Focus on quality,
not quantity

Consider offering four or fewer funds with style and market-cap flexibility

Circle chart evenly divided into three parts, showing U.S. Equity Streamline. One third makes up the Growth fund. Another third makes up the Dividend-focused fund. The last third is the Small-cap fund via a dedicated or all-cap fund.

Avoid checking each style box

On average, a DC menu has nine U.S. equity funds, making this asset class ripe for consolidation. Offering one fund per style box doesn’t provide significant diversification benefits.

Most U.S. equity style boxes are highly correlated to one another

Five-year correlation of U.S. equity funds by style box

This chart shows a comparison of several style boxes comparing them with the same styles. On each axis of the chart, the categories are listed as large growth, large value, large blend, mid-cap growth, mid-cap value, mid-cap blend, small growth, small value, and small blend.  Despite being different investment styles, their underlying asset movements are often correlated. They do not necessarily appear to be as diversified as they initially appear. The lowest correlation value compares a small-blend fund with a large-growth fund at 0.73. The highest correlation funds are mid-cap blend with a mid-cap value fund and a small-blend fund with a small-value fund, each yielding 0.99.

Source: Morningstar. Correlations for the five years ended September 30, 2018.

Correlation is a statistical measure that determines how assets move in relation to each other. A positive number means the assets move in the same direction, and a negative number means they move in opposite directions.

“ERISA doesn’t require plan sponsors to cover the style spectrum. In fact, 404(c) only stipulates three materially different risk-return options be offered. Instead of trying to populate each style box, plan sponsors should ask themselves what purpose each fund is serving.”

— Craig Duglin
Senior Product Manager, Capital Group

Get broad exposure with fewer options

Instead of focusing on style boxes, choose funds with flexibility to span styles and market capitalization. These funds:

  • Provide diversification
  • Allow skilled managers to seek the best investments from a broader universe

Since participants only choose a few funds on average ...

Two charts are shown for comparison. Both charts are based on funds that are compared by style, aligning the size of the fund—ranging from Micro to Small to mid-sized to large to giant—against the kind of fund they are, namely Deep-value, Core-value, Core, Core-growth, or High-growth. 
In the first chart, the funds displayed are restricted solely by style. For example, there is a fund only for large core, or only one fund for mid-sized Core-value, or only one fund for small Core-growth.
The second chart, using the same parameters, display funds that are broader and overlap several of the styles. The image looks similar to a Venn diagram indicating that each fund overlaps several of the styles, and can overlap each other.

... consider offering broader funds instead of one fund per style box.

Hypothetical charts for illustration purposes only.

Help manage volatility with dividend-focused funds

Consider including a dividend-oriented fund in the lineup. Historically, higher yielding equity funds have been more resilient in down markets. Funds focused on dividends have offered:

  • Less volatility
  • Meaningful capital appreciation potential

Higher yielding equity funds have been less volatile

20-year annualized return and standard deviation of actively managed U.S. equity funds by yield

Horizontal bar graph comparing the standard deviation of funds and their returns. The first bar shows funds with top-quartile yields having a standard deviation of 13.55 percent, with 6.08 percent in returns. The second bar shows funds with lower yields having a standard deviation of 14.97 percent, with 5.74 percent in returns.

Source: Capital Group, based on Morningstar data as of December 31, 2017. Funds include actively managed funds in the U.S. Large Growth, Large Blend and Large Value categories. Top-yielding funds were those funds whose distribution rates ranked in the top quartile. Other funds were all remaining funds.

Annualized standard deviation (based on monthly returns) is a common measure of absolute volatility that tells how returns over time have varied from the mean. A lower number signifies lower volatility.

This article illustrates the number and type of funds that a plan might offer; it does not describe participants' asset allocations.

How we fit

A disciplined approach to U.S. growth investing

The Growth Fund of America®
A time-tested growth strategy built for navigating a variety of market environments

Washington Mutual Investors Fund℠
A blue-chip fund focusing on dividends to help deliver consistent results

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

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