The Markets March 31, 2021

Adviser Op-Ed: The Case for Custom Default Investment Solutions

Michael Volo at CAPTRUST says it makes sense that target-date solutions have evolved the same way retirement plan products have over time—from closed architecture, proprietary solutions to open architecture solutions using best-in-class underlying investments.
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While off-the-shelf target-date fund (TDF) investments, in the form of mutual funds or collective investment trusts (CITs), have traditionally been the most popular investment options in the qualified default investment alternative (QDIA) space, the case for custom solutions is becoming more compelling.

A confluence of developments is influencing this, including greater recognition of the potential benefits of custom solutions by plan fiduciaries, technological advancements by recordkeepers administering the solutions, investment product innovation and growing retirement plan adviser experience and expertise in serving as a discretionary manager—commonly, as a 3(38) fiduciary investment manager for Employee Retirement Income Security Act (ERISA) plans.

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Custom default investment solutions can take many forms, from TDF-like asset allocation tools that use simple glide paths to allocate to a plan’s menu of investment options to fully customized managed account solutions, where participants receive their own customized portfolio based on their unique financial situation and everything in between. The one “in between” solution that has grown the most, in terms of efficacy and plan sponsor interest, is the expanding suite of custom target-date solutions. 

It only makes sense that target-date solutions evolve the same way retirement plan products have over time—from closed architecture, proprietary solutions to open architecture solutions using best-in-class underlying investments that leverage advancements in technology. While there are many differences in the level of customization and overall cost of custom TDFs available to plan sponsors today, there are some commonalities.

Ability to Control Underlying Investments

A custom target-date solution allows a retirement plan investment committee to select and control the underlying investment options within a TDF suite, often using funds from the retirement plan menu rather than pre-selected investments. A custom target-date solution gives the committee, in partnership with a 3(38) investment manager, additional opportunities to provide plan participants with a truly custom investment option, tailored to the unique needs of the plan.

Unlike traditional TDFs, in which control of the underlying funds rests with the fund provider, custom target-date solutions allow the adviser to replace or remove underperforming or more expensive funds within the suite to potentially increase risk-adjusted returns or reduce the cost of the solution. By selecting the individual funds within a target-date suite, committees can opt for passive management in asset classes where it makes sense and use active management in other asset classes. Additionally, committees and advisers can vet and analyze underlying funds in a custom glide path in terms of their risk-adjusted return to help fiduciaries better manage volatility.

An analysis of participant demographics and behavior, along with retirement committee preferences, can inform the creation of a custom glide path unique to the plan and tailored to the shifting demographic needs of the plan participants at each point in the glide path. In some cases, plan sponsors can name their target-date suites to personalize the vintages and make the series more familiar and discernable to plan participants.

Use of Technology

Advances in technology, improved recordkeeper capabilities and investment product innovation are all factors in helping make a custom target-date solution potentially more compelling than a traditional off-the-shelf product.

Enhanced reporting and data-gathering abilities, as well as improved participant communications and education, are just some of the advancements recordkeepers have implemented. Investment innovations include the ability to allocate a portion of the target-date option to a fund not available to participants in the core lineup, as well as the ability to use a guaranteed retirement income product to manage risk and allow for annuitization in retirement. 

Technology improvements have increased the quantity and quality of data points available for each plan participant. The ability to automatically gather individual participant data points, such as deferral rate, account balance and the existence of other related retirement plans—and to monitor changes in those data points over time—is what ultimately drives the level of customization available with each solution. With these advancements, the ability to bring personalized discretionary investment management services to each participant is now readily available through the use of technology platforms.

Implementing a Custom Solution

An ERISA 3(38) investment manager will charge an additional fee for assisting with the implementation of a custom solution, exercising discretionary authority over the underlying funds and providing an ongoing review. This may include conducting an initial participant study, constructing a glide path, determining asset allocation, replacing funds where necessary and monitoring performance and fees.

While a custom TDF solution can appear compelling, plan fiduciaries must perform appropriate due diligence to ensure that the 3(38) investment manager has the expertise and experience to help plan participants maximize the value of the offering. The manager also must have institutional financial health and durability to adequately protect the plan fiduciaries.

Plan sponsors should always consider whether their participant population or demographics are unique enough to warrant customization. If deemed appropriate, the expected benefits should be weighed against costs and other considerations. It is also important to note that the type of solutions available vary by recordkeeper; thus, plan sponsors should inquire as to the custom options offered by their provider. If that solution fails to meet the needs of the plan, it may be worthwhile to explore the offerings of other recordkeepers.

Behavioral economics tells us that most plan participants use a QDIA when enrolling in a retirement plan­­. Because of this, it is of the utmost importance that a plan’s QDIA is a thoughtfully constructed investment that considers each individual participant’s ability to meet their retirement goals. With the recent marketplace developments and the growing awareness among plan sponsors, custom default investment solutions—most prominently, custom target-date solutions—are poised to become more prevalent in the defined contribution (DC) retirement plan space.

 

Editor’s note:

Mike Volo has over 30 years of experience in the investment advisory and retirement services industries. He works alongside nonprofit organizations, higher education organizations, corporations, and public sector retirement plan sponsors to help solve their biggest challenges—managing fiduciary risk and helping employees to retire successfully.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.

The Markets March 30, 2021

Adviser Op-Ed: The Next Generation 401(k) Plan

Brad and Grant Arends at intellicents explain why they are committed to using managed accounts as a means of delivering customized portfolios at scale.
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Back in 2010, we realized that the 401(k) industry was centered on funds, fees and fiduciary governance—the legal/compliance part of our service—and not on the success of the people we ultimately serve. Even though the industry routinely educated people about plan designs, improved the investment menu, and measured participation and average deferral rates, participants were still hitting the normal retirement age without enough money to maintain their standard of living.

We decided to take a new path and started measuring and benchmarking outcomes. We followed up our education and advice services by focusing on how to use the plan to accomplish a goal: permanent vacations! Five years later—even though our firm had won several industry awards—we knew we hadn’t gone far enough. Many participants needed more than just plan advice. They needed financial life advice. 

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How could we expect tomorrow’s money—earmarked for retirement—to be on track when today’s money was a mess? We also realized advice can’t stop on the retirement date. It has to go through retirement, and it must be inclusive, not just for high-income earners and the wealthy.

So, in 2016, we re-engineered and rebranded our firm based on people-smarts and great technology to create a “next-generation 401(k) advisory service,” centered on taking a financial planning approach for every participant through our worksite financial wellness offering. This needed to be coordinated with our in-plan advice services to our participants, too.

Currently, the vast majority of 401(k) plans use target-date funds (TDFs) as their qualified default investment alternative (QDIA). But, with today’s technology, should all 45-year-olds be invested exactly the same way? Or, for that matter, all 30-year-olds? TDFs once made sense, but we believe that managed accounts are the natural evolution of in-plan advice for 401(k) and 403(b) plans.

This is more than just an asset-allocation service. It’s a personalized retirement savings strategy that can take into account both the participant’s current plan savings and their outside assets. Plus, it gives them plan savings rate recommendations, retirement withdrawal strategies and Social Security optimization. It brings a holistic financial planning approach to in-plan participant advice, enhancing participants’ ability to achieve retirement success by coordinating with their overall comprehensive financial plan.

Once thought to be overly expensive, price points for managed accounts have come down drastically, resulting in numerous clients converting their QDIAs to managed accounts. In our case, Morningstar’s technology platform allows us to be the 3(38) adviser on our clients’ managed accounts. We have had a 2,300-plus participant plan automatically invest every participant in our managed account program, and only 14 participants opted out of the service.

For advisers like us that routinely build five to 10 risk-based models for their plans, the Morningstar technology is incredibly useful. It takes into account 12 separate variables to give in-plan advice based on the entire participant. Ultimately, the solution delivers a goals-based financial planning approach that is integrated with many of the largest recordkeeping platforms.

401(k) advisory firms today need only look at many of the industry’s largest recordkeepers for verification of this financial planning emphasis. They are not only encouraging our clients to consider managed accounts, but they are actually offering formal financial planning services to our participants. How are we as an industry going to compete?

 

Editor’s note:

Brad and Grant Arends are co-founders of intellicents. Brad has worked in the retirement and employee benefits areas for over three decades, specializing in the service of plans covered by the Employee Retirement Income Security Act (ERISA). Grant has over two decades of experience in the retirement plan industry and loves helping his clients improve the daily lives of their most valuable asset—their employees.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.

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