Fixed income in DC plans: Understanding specific risks
Learn how certain fixed income categories can expose participants to unnecessary risk despite the diversification benefits they might provide
Categories like multi-sector bond and world bond offer opportunities for diversification in which retirement plan participants can avoid the ‘too much duration’ with ‘too little yield’ dilemma of the more traditional, government-centric fixed income asset classes. But alas, they come with their own challenges.
As line-ups look to enhance diversification, it’s important to acknowledge that diversification for the sake of diversification doesn’t always work out as intended. “While diversifying the duration/yield trade-off, strategies in these categories can sometimes end up being more aggressive than anticipated by delivering significantly more volatility than expected,” says Damien Comeaux, senior portfolio strategist at Janus Henderson Investors. “This can expose participants to unnecessary risk despite the diversification benefits.” Therefore, it’s important that DC-focussed financial professionals have a firm grasp on the specific risks these new categories may introduce.
“One of the most common places we’ve seen this misunderstanding is in the world bond space, which is made up of two sub-categories: World Bond and World Bond – USD Hedged,” Comeaux shares. “While a basic investment in either of these categories may help provide additional diversification, it could also very easily expose a participant to unwanted currency risk relative to the USD Hedged World Bond category.” Examine the 10-year analysis shown below:
Note the differences in 10-year outcomes when currency risk is part of the equation compared to when that risk is hedged out to the U.S. dollar. The most striking example of the negative impact participants could experience is in the 10-year maximum drawdown, in which the unhedged category underperforms its hedged counterparts by over 300 basis points.
While the example in the chart above focuses on just the two world bond categories, the concept illustrated certainly applies to other diversifying fixed income options outside of those traditional, government-focussed fixed income securities. “It is incumbent on plan line-ups to select diversifying elements for the fixed income sleeve but also to understand the level of risk – as well as excess risk – that these options may introduce in participants’ allocations,” says Comeaux. “As a risk-based asset allocation team, we are not as concerned with the returns as we are the risk differential, and unhedged currency risk is exactly that: risk. As such, we believe participants may be better served by having this uncertainty excluded from their fixed income allocation.”
Damien Comeaux, Senior Portfolio Strategist, Janus Henderson
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Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.
High-yield or "junk" bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings.
A retirement account should be considered a long-term investment. Retirement accounts generally have expenses and account fees, which may impact the value of the account. Non-qualified withdrawals may be subject to taxes and penalties. For more detailed information about taxes, consult a tax attorney or accountant for advice.
S&P 500® Index reflects U.S. large-cap equity performance and represents broad U.S. equity market performance.
Basis point (bp) equals 1/100 of a percentage point. 1 bp = 0.01%, 100 bps = 1%.
Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.
Standard Deviation measures historical volatility. Higher standard deviation implies greater volatility.
Janus Henderson Group plc ©
C-0821-39391 09-30-22
