Most participants invested in a qualified default investment alternative (QDIA) stayed the course in the first quarter, despite the tremendous decline in the market associated with the coronavirus pandemic, says David Blanchett, head of retirement research at Morningstar Investment Management.
Blanchett made this point during a recent webinar hosted by four industry organizations—the Defined Contribution Institutional Investment Association (DCIIA), the Retirement Advisor University, the SPARK Institute and the Plan Sponsor University.
Only 2% of those invested in a managed account made a trade and only 2.1% of those invested in a target-date fund (TDF) made a trade, Blanchett explains. By comparison, 17% of those who self-direct their investments made a change, he says, and 22.7% of those invested in more than one TDF vintage made a change.
“You don’t want them trading because this hurts them in terms of long-term performance,” Blanchett says, noting the tendency of nonprofessional investors to chase performance and “buy high, sell low.
Sharon Scanlon, a senior vice president who heads up retirement plan services at Lincoln Financial Group, agrees that investors in her company’s products mostly stayed the course in the first quarter.
Liana Magner, partner in the U.S. defined contribution practice of Mercer, adds that since the Great Recession of 2008, near-retirement TDF vintages have scaled back their equity exposure. In 2008, they suffered a 14% decline, whereas in the first quarter of 2020, they went down by 10.4%.
“This is mostly because they have less exposure to growth,” Magner explains. “Long-term bonds have helped as well. The key question is how will this COVID-19 crisis impact the TDF marketplace? Will they take on more downside protection? Will there be more focus on retirement income? Will there be more use of custom funds? It will take some time for the investment managers to become more strategic, but we do expect a reinvention phase.”
Joe DeNoyior, president Washington Financial Group, a division of HUB International, says one of the most important perennial challenges plan sponsors face is determining the appropriate QDIA for their workforce.
“The 2008 crisis exposed that not all TDFs are created equal,” he adds. “Some can mitigate volatility. Some are tactical. In this sense, TDFs have become more sophisticated, and we think sponsors should expand their due diligence as a result. Plan sponsors need to scrutinize their default options by taking a view through their employees’ eyes, as well as taking a look at their demographics.”
DeNoyior notes that more of Washington Financial Group’s clients have been considering managed accounts in recent years. DeNoyior expects more sponsors will adopt them, particularly as the expanded use of automatic enrollment and automatic escalation has resulted in higher balances.
“They can provide for difference risk tolerance and tend to have better stickiness of assets,” he says. “Once the dust settles from this crisis, we think plan sponsors will be more inclined to use managed accounts as the QDIA, or at least offer it in their plan.”
Doug McIntosh, vice president of investments at Prudential Retirement, says that plan participants generally have performed better during this crisis than in the Great Recession of 2008—largely because of the increased use of TDFs as the QDIA. In 2008, 60% of plans used TDFs as the QDIA. Today, that is 97%. In addition, “today, TDFs have generally taken down risk for those closest to retirement,” McIntosh says.
“The glidepaths have gotten more conservative,” he says. “As well, there are a broader set of asset classes being utilized, such as TIPS [Treasury Inflation Protected Securities] and private real estate, to minimize equity volatility and inflation.”
However, he believes TDFs need to become even more conservative, noting that some 2025 TDFs lost 20% to 25% of their value in the first quarter of 2020. “If I am only five years out from retirement, that is a concern,” he says.
In addition, the SECURE Act encourages plans to offer income solutions. McIntosh believes that should be part of the QDIA. He also expects TDFs and managed accounts to pair actively managed fixed income with low-cost passive asset management on the equity side.
As to how investors who manage their own portfolios fare compared to those in the QDIA, McIntosh says, the self-directed investors, especially those in brokerage accounts, underperform.