Caterpillar's 401K Retirement Plan: Reasonable Investment Choices But Could Be More Systematic

Caterpillar Inc. (CAT) manufactures and sells construction and mining equipment, diesel and natural gas engines, and industrial gas turbines worldwide. The company was formerly known as Caterpillar Tractor Co. and changed its name to Caterpillar Inc. in 1986. Caterpillar was founded in 1925 and is headquartered in Peoria, Illinois.

In this article, w report on Caterpillar Inc Investment Trust which is the master trust for Caterpillar's 401k plan.

The investment trust consists of 10 funds. These funds enable participants to gain exposure to 3 major assets: US Equity, Foreign Equity, Fixed Income.

The following table lists the asset classes those funds cover:

Asset Class	Name
MID-CAP BLEND	SPDR S&P MidCap 400
LARGE BLEND	iShares Russell 1000 Index
LARGE GROWTH	iShares Russell 1000 Growth Index
LARGE VALUE	iShares Russell 1000 Value Index
SMALL BLEND	iShares Russell 2000 Index
LARGE BLEND	iShares Russell 3000 Index
High Yield Bond	JPMorgan High Yield Bond R5
Emerging Markets Bond	JPMorgan Emerging Mkts Debt R5
Intermediate Bond	JPMorgan Bond Instl
Foreign Large Blend	Vanguard Total Intl Stock Index Inv

 

Asset Class	Number of funds
REITs	0
Balanced Fund	0
Fixed Income	2
Commodity	0
Sector Fund	0
Foreign Equity	1
Emerging Market Equity	0
US Equity	6
Other	1
Total	10

As of Mar 25, 2011, this plan investment choice is rated as average based on MyPlanIQ Plan Rating methodology that was designed to measure how effective a plan's available investment funds are . It has the following detailed ratings:

Diversification -- Rated as below average (14%)
Fund Quality -- Rated as average (61%)
Portfolio Building -- Rated as average (60%)
Overall Rating: average (46%)

Discussions

The trust presents an interesting lineup of investment choices: in the U.S. equities, it covers large, mid-cap and small cap stocks. In large cap stocks, it further gives choices in growth and value styles. But it decides to give only mid-cap blend and small blend stock styles to the participants. For international equity, it has only one choice.

On the fixed income side, it is getting more interesting: in addition to a broad base bond index fund (JPMorgan Bond Instl), it gives a high yield (junk) bond fund and an emerging market bond fund, both are at the end of the highest risk spectrum among fixed income (bond) funds.

A natural question to ask is why only those two fixed income funds? How about fixed income funds in other categories such as investment grade corporate bond, long treasury bonds or international bonds. Maybe the reason behind this is that the bond index fund covers most of the short, intermediate term government and corporate bonds. Offering two highest risk bond funds would allow participants to increase their risk premiums.

Portfolio Discussions

The chart and table below show the historical performance of moderate model portfolios employing strategic and tactical asset allocation strategies. For comparison purpose, we also include the moderate model portfolios of a typical 3 asset SIB (Simpler Is Better) plan . This SIB plan has the following candidate index funds and their ETFs equivalent:

US Equity: SPY or VTI
Foreign Equity: EFA or VEU
Fixed Income: AGG or BND
Performance chart (as of Mar 25, 2011)

The following portfolios are constructed using two typical asset allocation strategies: Strategic Asset Allocation and Tactical Asset Allocation.

Strategic Asset Allocation is based on well known modern portfolio theory and its key features include: diversification, proper fund selection and periodically re-balancing.

Tactical Asset Allocation works on a diversified array of assets provided by funds in a plan and adjusts asset mixes based on market conditions such as asset price momentum utilized by TAA.

Performance table (as of Mar 25, 2011)

This plan's Strategic Asset Allocaton moderate portfolio matches the three asset benchmark's one in terms of returns. However, it does have higher Sharpe ratio, indicating the virtue of the US asset class choices and the extra fixed income funds.

The Tactical Asset Allocation moderate portfolio beats its three asset counterpart by a big margin. This again is due to more fund choices in US stocks and fixed income bonds.

Currently Commodities, US Equity and Real Estate are doing well. Only US Equity is available to Caterpillar Inc Investment Trust participants.

To summarize, Caterpillar Inc Investment Trust presents some reasonable investment choices. Some of major asset classes such as REITs and emerging market stocks are missing from the plan. Adding funds to allow exposure to these major assets would allow more diversification and more opportunities to enhance return while reducing risk.

Symbols:CAT,SPY,VTI,EFA,VEU,AGG,BND,HYG,JNK,PHB,CIU,BIV,GWL,PFA,IVE,IWW,JKF,VTV,ELV,PWV,RPV,SCHV,IVV,IYY,IWV,VV,DLN,RSP,SCHX,IVW,IWZ,JKE,VUG,ELG,QQQQ,RPG,SCHG,IJH,IWR,JKG,VO,MDY,EMM,PJG,DON,EZM,MVV,IJR,IWM,JKJ,VB,DSC,PJM,DES,SAA,UWM,SCHA,PCY,

Exchange Tickers: (CAT),(SPY),(VTI),(EFA),(VEU),(AGG),(BND),(HYG),(JNK),(PHB),(MDY),(IWM),(IWV),(IWW)

Disclosure:

MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

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