“Failure to Diversify” Allegation Raises Important Questions for Plan Sponsors

A recent legal case highlights the issue of equity funds being too highly correlated and fixed income options too limited within retirement plans. Retirement Director Ben Rizzuto outlines some of the key questions plan sponsors should consider as they review their plan lineups in light of the allegations raised in the case.

A new lawsuit just added something new to worry about when it comes to your retirement plan and your fiduciary duty. In the Fleming v. Rollins case, we see many of the same common themes as in past ERISA class action lawsuits, including excessive fees, expensive share class usage, failure to monitor investments and imprudent investments.

What is different about this case is the “failure to diversify” allegation.

The claim is that the plan menu subjected participants to undue risk due to 1) equity funds being too highly correlated and 2) having only ONE (emphasis mine) fixed income option. Overall, the menu included a total of 12 funds: 11 equity funds and one fixed income fund. Those two issues open a couple different cans of worms and raise some important questions for plan sponsors to consider.

Plan sponsors should ask themselves whether their investment policy statement (IPS) includes a line item to analyze the correlation between equity options within the core menu. In looking at a couple sample IPS templates, I personally found no mention of correlation between funds. The templates did include correlation to asset classes and contained language around providing participants with the ability to diversify but nothing regarding how funds behave in comparison to each other. Even if they’ve provided a sufficient number of options (more on that in a moment), plan sponsors should consider whether they are sufficiently different when it comes to participants’ long-term assets.

The second questions plan sponsors should ask is how many fixed income options should be provided to participants? More broadly, what is the right number of core menu options? Some have said that offering too many choices leads to participant confusion and inaction. More recently, some have argued that more core menu options can actually lead to better performance for self-directed participants. We will never know what the “right” number of fixed income options is, but it is certainly more than one.

Fixed income becomes a larger percentage of participants’ allocations as they age, just as retirement plan assets are becoming a larger portion of the assets participants will utilize to meet retirement expenses. And as more plan sponsors feel it is part of their responsibility to help create a dignified retirement for plan participants, they should do more to ensure the options offered meet the current and future needs of participants.

With that said, I want to provide advisor and plan sponsors with some ideas and questions to consider as they review their plan lineups based on these recent developments.

  1. Check correlations among equity, fixed income and all funds within your core menu.
  2. How will the plan’s fixed income options potentially perform during different market cycles?
  3. Will fixed income options provide the yield participants seek to help dampen volatility?
  4. Does it make sense to add a fixed income fund that provides exposure to different parts of the fixed income universe?
  5. Do any of the plan’s fixed income options have exposure to risky sectors?

While the Fleming v. Rollins case adds to the list of items to review, remember that it also raises tough – but critically important – questions that will ultimately help plan sponsors create a prudent process and fulfill their fiduciary duty.