Recession? Probably, but not yet: What plan sponsors need to add to their portfolios now

An atmosphere of hesitation has loomed over the investment market recently, as investors seek the right place to put their money. That sense of delay is likely to persist through the end of the year due to uncertainty caused by continued high inflation, fear of stagnation and rate equivocation, according to Nuveen Retirement’s second-half 2023 outlook, Testing the waters: From waiting it out to wading in. 

Nuveen said indicators point to a limited U.S. recession in the medium term. The firm said it doesn’t expect a long or severe global recession but a mild recession to emerge next year. The firm’s expectation of moderating inflation this year has materialized, although its expectations for weaker economic growth and higher unemployment have not. However, Nuveen said it still expects U.S. core inflation to be near 4% at year-end, which is double the Fed’s 2% target.

Nuveen’s outlook suggests now might be the right time for investors to begin wading in rather than waiting for economic clarity.

“We’re increasingly confident that peak inflation is behind us and that economic growth is poised to decelerate during the remainder of 2023 and into 2024,” said Brendan McCarthy, head of Nuveen Retirement Investing. “Against this backdrop, we expect the Fed to likely pause its hike in interest rates and the 10-year yield to subsequently decline through year-end. Given this moderated outlook for inflation, growth and interest rates, we recommend a diversified fixed income portfolio, which has historically outperformed cash when the Fed’s rate hikes stop.”

Within the retirement ecosystem, Nuveen pointed to qualified default investment alternatives (QDIAs) as a great way to put cash to work. A QDIA is the default investment used when a participant contributes money into their employer-sponsored retirement plan without making an investment election. Examples include target date funds, balanced funds and managed accounts.

“A QDIA helps ensure participants have access to a professionally managed, diversified investment within their retirement plans,” said McCarthy. “By definition, a QDIA must be diversified, which can help reduce a portfolio’s volatility by spreading investment risk across multiple asset classes. For instance, a QDIA will rebalance the portfolio back to its target allocation to maintain its strategic diversification by periodically selling assets that have outperformed while buying assets that have underperformed, ultimately reducing risk over time.”

Investors may also want to consider adding a fixed-income annuity to their allocation, Nuveen said.

“Lifetime income solutions are gaining traction in the DC marketplace as more plan sponsors see these solutions as a way to provide their employees with the option of a ‘pension-like guaranteed income’ through their company’s existing 401(k) plan,” said McCarthy.

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There are several reasons for plan sponsors to consider adding these solutions to a portfolio, including safe harbor provisions of the SECURE Act of 2019 that have made it easier to add guaranteed income solutions to their plans. In addition, fixed-income annuities, have the potential to improve a portfolio’s performance, lower its volatility and reduce fees, noted McCarthy. When embedded inside of a target date solution, they can potentially provide a better investing experience even if the participant does not choose to annuitize. Finally, in-plan lifetime income solutions can be a key way for plan sponsors to address the increasing risk of Americans outliving their income in retirement.

“By investing in multiple asset (and sub-asset) classes, a diversified investment allocation strategy can help reduce the overall risk of a portfolio and enhance stability. Different asset classes tend to respond differently to various economic factors,” McCarthy said. “By diversifying, investors may reduce volatility, as various market conditions may cause one asset class to decline while others may perform well. Additionally, incorporating alternative investments, such as private real estate, may offer better downside protection and create more diversified sources of risk than investing solely in public asset classes.”

There are two key strategies that plan sponsors and advisors can undertake to help their participants weather the impacts and anxieties associated with periods of economic volatility, said McCarthy:

• First, it is important for plan sponsors to communicate and provide guidance to their participants to stay the course through times of economic uncertainty. Plan sponsors should remind participants that retirement investing is a long-term journey and their target date fund is designed to withstand various market cycles, including down markets, he said.
• Second, plan sponsors and advisors may want to consider replacing a portion of their core bond portfolio with a fixed-income annuity. These solutions can provide bond-like returns over the long term but without the volatility. This can be most helpful to those participants who are closest to retirement. They also offer the participant the benefit of being able to convert that investment into a guaranteed lifetime income stream at retirement, he said.