Documenting a TDF Selection Process Is Key

Plan fiduciaries need a complete grasp of the vulnerabilities of their target-date strategies, and sources recommend tools and a documented process.

The rapid adoption of target-date investment strategies by plan sponsors over the last few years took placed in a risk-on, low volatility environment, says Josh Anderson, a financial adviser with Raymond James. “When the dust settles, it will be important for plan sponsors to have a documented process that supports their selection rationale,” he tells PLANADVISER.

The top factor for plan sponsors to have in place is a process to support the decision-making process of evaluating and choosing a target-date fund (TDF), Anderson says. 

Plan sponsors often struggle with the process, Anderson notes. “Like anything else, benefits decisions are often trumped by business priorities,” he says, citing the 2013 fact sheet of tips for ERISA plan fiduciaries from the Department of Labor (DOL). “The top tip is establishing a process to compare, select, conduct due diligence and education to deliver this effectively.”

Data is key, according to Russ Shipman, senior vice president of the retirement strategy group at Janus Capital Group. Plan sponsors need to consider both psychographics and demographics of the employee population. “Does the work force have access to a defined benefit (DB) plan as well as the defined contribution (DC) plan?” he asks. “A younger tech company will have a different profile from what Shipman terms an old-line manufacturing company with a DB plan. Depending on the circumstances, a balanced fund could be better than a TDF.”

Anderson recommends examining plan behavior and practices. Is re-enrollment being considered? How many actives versus terminated participants are in the plan? Other factors include: the sophistication level of participants; plan goals; and investment philosophy. All can affect the type of solution that is right for the plan, he says.

Participant outcomes are a critical factor. “What does the retirement base look like?” Shipman asks. “In a qualified trust, and as fiduciary to that trust, the plan sponsor should think about those people and their readiness.” It may seem obvious, but plan sponsors need to look at the people they serve.

Glide Path Factors

According to Shipman, one provider uses a method that plots all plan participants for each plan client on an investment allocation graph. The “y” axis represents “Participant Allocation to Equities” and the “x” axis is “Participant Age.” Next, they superimpose a highlighted glide path band based on their in-house TDF product series’ allocation to equities. 

The method is not perfect, Shipman says, since it doesn’t account for other investments an individual or family may have, or other extenuating inputs to their financial picture. “However, it provides a count and percentage of in-plan participants that fall in their perceived ideal equity exposure range, given age,” he says. “The plan sponsor can then work to educate around any real or perceived shortcomings of the asset allocations of the employee base.”

Diagnostics are also important, says Nathan Voris, large market practice leader of Morningstar Investment Management. “We take a broad total wealth approach,” he says. Morningstar tests the glide path to assess income replacement rates, and they use a range of benchmarks.

“There has to be a way to say this is the right glide path,” Voris says. The consultant or adviser can test for wealth creation, or income replacement based on the design of the glide path — Voris recommends using the industry’s experts, either a project consultant or a consultant on retainer, as long as the provider has thorough knowledge of TDFs. Since this is conceivably the most important investment option in the plan, selection is critical.

Younger, more vulnerable participants are being put into these vehicles, Shipman cautions, noting that for a time the industry seemed comfortable about any downside, but that complacency seems to be disappearing. “I applaud the industry for embracing the process and duty,” he says.