The Markets October 29, 2007

Target-Date Shift Not Waiting for QDIA

Across all plan sizes, target-date funds are the most common default investment option although, in general, small plans are much less likely to have them on their menu than are mid and large-size plans.
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Recent research from RiverSource Investments and PLANSPONSOR revealed that nearly one quarter of all plans (23.4%) have an automatic enrollment feature in place. However, mid-size ($20 million to $200 million in assets) and large plans (more than $200 million in assets) are more than three times as likely as small plans (plans with less than $20 million in assets) to have implemented such a feature (39.8%, 36.9%, and 11% respectively).

When those plans selected their default investment option, target-date funds were the most popular options across all plan sizes, at use in 42.3% of plans. About one-third of small plans (31.5%) and mid-size plans (36.2%) employed such funds as their default option, compared to 62.1% of large plans. Balanced funds were the next most common default investment selection, used by 21.9% of plans, showing plan sponsors had no qualms about implementing an equity option as a default selection, even before the final qualified default investment alternative (QDIA) regulations were released from the Department of Labor (DoL). Unlike target-date funds, small plans were the most likely to employ balanced funds as a default fund (30.7%), followed by mid-size plans (21.5%), and large plans (14.3%). The more traditional defaults of stable value and money market funds did not get as much use, in place at only 15.9% and 4.7% of plans, respectively.

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Asset Allocation Fund Use

Although the great majority of mid-size and large plans have adopted lifecycle funds in their investment menu, small plans are slower to jump on the bandwagon. Nearly 70% of all defined contribution plans in the study have at least one lifecycle fund option in their menu. Eighty-nine percent of large plans and 89.9% of mid-size plans offer a lifecycle fund to their participants. However, only 53.9% of small plans in the study offer a lifecycle fund. Of the small plans that do not offer a lifecycle fund, the most common reason cited for this was that lifecycle funds were not board approved (35.5%), while 25% said they felt their plan had enough investment options.

Overall, on average 21.5% of participants’ balances are in lifecycle funds, the study found.
Despite that lack of offering, participants in small and mid-size plans keep more of their balance invested in asset allocation (both lifecycle and lifestyle) funds. In small and mid-size plans, an average of 22.9% of participants’ balances is invested in such funds, compared to 17% in large plans. This news might be a little disconcerting when considering that these funds are designed for a participant to invest fully in one of these funds.

Of plans that offered asset allocation funds, target-date funds were the most common type offered, although over half of mid-sized plans said they offered risk-based funds in their investment lineup. Regardless of plan size, more than 70% of defined contribution plan sponsors in the study that offer a lifecycle fund option use a fund that is proprietary to the plan’s recordkeeping firm. Large plans are only somewhat less likely to use a proprietary fund from the recordkeeper.

When asked whether the “set it and forget it” approach of lifecycle funds is appropriate for most participants, and whether participants feel the need for lifecycle funds, mid-size and large plans were more likely than small plans to embrace the lifecycle approach. Additionally, small plans were almost twice as likely to “strongly agree’ with the statement that lifecycle funds require too much education for participants to understand.

A total of 2,335 firms participated in the study, developed jointly by RiverSource and PLANSPONSOR, and conducted via a Web-based anonymous questionnaire. Of these, 1,326 or 56.8% were small plans, 623 were mid-size plans, and 385 were large plans.

A summary of survey findings is available here.

IMHO October 27, 2007

IMHO: It’s About Time

It may have lacked the hoopla of a midnight Harry Potter release, but in retirement industry circles, last week’s publication of the Department of Labor’s final regulations on qualified default investment alternatives (QDIAs) was nearly as eagerly anticipated.
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And, like the speculation as to which Potter character would survive the latest saga, the early betting had been that stable value would not make the QDIA cut—and, in large part, that turned out to be the case. Instead, stable-value (or more precisely, capital preservation) vehicle proponents had to content themselves with a sanction as a short-term repository for contributions (up to 120 days—long enough to accommodate the 90-day period that defaulted participants have to opt out), and the assurances from the DoL that they were sure that those vehicles would find a home alongside other options in the time-focused asset-allocation products that were accorded QDIA status (ironically, IMHO, in that regard, capital preservation vehicles seemed to fare better than did pure risked-based allocation fund alternatives).
There was, however, at least one significant victory for capital preservation vehicles: the DoL’s final regulation extends the same QDIA status protections to defaulted contributions made to those vehicles prior to December 24, 2007, the effective date of the new regulations. To some, that decision smacked of a “sellout’ by the DoL—and it certainly seems a striking inconsistency considering the clear preference accorded diversified, age-based funds in the regulations. As one adviser remarked to me last week, “What was the DoL thinking?’
Frankly, while the decision initially surprised me as well, the longer I consider it, the better I like it.
Considering the inertia associated with the choice of these selections, there is every possibility that plan sponsors permitted the flexibility to leave those existing default options in place will do exactly that—a result that certainly has to be a concern for those who question the prudence of those investments over the long term.
Consider the Alternatives
But consider what the result might have been had the DoL not provided that flexibility. We could well have had to absorb millions, if not billions, of defaulted investment liquidations—movement that could have had severe financial consequences for the market(s), and potentially for the plans that would be presented with huge surrender charges. Spared those charges, it is still possible that that massive shift of money could have occurred – departing their current positions—and entering new ones—at an unpropitious moment.
Even if plan sponsors had decided to simply stay the course on their own (the final regulations cautioned fiduciaries that the exclusive purpose rule precluded the imposition of fees on participant balances just to achieve fiduciary protection), that decision would almost certainly—and sooner rather than later—have drawn the focus of litigators who would cite the DoL’s pronouncements as a proof statement that the investments defaulted in good faith were, in fact, imprudent.
Is this a “victory’ for capital preservation proponents? Well, perhaps in the short term, but there’s no mistaking the DoL’s clear intent. The grandfather clause extends only to the balances so invested as of the effective date—not for contributions defaulted after that. Frankly, much as some plan sponsors still prefer the stable-value option (and many do)—and even though the DoL didn’t say that a capital preservation default was inherently imprudent—I think it’s reasonable to expect that these monies will begin to shift toward QDIA-sanctioned alternatives in the months ahead, as they already are. But thanks to the reasoned approach made possible by the final regulations, they will be able to do so in a measured, prudent fashion.

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