3 reasons to use active management in your DC plan menu

A market-cap weighting approach isn’t ideal for DC plan assets

The prevailing method of constructing a stock index — except for a few, such as the Dow Jones Industrial Average, which predates modern portfolio theory by many years — is to weight the holdings in proportion to the total market capitalization of each stock in the index. The S&P 500 Index and its sister indexes, as well as all the Russell and MSCI indexes, are built this way.

Letting the market decide how to weight positions tends to result in biases toward larger, growth-oriented companies at the expense of smaller, value-oriented names. Participants may benefit from this approach when those large, expensive companies are firing on all cylinders, but when they fall out of favor it can wreak havoc on a retirement portfolio.

If a DC plan’s investment menu consists of only index funds, the result may be less diversification and higher exposure to risk for plan participants. We believe it makes more sense for DC plan sponsors to offer investment strategies managed by serious and devoted professionals, rather than by computer-based, mechanically built funds.

Experienced active management can help DC participants avoid succumbing to their emotions

During times of volatility, an active manager may choose to either scale back on holdings within certain sectors or focus on companies with the most reasonable valuations.

On the other hand, an index fund has no means by which prudence, common sense or good judgment could override the programming used to build it. Markets and sectors go up and go down — but should unsuspecting 401(k) investors watch their account balances follow suit?

Index funds offer no protection to investors when either fundamental or psychological forces drive down stock prices. Only a prudent active manager can take the action necessary to protect investors’ principal when the market — or any individual stock or sector — is in trouble. We believe risk management is a particularly important consideration in the DC space, where less sophisticated investors may be more susceptible to emotional reactions during periods of market distress, thus jeopardizing their longer-term retirement strategy. 

Passive management isn’t always a bargain

Few plan sponsors (or participants, for that matter) would disagree that, over long investment periods, funds with lower investment expenses are preferable to those with high expenses.

However, a well-kept secret about index funds is that the options available to DC plans are not as inexpensive as might be supposed. In our view, DC plan sponsors tend to favor larger funds; however, the correspondence between fees and performance is more complicated than index fund marketing could lead us to believe. The median expense ratio for large cap index funds (including the 12b-1 fees necessary to support the administration and communications functions of a DC plan) is closer to 68 basis points¹ than the near-zero level that is often advertised in the marketplace.

The retirement security of DC plan participants is in their own hands, and the fiduciaries that manage DC plans bear the responsibility of making available the tools needed to achieve financial security. Relying on passively managed index funds is a potentially risky course that forgoes the benefits of professional risk management.

Important information

Past performance does not guarantee future results. This market insight has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations and (6) changes in the policies of governments and/or regulatory authorities. The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors. Investors cannot invest directly in an index. All investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. All security transactions involve substantial risk of loss. ©2022 Voya Investments Distributor, LLC • 230 Park Ave, New York,