Target-Date Fund Market Needs Benchmark

Plan sponsors are confronted with a bewildering array of target-date funds - but lack a generally accepted benchmark for the popular product category.

Recognizing this, in the December issue of the Cerulli Edge newsletter, Cerulli Associates asserts that players in the target-date market vying for plan sponsors’ attention will have to distinguish themselves more on the nature of how the asset allocation funds change over time – their “glide path.”

“Because of the unique target-date-based investment strategy of these funds, as well as the absence of a long-term track record among many of the newer target-date/lifecycle funds, competitors are waging positioning wars,” Cerulli researchers said. “While fees are somewhat of a competitive differentiator, the central debate is over which manager has constructed the preeminent glide path.”

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Underlying the glide path debate, Cerulli claims, is a discussion about:

  • strategic versus tactical asset allocation,
  • active versus passive management, and
  • the merits and drawbacks of multi-managed portfolios.

Even with the glide path uncertainty, Cerulli maintains, there is a truth plan sponsors and the asset managers from which they get their investment options should not lose sight of – that the industry will still eventually have to develop a benchmark by which their products can be evaluated. “The importance of this issue cannot be downplayed, as these funds may ultimately represent the sole or largest source of retirement income funding for many investors, as they are able to rely less on Social Security, proceeds from appreciated home/real estate, and defined benefit (DB) plans,” Cerulli said in the article.

Plan sponsors should not accept and asset managers should not put out into the market anything less than a carefully deliberated series of decisions about how target-date products should be built. “Cerulli contends that the glide paths that will be most attractive to sponsors and other pro buyers will be those developed in organizations that place intellectual rigor ahead of quick fixes,” the researchers concluded.

Finally, plan sponsors should not buy into claims by some target-date fund creators’ for potential results in helping participants reach and comfortably live through their retirement since, as Cerulli points out, many important influences such as participant savings behavior and the participant’s ultimate health will affect the ultimate size of their savings nest egg.

“If an investor is laid off from their job, becomes incapacitated in some way, or experiences some other disruption to their income stream, there may be profound implications for their retirement plan,’ Cerulli noted.

IRS Publishes Company Stock Diversification Guidance

In an effort to enact Pension Protection Act (PPA)-mandated changes, the Internal Revenue Service (IRS) has put out a proposed regulation generally barring restrictions on publicly-traded employer stock investments in defined contribution plans.

Reg-136701-07 provides that a plan allowing participant investments in company stock has to include provisions allowing the investor to sell off the company stock holdings and move the assets to another investment option. These rights must be provided to each participant, to each of the participant’s alternate payees who has an account under the plan, and to each beneficiary of a deceased participant, the proposed regulations said.

If a plan calls for employer contributions other than elective deferrals to be invested in employer stock, a divestment right must be provided to each participant who has at least three years of service, to each alternate payee who has an account under the plan with respect to a participant who has at least three years of service, and to each beneficiary of a deceased participant, regardless of whether the participant had at least 36 months with the company.

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According to the proposal, a participant has three years of service on the last day of the plan’s vesting period that constitutes the completion of the third year of service or the employee’s third anniversary for a plan that either uses the elapsed time method or that does not define the vesting computation period because the plan calls for immediate vesting.

Further, the proposed regulations require a plan to provide participants granted diversification rights the opportunity at least four times a year to sell off their employer securities and reinvest the cash proceed in another investment.

Diversified Investments

The rule says the person should be able to choose from no fewer than three investment options, each of which is diversified and has materially different risk and return characteristics. Investment options constituting a broad range of investment alternatives under Department of Labor regulations are treated as being diversified and having materially different risk and return characteristics.

The latest IRS release of proposed regulations under Section 401(a)(35) came from Section 901 of the PPA and incorporate diversification guidance from Notice 2006-107 released in December 2006, the IRS said.

Under the proposed regulations, a DC program which holds publicly-traded employer securities, referred to as an “applicable defined contribution plan,” is subject to the diversification requirements of Section 401(a)(35) unless it is exempted as a stand-alone employee stock ownership plan (ESOP) or as a one-participant retirement plan.

The proposal would go into effect January 1, 2009, and until that date, Notice 2006-107 will continue to apply. Written comments are due by April 2 to CC:PA:LPD:PR (Reg-136701-07), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044.

The proposed rules are here.

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