For Financial Professionals in the US

Has the Time Come to Simplify Foreign Equity Offerings in 401(k)s?

Matt Sommer, PhD, CFA, CFP®

Matt Sommer, PhD, CFA, CFP®

Head of Specialist Consulting Group

Jul 19, 2022
4 minute read

Recent changes in the capital markets offer plan sponsors a timely opportunity to rationalize their 401(k) lineups. Head of Defined Contribution and Wealth Advisor Services Matt Sommer discusses why there may be value in offering a single foreign blend equity option.

One of the most important decisions plan sponsors must make is determining the total number and different types of investment options that comprise a 401(k) plan’s core lineup. While the majority of new contributions flow to a plan’s qualified investment default alternative (QDIA), research suggests that a non-trivial number of participants – typically older, higher earners with larger account balances – still prefer to build their own asset allocation. Further, many managed account programs will customize a participant’s asset allocation using only options in the plan’s core lineup. These factors suggest core lineup construction and oversight remains a critically important fiduciary responsibility, despite the prominence of QDIAs.

Foreign Large-Cap Equity Options: A Mixed Bag

When it comes to U.S. large-cap equity, the vast majority of plans offer options representing all three Morningstar style boxes. There appears to be consensus within the marketplace that U.S. large-cap value, large-cap growth and large-cap blend are fundamental building blocks for participants who choose to self-direct, or as a discretionary asset allocation solution when using a managed account program.

There seems to be less agreement regarding the optimal construction of large-cap foreign equity options. Some plans mirror their U.S. large-cap design and offer value, growth and blend. Other plans offer only value and growth, some only an either/or growth/value option, and yet others offer only a blend.

While there is no right or wrong answer, we think recent market volatility may present plan sponsors with an opportunity to revisit their existing design and make any necessary adjustments.

Growth vs. Value: The Roller Coaster Ride Continues

Over the last 10 years, foreign large-cap growth has outperformed foreign large-cap value. Perhaps not surprisingly, 401(k) assets in foreign large-cap growth dwarf those invested in foreign large-cap value. More recently, however, not only has the dispersion of returns between growth and value widened, but growth is also no longer a sure winner.

Looking at the table below, there was little difference in returns from 2012 through 2014. From 2015 through 2020, growth was the clear winner in every year except 2016. Throughout 2021 and through May 31, 2022, however, value easily comes out on top. Looking at this table from a 401(k) participant’s perspective, it’s a roller coaster ride that can be unnerving and ultimately lead to behaviors that hardly ever work – namely market timing.

Ex-U.S. Growth vs. Value Outperformance (1/31/2012 – 5/31/2022)

Source: Bloomberg, as of May 31, 2022. Data based on MSCI ACWI ex USA Growth Index and MSCI ACWI ex USA Value Index. Past performance does not predict future returns.

Smoothing the Ride with a Foreign Blend Equity Option

Based on these emerging trends, we suggest plan sponsors consider offering a single foreign blend equity option. Over the long term, holding both value and growth stocks should help smooth the ride for participants rather than subjecting them to the natural market rotations that inevitably occur between these two distinct styles. At the same time, little is lost when using this approach to construct a well-diversified portfolio that consists of both domestic and foreign equities.

Plan sponsors who consolidate into a single blend option will also free up “shelf space” to add other investment options that are top of mind, such as real return, environmental, social and governance (ESG), and guaranteed lifetime income. While there is no requirement that a new option can only be added if an existing option is eliminated, plan sponsors must be mindful of having too many options, which can be confusing for participants as well as requiring additional fiduciary oversight.

Recent changes in the capital markets offer plan sponsors a timely opportunity to rationalize their 401(k) lineups. While each plan is different and must meet the needs of its participants, there may be value in consolidating multiple large-cap foreign options into a single investment. We suggest plan sponsors add this topic as an agenda item for their next investment committee meeting with their plan’s advisor.

A defined contribution partner with more to offer