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Retirement Perspectives

Defined contribution plan sponsors should include a diversified fixed income offering for a strong, fiduciary-built investment menu.

Using a disciplined process and building a diversified investment menu are basic tenets of a retirement plan fiduciary’s responsibilities. By allocating investments across different categories and asset classes, areas that behave differently under varied market conditions participants may seek to increase returns, while reducing risk. With this in mind, it may be time for your defined contribution plan clients to consider a more diverse set of fixed income options in their overall menu construction strategy.

What’s on the menu—and what makes a good mix?

We see three opportunity areas to consider when constructing an efficient investment menu.

1. Fiduciary considerations: Always consider the needs of the participant base and adhere to the Investment Committee focus and the Investment Policy Statement to determine what asset classes should be included in a prudent menu.

2. Menu efficiency: Provide greater diversification without overcrowding the menu and risking participant inertia. For example, a plan might include one or two fixed income investment options that go beyond traditional components like stable value and core bond funds.

3. Balancing active or passive options: While the industry trend has been migration to passive management across many asset classes, this subject still sparks lively debates in the marketplace. At Lord Abbett, we believe closer examination is required by sponsors and their advisors to determine whether or not passive strategies are always the prudent choice for each asset class.

Stretch your thinking beyond the typical

Investment menu construction can be influenced by a range of variables based on each advisor’s methodology and, of course, the needs of sponsors and participants. Tradition may be an unintentional influence as well. For example, a typical core menu might include two fixed income options: stable value, or some type of cash option, and intermediate bond. High yield is not always included as a choice for participants, depriving them of potentially useful diversification. If that reflects your usual menu, consider expanding beyond intermediate bond by offering a high yield bond or other complementary fixed income option.

Bulking up a thin fixed income menu…but not too much

There are long-standing misconceptions about high yield, often labeled as too volatile and risky—essentially junk bonds. Yet the reality is that high yield can be a potentially effective diversifier for a menu, offering more diverse fixed income exposure that could bring healthy returns without the high volatility that investors unfamiliar with the asset class might expect.

Potential benefits of high yield

  • While past performance is not an indicator of future results, high yield has provided attractive return for the associated level of risk.
  • In one analysis comparing U.S. high yield and U.S. equities, high yield provided 83% of the return with 54% of the volatility of U.S. equities, for the period of 1/1/92 through 9/30/18.1
  • Adding a high yield option to a menu can provide the potential diversification benefits of another fixed income sector for defined contribution plan participants.

What about a multi-sector approach?

If moving from intermediate bond to high yield feels like too big a step, take a look at a potential middle ground. Those who may be concerned about participants investing in a pure high yield strategy might consider the potential benefits of a flexible, multi-sector approach. A multi-sector bond fund typically offers a mix of different income sources, with more high yield than an intermediate bond fund and less potential risk than a fully high yield strategy. 

Busting common investment myths

Myths abound in the financial world. Here are three to smash when it comes to building a well-diversified investment menu:

Myth 1

All active investing is the same and doesn’t—or can’t—add value. Research from two professors at Yale University shows that portfolio managers who are more active—that is, who spurn “index hugging”—are most likely to outperform.2

Myth 2

Passive investing is cheaper. Not always. Make sure you review the expense ratios closely.

Myth 3

Index risk is desirable or replicable. There is always some inefficiency in the market, which active management can exploit. And unlike the S&P 500® Index, the high-yield index is not easily replicated.

Passive may be the trend, but active management may make more sense for fixed income options

Fixed income is one of the investment categories where we believe active management may deliver more for participants.

Essentially, no matter how efficient a market becomes, some inefficiency will always remain, and this leaves open the possibility of outperformance by an active manager. These investors believe there are inefficiencies or mispricings in the market that can be exploited. In essence, market efficiency is always in flux and can represent potentially meaningful return and diversification opportunities for investors.  

This is not to say that passive strategies do not have a role to play on menus and in portfolios. For example, certain categories, such as large cap equities, may be a good fit for passive funds. However, we believe that the complexities in the bond markets require the abilities of skilled managers to realize the potential returns they represent.

“Active management will always be critical to capital markets and some portion of funds will always be actively managed,” says Tom O’Halloran, Partner and Portfolio Manager. “The need for rational allocation of capital ensures that it will always play a role. Even passive management, which assumes that the market is efficient, relies on active management to make the market efficient.”

What’s more, taking a passive approach with fixed income investing can leave investors potentially more susceptible to movements in interest rates. Alternatively, an actively managed combination of fixed-income securities may be an attractive option for participants seeking income and total return amid market turmoil. “For those looking to avoid typical equity volatility, a diversified portfolio of low-duration strategies may provide attractive income with limited interest-rate risk, along with the potential to benefit from further rate increases by the U.S. Federal Reserve,” says Stephen Hillebrecht, CFA, Fixed Income Product Strategist.

Take the next step

Lord Abbett seeks to  provide consistent long-term performance, competitive expenses, and extensive resources that help you meet the investment needs of your defined contribution plan sponsor clients and their participants.

Menu construction and ongoing refinement are core elements of the value you demonstrate to plan sponsors. Ask your Lord Abbett Relationship Manager to conduct a client menu review to see what opportunities are available to best support your client’s objectives.  For more information, contact us at 888-522-2388.

 

1 Source: Credit Suisse. High Yield bonds are represented by the Credit Suisse High Yield Index. Stocks are represented by the S&P 500 Index.  

2 K.J. Martijn Cremers and Antti Petajisto, “How Active Is Your Fund Manager?” The Review of Financial Studies (September 2009).

 

Past performance is no guarantee of future results.

*Thomson Reuters Lipper Fund Awards: Lord Abbett High Yield Fund Class I was #1 for 10-year performance through 12/31/2017 (out of 103 similar funds). Click here for the complete list of funds in the 2018 Lipper Awards. 

About the Thomson Reuters Lipper Fund Awards: For more than three decades and in over 20 countries worldwide, the Thomson Reuters Lipper Fund Awards have honored funds and fund management firms that have excelled in providing consistently strong risk-adjusted performance relative to their peers. For more information, please contact Markets.Awards@thomsonreuters.com or visit http://www.lipperfundawards.com/. Details about the methodology for these awards can be found here.

**Among 59 qualifying U.S. fund companies. Based on net total return as measured against its Lipper category for the period ended 12/31/2017. Lord Abbett Funds ranked 3 out of 59, 1 out of 54, and 1 out of 50 mutual fund families within the taxable bond category for the 1-, 5- and 10-year periods ending 12/31/2017, respectively. Click here for more information

Source: Barron’s, “Best Fund Families of 2017” March 10, 2018. Barron’s rankings are based on asset weighted returns in funds in five categories: U.S. equity, world equity (including international and global portfolios), mixed asset (which invest in stocks, bonds and other securities), taxable bond, and tax-exempt (each a "Barron's ranking category"). Rankings also take into account an individual fund's performance within its Lipper peer universe. Lipper calculated each fund's net total return for the year ended December 31, 2017, minus the effects of 12b-1 fees and sales charges. Each fund in the survey was given a percentile ranking with 100 the highest and 1 the lowest in its category. That ranking measured how a fund compared with its peer "universe," as tracked by Lipper, not just the funds in the survey. Individual fund scores were then multiplied by the 2017 weighting of their Barron's ranking category as determined by the entire Lipper universe of funds. Those fund scores were then totaled, creating an overall score and ranking for each fund family in the survey in each Barron's ranking category. The process is repeated for the five- and ten-year rankings as well.

Barron's Fund Family Rankings are awarded annually. © Reuters 2018. All Rights Reserved. Lipper Analytical Services, Inc. is an independent mutual fund research and rating service. Although Lipper makes reasonable efforts to ensure the accuracy and reliability of the data contained herein, the accuracy is not guaranteed by Lipper.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided reflects Lord Abbett’s views as of the date of this presentation. Such views are subject to change without notice.

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

This material is provided for general and educational purposes only. The examples provided are for illustrative purposes only, and are not indicative of any particular investor situation.

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

Indexes are unmanaged and are not available for direct investment.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

About The Author

Lord Abbett Funds to Explore for Greater Diversification

 

Growth Leaders Fund

Total Return Fund

Bond Debenture Fund

High Yield Fund

Floating Rate Fund

Award Winning Approach

  • 2018 Lipper Fund Award: Lord Abbett’s High Yield Fund Class I was recognized as the top fund for 10-year performance.*
  • 2018 Barron’s Awards: Lord Abbett ranked #3 in the  Taxable Bond Category.**
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