Bond choices too narrow for 401(k) investors: advisers

Despite the market rebound, investors are continuing to pour money into bond funds, causing a number of asset managers and financial advisers to make sure that their clients are diversifying their fixed-income holdings.

This is of particular concern in the retirement business, where 57% of 401(k) plans offer just one bond fund, according to Hewitt Associates LLC.

“We are seeing more 401(k) plan committees talk about what they can do to diversify their fixed-income menus,” said Don Stone, president of Plan Sponsor Advisors LLC.

The need seems acute: Although 72% of investors who responded to a recent survey conducted by The Hartford Financial Services Group Inc. said that bond diversification is important, more than half of them don’t know what fixed-income classes they hold.

Liquidty concerns

Advisers are obviously concerned about liquidity, especially with older workers.

“I don’t want to be in a position where clients get into a cash crunch,” said Kevin Brosious, president of Wealth Management Inc., which has $6 million under management.

Thousands of older workers saw their nest eggs decimated during the market crash, and many of them are rethinking their risk tolerance and putting more of their money into fixed-income funds.

Similarly, many younger investors are chasing performance and investing in such funds more heavily, experts said. As of Oct. 31, investors had poured $312.8 billion into bond mutual funds this year, the most in at least 25 years, according to the Investment Company Institute.

The trend continued in November as bond funds netted $33.4 billion, while equities suffered $7.7 billion in net outflows, according to Morningstar Inc.

The question many industry officials are now debating is how many fixed-income funds should be included in a 401(k) plan.

Some advisers and fund company officials think that it is appropriate for a 401(k) plan to have one bond fund, as long as that fund is diversified in its holdings.

“It might be enough if it’s a total bond portfolio, which is what a lot of our plan clients use,” said Fran Kinniry, principal of the investment strategy group at The Vanguard Group Inc. “It means the investors own the entire bond market.”

Vanguard’s Total Bond Market II Index Fund had year-to-date net flows of $11.7 billion as of Nov. 30, according to Morningstar. That was in second place among bond funds, behind the $47 billion raked in by the Pimco Total Return Fund, offered by Pacific Investment Management Co. LLC.

A number of industry experts said that no matter how diversified a portfolio is, 401(k) plans should offer more than one fixed-income fund.

“Offering just one fixed-income fund doesn’t constitute adequate diversification for something as serious as a retirement plan,” said Alex Quint, president of the advisory firm Quint Miller & Co.

Investors’ lack of understanding that different parts of the fixed-income market can perform very differently is of particular concern given recent fund flows.

“When people ask how the bond market is doing, I respond: “Which part?’” said Carolyn Gibbs, head of global high income for Invesco Aim Management Group Inc.’s worldwide fixed-income group. “The bond market is as diverse, if not more diverse, than the equity markets.”

This is particularly evident when looking at the performance of various fixed-income sectors.

“If you look at 10-year Treasuries, last fall, they had a total return of 9% in November alone; meanwhile, high yield was getting hammered,” Ms. Gibbs said.

“Clients are good at diversifying between stocks and bonds, but many of them are overweighted in one bond category,” said John Diehl, senior vice president of business development at The Hartford.

The limited number of fixed-income fund offerings within the typical 401(k) plan is particularly troubling for older investors, who tend to be heavily weighted in this asset class, said Eric Jacobson, director of fixed-income research at Morningstar.

“Investors for whom a fixed-income allocation becomes more important — and by extension, a larger portion of assets — one or two funds is unlikely to provide sufficient diversification across fixed-income sectors,” he said.

A number of record keepers are talking about this issue and looking at adding more fixed-income funds to their plans, said Luis Fleites, vice president and director of retirement markets at Financial Research Corp.

“This is a great opportunity for advisers and asset managers in the defined-contribution space to help sponsors with their plan lineups,” he said.

The Hartford has put out a series of white papers for advisers to emphasize the importance of fixed-income diversification, Mr. Diehl said.

Similarly, Invesco Aim has made fixed-income diversification a main talking point with advisers. “We have groups spending time talking about the asset allocation process and saying how important it is across the portfolio,” Ms. Gibbs said.

Since so many investors have access to only one or two fixed-income funds in their 401(k) plan, some advisers are looking toward other retirement vehicles to diversify.

“Usually, our clients have individual retirement accounts, so I will use that to help them diversify their fixed-income holdings,” Mr. Brosious said. If a plan has a self-directed brokerage account, that can also be used to diversify fixed-income holdings, he said.

“My emphasis on fixed-income diversification isn’t going away,” Mr. Brosious said. “I don’t want to be in a position where clients get into a cash crunch; liquidity is very important.”

Many advisers who work with retirement plan sponsors are advising them to have at least two or three fixed-income funds.

“With fixed income, you certainly want to have choices,” said Robert Wander, president of Wander Financial Services LLC. He recommends that his 401(k) plan clients offer two or three such funds.

“You don’t want to have too many, because then people get paralyzed about which ones to choose,” Mr. Wander said.

Long-term trend?

One area of debate among industry experts is whether this rush to fixed-income funds is simply performance chasing or part of a more long-term trend as baby boomers start to retire.

“Across the board, there is no question that everyone is rethinking risk tolerance — both the aging population and those younger after having a year like last year,” said James Supple, executive vice president of distribution at Fidelity Investments.

But Mr. Kinniry disagrees with this notion.

“I think we are seeing what we have been seeing for many decades,” he said. “People are buying the asset class that has performed the best in the last three to five years.”

E-mail Jessica Toonkel Marquez at [email protected].

Related Topics: Fidelity Investments, Vanguard Group