The Markets September 17, 2020

PANC 2020: Is It Time to Re-evaluate TDFs?

There are a variety of TDF solutions to meet participants needs, so when should a custom solution be considered, and how do advisers evaluate TDFs in an unprecedented year for the markets?

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Since passage of the Pension Protection Act (PPA) in 2006, target-date funds (TDFs) have become the most popular investment option in defined contribution (DC) retirement plans.

“Last I checked—and the numbers are fluid—there’s about $2 trillion from the DC industry is invested in TDFs, and this is mainly because so many plans are defaulting so many people into them,” Daniel Oldroyd, portfolio manager and head of target-date strategies, J.P. Morgan Asset Management, told attendees of the 2020 PLANADVISER National Conference during a virtual session.

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Brian Hanna, a partner at Everhart Advisors, said his firm offers comprehensive services, but in the investment monitoring space, monitoring TDFs is 80% to 90% of his focus since that’s where so many assets are. “I spend time educating plan sponsors about the power of re-enrollment and using TDFs as the plan’s QDIA [qualified default investment alternative],” he said. “I focus on helping sponsors have a prudent process for evaluating TDFs. We talk about fit with plan demographics and plan goals.”

Hanna said the bulk of conversations with committees now is about the use of TDFs by participants and the use of whatever do-it-for-me strategies the plan offers. He said conversations used to be about glide paths and risk, but once the Department of Labor (DOL) published its tips for evaluating TDFs, he tells committees that best practice is to focus on those items and document the process.

“The PPA [Pension Protection Act] was as good as it gets as far as retirement plan legislation,” said Nate Palmer, managing director, Portfolio Management Group, Wilshire Funds Management. “It addressed participant inertia and investment diversification. Since then, we’ve had an incredible improvement in retirement outcomes.”

Palmer said that back in 2004, his firm decided to go with custom TDFs for its plan. “There weren’t CIT [collective investment trust] TDFs back then, so we were able to provide a custom solution at a lower cost,” he explained. “We also could offer a variety of active and passive investments—back then TDFs were either/or—and we also wanted to offer more diverse asset classes.”

However, Palmer noted that with today’s new products, there are active/passive blended solutions, CIT solutions, and more asset class diversification, and he said he expects more to come. “There are so many good choices to consider, but if a plan’s participant population is different than average, advisers maybe still should consider custom TDFs,” Palmer said.

The Effects of COVID-19 on TDFs

Oldroyd pointed out that investors essentially went through an entire market cycle within less than a month this year. “In the course of three weeks, the markets dropped approximately 30%, then assets rallied,” Oldroyd said. “Now, we are conditioned that a 1% move in a day is tiny because of the sheer amount of uncertainty.” He noted that year-to-date, the S&P 500 is up 6.25%, and the average TDF at the end of a person’s glide path is up 2% to 4%.

He compared it to the Great Recession, when warning bells went off in 2007, the markets went through a “slow motion train wreck in 2008,” and markets started to rally around March 2009.

That stretched over three years, so plan sponsors may be wondering how to judge their plans’ investment performance this year. “I don’t know if two weeks in March and three weeks in April will merit the same impact as discussions during the 2008/09 crisis,” Oldroyd said. “TDFs are made to continue investing. Those who stuck with it have done pretty well.”

However, he said fixed income will probably be a topic for committee discussion for the next 18 months because the Federal Reserve said short-term rates are not going up any time soon. “The best that happens now is fixed income doesn’t move around much in response to equities versus the usual inverted correlation,” Oldroyd said. “You can determine whether you were too heavily in credit and securitized debt.” He explained that during the COVID-19 pandemic, investors wonder how people are going to pay their car payments, mortgages and credit card debt.

“If something is broken, sell, but if nothing is wrong with the system, think about the long-term and stay put,” Oldroyd said. “I think discussions should be about how to adjust for a brand new market cycle that, I think, is starting now.”

Dislocations in the market, such as what happened this year because of the COVID-19 pandemic, can expose weaknesses in TDFs, Palmer said. There may be tilts and biases within them. For example, he said growth has outperformed value by more than 30%. “The pandemic has identified clear winners and losers, so plan sponsors and advisers might see overweights and deficits in TDFs,” Palmer said. “Never let a good crisis pass us by to help us make things better.”

He said advisers should make sure TDFs are as diversified as they should be in style, and the same thing is true for fixed income allocations in the funds. “This year has taught us to make sure some of the fixed income exposure is in defensive, high-quality, intermediate- to long-duration vehicles or more diversified, all-weather multi-asset solutions,” Palmer said.

As an adviser who speaks to plan sponsors and their investment committees, Hanna said six months is nothing when they consider the long term. “Most of us were not concerned at the plan level or TDF level. It had very little impact. Again, we looked at fit,” he said. He added that he didn’t get a lot of questions from plan sponsors about their TDFs because they were so focused on other impacts to their businesses.

However, Hanna said he did find that he had plan sponsors’ attention about TDFs, and investments in general, for the first time in a long time because there was so much volatility in the markets. He used the opportunity to reiterate to them the importance of making sure glidepaths were appropriate for participants and whether there was sufficient downside protection for those close to end of their glidepath. “They didn’t make a lot of changes, but they listened more,” Hanna said.

The Future for TDFs

Oldroyd said it will take time, but the Setting Every Community Up for Retirement Enhancement (SECURE) Act will have some impact on TDFs, as plan sponsors start to think about in-plan lifetime income. “We are pivoting to what to do with savings once a person gets to retirement,” he said. “There’s been managed payout funds, general income funds, multi-asset income funds, a general concept of options. Guarantees, I think, would be very valuable.”

Oldroyd added that J.P. Morgan Asset Management is exploring combining TDFs with annuities. “We’re looking at how spending needs are going to be variable, using real data about spending in retirement,” he said. “Spending is dynamic so withdrawal rates should be dynamic. We will see more in this space, whether in or next to TDFs.”

Wilshire Funds Management has recently partnered with BNY Mellon for an adviser-facing solution to bring custom TDFs to small- to mid-market retirement plans, Palmer said. “I think it’s going to provide more choice for advisers to create more specialized solutions, and it will better facilitate the inclusion of lifetime income options, which may be coming,” he said.

“We watch, learn and evaluate,” Hanna said. “Sometimes issues that don’t exist are created so solutions built can be marketed, but trusted names will address issues that are there and the industry will embrace them and they will become best practice. I’m excited to watch where it goes.”
Compliance September 17, 2020

ERISA Excessive Fee, Self-Dealing Suit Targets MEP

Pentegra Retirement Services and other plan fiduciaries are accused of failing to make sure fees are reasonable and acting in Pentegra’s, not plan participants', interest.

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An Employee Retirement Income Security Act (ERISA) lawsuit has been filed against Pentegra Retirement Services and the Board of Directors of the Pentegra Defined Contribution (DC) Plan, multiple employer plan (MEP) for financial institutions, alleging the plan fiduciaries failed to ensure reasonable fees for plan participants and engaged in self-dealing.

The complaint accuses Pentegra of using the plan to generate “greatly excessive administration fees, to benefit itself.” It alleges that in 2010, plan assets were used to make a $7,370 payment to the Ritz Carlton Naples and a $5,015 payment to the New York Palace Hotel “presumably for defendants’ personal benefit.”

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After a discussion of how large plans can negotiate lower fees than small plans and how fixed per-participant fees allocated pro-rata by participant account balance is what “a prudent fiduciary would” do, the complaint states, “The plan paid Pentegra millions of dollars each year in excessive fees for recordkeeping and administrative services, from at least 2014 until 2018.” The lawsuit says the plan’s Forms 5500 show that in 2014, when the plan had 26,469 participants, it paid Pentegra at least $9.52 million in direct recordkeeping and administration fees, or an average of $359.70 per participant. By 2018, the plan had grown to 27,227 participants, and Pentegra’s fees had grown to $10.58 million, or $388.77 per participant. “Indeed, Pentegra’s fees rose every year over a decade, during a time when the retirement plan administration industry generally saw declining fees, and despite the fact that Pentegra’s services have remained the same throughout that time period,” the complaint states.

The plaintiffs compared the Pentegra MEP to Nike’s 401(k) plan, which they said with approximately 19,000 to 26,000 participants, paid $21 per participant for recordkeeping services in 2012 and 2016. The complaint listed several other examples of plan for which recordkeeping expenses were between $14 and $31 per participant. Comparing Pentegra’s plan to another large MEP, the complaint notes that the other plan uses an outside recordkeeper and paid an average of $80 per participant. “Pentegra’s 2018 average per participant fee of approximately $388 for similar ‘contract administrator’ services was 485% higher,” the complaint states.

Pentegra is accused of failing to regularly monitor administrative fees or to regularly solicit competitive bids from third-party providers to keep fees in check. The lawsuit also said Pentegra failed to monitor total compensation from all sources.

Prohibited Transactions

The complaint moved on to say that Pentegra, as a plan fiduciary, caused the plan to retain Pentegra as recordkeeper and “contract administrator,” to use Pentegra collective investment trusts, and to pay plan assets to Pentegra. Pentegra dealt with the assets of the plan in its own interest or for its own account; acted in a transaction involving the plan on behalf of a party whose interests were adverse to the interests of the plan, its participants and beneficiaries; and received consideration for its own personal account from parties dealing with the plan in connection with transactions involving the assets of the plan, all in violation of ERISA Section 1106(b)(3), the complaint says.

“In light of the excessive fees and increasing amounts paid while services remained constant, the continued retention of Pentegra as the plan’s administrator, and the board’s apparent failure to solicit bids from recordkeepers, providers of contract administrator, or 3(16) services, it is evident that Pentegra through its employees, controlled the decisions of the board, causing it to favor Pentegra,” the plaintiffs allege.

The complaint says that from 2014 to 2018, the defendants caused more than $50 million in direct payments to be taken from the plan and paid to Pentegra.

It also states that the “defendants failed to engage an independent fiduciary to determine whether it was in the interest of plan participants to engage in this scheme or whether the services the Pentegra employees performed were necessary for the operation of the plan, whether the amounts charged for those services were reasonable, and whether Pentegra was paid only its direct expenses incurred in providing necessary services to the plan.”

Excessive Fees for Investments

The lawsuit claims that since the plan is considered a “mega” plan based on its assets, it had “tremendous” bargaining power to obtain low fees for investments and investment management. It says that the defendants selected and continue to retain higher-cost share classes for the plan investment options than were available to the plan based on its size, including lower cost share classes of otherwise identical mutual funds, separately managed accounts (SMAs), and/or collective investment trusts (CITs).

“By providing plan participants the more expensive share classes of plan investment alternatives, the defendants caused participants to lose over $37 million in retirement savings,” the complaint alleges.

Robert D. Alin, first senior vice president and general counsel said: “To date, we have not been served but are aware of the complaint. We reject the claims and intend to mount a vigorous defense against them. In fact, Pentegra is looking forward to strongly defending this lawsuit and standing up for the valuable services we provide to participating employers and their employees.”

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