% without loss of principal. If you're going to manufacture dog food, you'd better make sure the dog will eat it. Stable value funds - that's the food dogs will eat," he said.
Mr. Reinking and others said they think GIC and stable value funds behave much more like money market funds than bond funds, making them an inadequate substitute. Mr. Blank suggested bond exposure can be included somewhat painlessly in defined contribution option line-ups through lifecycle funds and stable value funds that include synthetic GICs, which are essentially actively managed bond portfolios with a book value wrapper.
The controversy is not likely to go away soon. Robert R. Corrick, managing director of investments at Defined Contribution Advisors Inc., Minneapolis, said the addition of bond funds for defined contribution plan investment is becoming necessary in plans where participants are more sophisticated.
"I recommend bond funds be included in the DC plans of companies with relatively sophisticated investors and GIC funds where the employee population is less advanced. Bonds have a definite place in the DC portfolio, particularly where participants have learned to diversify their accounts in appropriate asset classes. There are very different return characteristics between bonds and GICs," said Mr. Corrick.
Mr. Corrick said most stable value funds are based on bonds with too short of a duration to offer the real portfolio diversification of long to intermediate bond funds.
But despite some sponsors' best efforts, participants just don't use bond funds even if they have a chance. Clorox Co., Oakland, Calif., has offered a passive bond fund since 1983 in its $100 million 401(k)/profit-sharing plan, said Nancy J. Roche, assistant treasurer and manager of benefits funding. And the overall allocation of plan assets to the bond fund has been steady around 10% for years. "It just isn't one of the core options. It's never caught on and it just doesn't seem like it ever will," Ms. Roche said.
Clorox doesn't offer a GIC or stable value fund, so employees seem to rely on the money market fund for conservative investment. Clorox employees seem much more interested in equities, to the tune of about 80% of plan assets.
"I hate to see one of a limited number of 401(k) options taken up by an option most participants won't use, like a bond fund," said Stephen J. Butler, president of Pension Dynamics, Larkspur, Calif. Hewitt's data found plan sponsors surveyed offered an average of 6.3 investment options.
But Ms. Roche said Clorox won't eliminate bonds as an asset class when it changes its investment options later this summer. "We can't get rid of the bond fund completely. It does have its dedicated little core of investors who won't budge out of it."
Data from Eager & Associates Inc., Louisville, Ky., suggests that if anything, even fewer plan sponsors are adding active bond funds to their defined contribution plans. Just 7% of total searches for defined contribution plan investment options were for active bond funds, Eager's Tracker service showed, a slight rise from 6% in 1994 but down from 10% in 1993.
Of the total amount of defined contribution money moved by sponsors to new vendors, just 3% went into active bond options in 1995, compared to 1% in 1994 and 11% in 1993.
