Widening the Target

For plan sponsors, “the target-date fund still seems to be the preferred way to go, but there is a lot more discussion than ever before” with employers about the right asset-allocation funds, says Paul D’Aiutolo, an institutional consultant at UBS in Rochester, New York. “I do not find it is an end-all anymore.” For advisers helping sponsors pick asset-allocation funds, consider these four things: 

1. Remember the employee demographics. Employers continue to focus on target-date funds as defaults, particularly if their employee base averages less than 45 years old, D’Aiutolo says. However, interest has grown in hybrid target-date funds that allow for an aggressive, moderate, or conservative allocation­ within each target date, says Thomas Clark Jr., a Vice President at Lockton Investment Advisors­, LLC, in Washington. “There is definitely more interest [from sponsors] in that since the market crashed in 2008,” he says, given that these hybrids accommodate differing risk preferences. “Once you get a lot of workers older than 45, their needs tend to be more customized,” D’Aiutolo says. It is “a little less intense” than pinpointing individual participants’ risk tolerances for managed accounts, Clark says, “because you can start with a moderate fund, and then they can go up or down a level if they want.” 

While often used as an investment option, managed accounts do not get selected frequently by ­sponsors as a default, says Brian Ward, a Managing Director at Ward Financial Advisory at Wells Fargo Advisors in Brentwood, Tennessee. “It comes back to a fee concern,” he says. Only 4% of employers that use defaults have chosen managed accounts, according to the Profit Sharing/401k Council of America’s 2009 “PSCA Target-Date Funds Survey.” These accounts typically carry a 25- to 40-basis-point fee in addition to the fund expenses, D’Aiutolo says. Plans often find they can work with an adviser to build customized, hybrid funds based on the core lineup that accomplish similar goals for less cost, he adds. 

Just 6.6% of employers surveyed by PSCA picked risk-based funds as their default. Some plan sponsors want to treat all participants the same initially rather than put them into different glide paths, Ward says, so they may default everyone into a moderate risk-based fund. Participants then can decide to get more aggressive or conservative.  

Stable value, likewise, remains a frequent plan option but seldom-used default. “We definitely do not encourage it [as a default], because of the complexity,” D’Aiutolo says, citing the underlying investment-value declines some funds saw after the market downturn. “You do not really know what you are buying,” he says.  

Ward points to the relatively low long-range returns. “The fact is that, over the long term, a diversified portfolio generally will do better than a stable-value fund,” he says. 

2. Know the sponsor’s glide path philosophy. “We look for the sponsor to answer the to-or-through question,” D’Aiutolo says, referring to whether a fund’s glide path ends at retirement or goes throughout a participant’s lifetime (see “When One Size Fits Almost No One,” PLANADVISER, March-April, 2010). Some paternalistic sponsors believe they have a lifelong responsibility to help employees. Others want to help workers get to retirement, and see their responsibility ending there.  

At the most basic level, Clark has glide-path conver­sations with clients about the to-versus-through issue. Many recordkeepers now allow an independent consultant to alter glide paths and asset allocations, he says. “So, for those recordkeepers, there is significant flexibility.” For recordkeepers that only have proprietary target-date funds, “that is kind of set in stone, so [plan sponsors] do not have a choice,” he adds. 

For sponsors with a more sophisticated understanding of glide paths, Clark says, “we are talking about, ‘In the world of target-date funds that are managed through retirement, how do my target-date funds stand up?’”—as more or less aggressive. “Most employers just do not want to be on the outer edge,” he says. “They do not want to be super-aggressive or super-conservative.” 

3. Do not judge performance in a vacuum. Evaluating asset-allocation funds’ performance proved challenging even before the market crash, but has become more complicated given recent volatility. “For those in target-date funds as a default, we are trying to provide participants with a steady experience, not necessarily to outperform the market,” D’Aiutolo says. So, he puts together blended index benchmarks that reflect the asset classes in each plan’s lineup, and compares the funds’ results to the benchmarks over one, three, and five years. “Generally speaking, we take the mindset that, if participants fared better than they would with the blended index, with a little less volatility, then we have done well by those participants,” he says. 

Help sponsors understand that they should not judge asset-allocation funds’ performance in a vacuum, Ward says. In picking these funds, sponsors need to know what they want in terms of underlying investments: Are they comfortable with a fully proprietary lineup of funds, or do they want a multi-family setup? Are they focused on passive or active investing? What alternative asset classes does the sponsor think are appropriate for that plan? 

Clark uses Lockton’s proprietary target-date fund analyzer tool that lets him gauge funds based on their glide path and ability to move along the efficient frontier using diversification strategies. “Understanding all of the components of target-date funds is more important than just understanding their absolute return,” he says. 

4. Help negotiate lower-fee share classes. “It makes a lot of sense for plan sponsors if you bring that to their attention and say, ‘We can save participants 35 basis points or 50 basis points’” for plans with $50 million and more in assets, Ward says. He advises asking providers to “give us your fee disclosure, gross-to-net pricing, so we can understand where the fees are, and who pays what.” With that, an adviser can do a benchmarking study to get a feel for the fees’ fairness.  

“There is opportunity for plan sponsors, especially those that have been with a vendor for four or five years-plus, to go back to the vendor and negotiate for lower-priced share classes,” Clark says. He recommends starting with what he calls a “dealer invoice” in renegotiating investment fees. “We will do an internal analysis, based on our benchmarking, and determine a fair revenue for that vendor, in basis points or in hard-dollars per participant,” he explains.