Data & Research April 9, 2013

Target-Date Funds ‘Structurally Unsound,’ Paper Says

Though a worthy idea, the target-date (TD) fund concept appears to have been implemented hastily and poorly, a paper asserts.
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In the paper, “Target Date Funds: Structurally Unsound,” Marc Fandetti with Meketa Investment Group says, “The presence of serious structural flaws in the current generation of TD mutual funds suggests that most but not all such funds should be avoided by plan sponsors and investors, or at the very least used with extreme caution.” Fandetti argues that TD funds are expensive due to heavy reliance on active equity managers, and as such are priced (and behave) like actively-managed equity funds, and, actively managed TD funds likely cannot, on average, add alpha over time.  

“TD fund excess return (positive or negative, relative to a benchmark) can result from asset-allocation decisions, underlying manager decisions (both security selection and varying asset class or ‘beta’ exposure), or both. It is difficult for all but the most sophisticated plan sponsors and advisers to conduct rigorous enough performance attribution to truly get to the bottom of realized returns. And if such analysis is beyond the capability of many plan sponsors, it is almost certainly not possible for the vast majority of plan participants. In this sense, TD funds are opaque,” the paper says.   

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Fandetti advises that plan sponsor should understand the causes of under or overperformance relative to the TD fund manager’s chosen benchmark. If, for example, a TD fund manager’s over- or underperformance is attributable to asset allocation and not manager performance, the plan sponsor may want to look for similarly allocated TD funds that are less (or not at all) reliant on active management.  

When speaking about TD funds’ glide paths, Fandetti argues that “to quibble today about asset allocation decades hence is probably a distraction,” and “[c]urrent risk should probably weight (far) more heavily in plan sponsor or participant TD fund decision-making.”  

The paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2243185.

Data & Research April 9, 2013

Solutions Exist for Easier Plan-to-Plan Rollovers

The Government Accountability Office (GAO) has recommended regulators take certain steps to make plan-to-plan rollovers easier for defined contribution (DC) participants.
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The agency found the current rollover process favors distributions to individual retirement accounts (IRAs). Waiting periods to roll into a new employer plan, complex verification procedures to ensure savings are tax-qualified, wide divergences in plans’ paperwork and inefficient practices for processing rollovers make IRA rollovers an easier and faster choice, especially given that IRA providers often offer assistance to plan participants when they roll their savings into an IRA. (See “Plan-to-Plan Rollovers Should Be Easier, GAO Says.”) 

“I think plan-to-plan transfers are a hidden gem and an overlooked tool in the industry’s toolbox,” Spencer Williams, CEO of Retirement Clearinghouse, told PLANADVISER. Williams said data from the Employee Benefit Research Institute (EBRI) indicates if the participant cash-out rate was cut by 50% across DC plans, it would add about $1.3 trillion to participants’ retirement savings jackpot.  

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One solution is for employers to offer new employees a roll-in service. Williams noted there are more than nine million employees with DC plan accounts that change jobs every year. A roll-in service would address the deterrents mentioned in the GAO report. All the employee has to do is sign the paperwork and then rollover experts complete the verification that the assets are tax-qualified and coordinate the timing of the rollover.   

Retirement Clearinghouse has experienced a roll in rate of 33% with clients that use its service, Williams said—significantly higher than the 10% typical rate mentioned in the GAO report. Plan-to-plan rollovers not only improve retirement savings for employees, but they increase the scale of the plan for employers, which can improve costs. “It’s a win-win for everyone,” Williams concluded.

 

(Cont’d…)

In a statement following the GAO report, Aon Hewitt expanded on the benefits of encouraging participants to keep their DC assets in the employer-sponsored retirement system. “Employees who choose to roll retirement money into an IRA risk losing key features from within the employer-provided system, which can significantly impact long-term savings goals,” the consultant said.   

These benefits of keeping assets in the system include: 

  • Enhanced purchasing power—Because larger defined contribution (DC) plans have hundreds or thousands of participants and assets of tens of millions of dollars or more, enhanced purchasing power allows them to offerinstitutional class investment products to employees at a lower cost for similar products than an individual would purchase on their own in an IRA; 
  • Access to unbiased tools and resources—These tools often include education, modeling tools, online advice, managed accounts, lifetime income solutions and access to experienced phone representatives; 
  • Like the investments, these are usually offered a much lower cost than what is available to individuals outside of the employer system. In addition, employees who also have a defined benefit (DB) plan with their employer benefit from integrated modeling tools that allow them to better manage their retirement savings; and  
  • Employer expertise—By participating in a qualified plan, workers benefit from the fiduciary oversight and expertise of the plan sponsor and often outside experts in areas such as selecting investment options and reviewing plan design alternatives.   

Aon Hewitt says education is key. Plan sponsors should make sure employees have access to the right information about their options, and that they receive it at the right time. This means not only at the time of retirement or termination, but well in advance to help with planning. Use multiple channels, so that employees have options across self-service vehicles, such as online information, phone, or in-person support. Periodically, and at an employee’s termination, employees should be provided with resource materials or an educational campaign explaining the benefits of employer-provided plans, with clear and simple instructions on how to roll one plan into another. Plan sponsors could post this information on provider websites along with phone numbers and web links for help.    

Aon Hewitt also says offering an attractive investment lineup and a retirement income option for those nearing retirement could provide the incentive DC participants need to keep assets within the employer-sponsored system.

 

 

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