(May 22, 2013) – Defined contribution (DC) portfolios still woefully under perform their defined benefit counterparts because of poor asset allocation strategies, according to a new whitepaper.
Hewitt EnnisKnupp, the Chicago-based investment consultant, believes DC plans are coming at the diversification issue from the wrong direction.
Instead of offering hundreds of different types of funds, plan sponsors should focus on investment options which just focus on growth, income, inflation protection, and preserve capital.
DC investment strategies are a hot topic on both sides of the Atlantic – last week a UK-based investment steering group called for DC investors to take on more illiquid assets to help boost growth.
While in America, a report from Mercer Bullard found offering too many investment choices for the 401(k) led to poor member decision-making and worse financial outcomes.
Hewitt EnnisKnupp’s whitepaper found DC funds currently make two key mistakes: offering too little in the way of inflation hedging products and too many higher risk/return options, such as REITs, high yield bonds, commodities, and emerging market funds.
“Most plans do not include an inflation-hedging solution such as TIPS (Treasury Inflation-Protected Securities),” said the report.
“Our research shows that a portfolio of intermediate duration TIPS with a small allocation to commodities would be expected to provide… an inflation-hedging solution that has a low to modest volatility and tracking error relative to unexpected inflation over a short investment horizon.
“While these investments are often criticized for their short-term tracking error, we believe this is well within the participants’ investment horizons and risk tolerance.”
A tiered investment structure is also recommended, with the options available on the core tier being limited, and then a broader suite of underlying options to improve diversification and provide exposure to new markets sitting underneath.
Further scrutinizing of costs was also called for, as well as helping members to gain a better understanding of their real risk tolerance levels.
Hewitt EnnisKnupp found that older participants (those over 30 years old) had often adopted too low a risk/return strategy, and resulted in losing 1% in performance per year, accumulating to 20% over their potential career, or four years of their projected retirement income.
The full report can be read here.
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