Bond losses in 2022 hurt defined contribution plan participants particularly hard.
That’s because defined contribution plans rely heavily on passively managed core bond funds to provide fixed income exposure to participants. About half of fixed income portfolios used in target-date-funds, which represent the majority of DC assets, are passively managed and benchmarked to the Bloomberg U.S. Aggregate Bond Index, according to investment management consultant Mercer. The index, lost 13 percent in 2022 as interest rates rose. In contrast, the median performance of the actively managed fixed income portfolios in target-date funds lost 9.8 percent last year.
“In general, active managers were able to outperform the benchmark,” said Kelly Henson, Mercer’s U.S. DC investment strategy leader. “Through duration management, sector allocation, and credit selection, they were able to at least protect [investors] a little bit.”
Unlike index funds, active managers’ can invest in high-yield bonds, short duration, and emerging market debt.
According to Jessica Sclafani, senior defined contribution strategist at T. Rowe Price, the underperformance of passively managed fixed income products in target-date funds was due in large part to the 40 percent weight of U.S. Treasuries in the Bloomberg U.S. Aggregate Bond Index at the end of 2022. The index has lost an annualized 4.5 percent over the past three years.
Jeremy Stempien, portfolio manager for Prudential’s target date funds, said other fixed income securities fared better, last year including Treasury Inflation Protected Securities, which lost 0.85 percent, and high yield bonds which gained 2 percent.
DC plans rely heavily on index funds, but Stempien argues that sponsors should start taking an active approach to fixed income. “I think a lot of plan sponsors would say most active managers are not outperforming the benchmark, and therefore, I’m going to pass,” Stempien said. “But that rhetoric holds true for equities to a much larger extent than for fixed income. Historically, when you look at fixed income, active managers tend to have a pretty good track record against their benchmarks.”
Sclafani added, “We are trying to think about how to improve on core bonds to lessen participants’ reliance on U.S. interest rates.”
