Much of the public criticism of target-date funds has focused on the "glide paths" they follow as they reduce their equity exposure over time (see "Are Target Funds on Target?" May). Some funds with a target date of 2010 lost 30% or more of their value in 2008, prompting complaints that they were overly invested in equities for participants nearing retirement age.
But a recent PSCA survey shows plan sponsors themselves are less concerned with glide paths than they are with the quality and cost of their target-date funds' underlying investments. Where target-date portfolios are invested exclusively in a vendor's own funds — and especially where those underlying funds are higher-cost, actively managed funds — some sponsors are wondering if they're getting the best possible investments or simply padding the vendor's revenue stream.
Earlier this year, Stanford University got rid of actively managed target-date funds it had been offering participants in its retirement-savings plan — along with more than 200 other actively managed mutual funds — in favor of target-date funds from Vanguard Group that invest exclusively in low-cost index funds. The plan's investment committee, says the school's vice president of human resources, Diane Peck, "collectively didn't feel it was appropriate" to continue offering the higher-cost, actively managed funds, although plan participants who want them can still access them through a self-directed brokerage window.
Meanwhile, some plan sponsors are leery of steering plan participants of the same age into the same target-date fund regardless of extenuating financial circumstances. For example, employees working for a company that offers both a 401(k) plan and a defined-benefit plan might want to take more risk in their target-date funds than employees working for a company that offers only
a 401(k) plan.
To address this issue, Great-West recently introduced a family of target-date funds that features a choice of three different glide paths and risk profiles for sponsors to choose from — conservative, moderate, and aggressive. To allay concerns about getting stuck with a vendor's proprietary funds, this new family of target-date funds also invests in 28 different underlying funds from 20 different investment managers, and offers a mix of both passive and active investment strategies.
"Managed accounts" are another investment option attracting the attention of plan sponsors. With managed accounts, an investment adviser slots plan participants into preassembled portfolios based on their age, expected retirement date, risk tolerance, and other personal financial factors. Like target-date funds, managed accounts are recognized by the Labor Department as QDIAs, and as such offer the same fiduciary safe harbor. Bank of America Merrill Lynch says that 24 of its 40 largest plan-sponsor clients — and more than 300 of the roughly 1,500 plans it manages — offer its managed-account service. And plan provider Standard Retirement Services reports that about 40% of the plans it is signing up as new customers this year are using its managed-account service.
Fees and Expenses
Washington's push to get more information to 401(k) plan participants about plan expenses will have repercussions for plan sponsors. The proposed 401(k) Fair Disclosure for Retirement Security Act would require that sponsors provide fee disclosures on investment options to plan participants, and while it has been pushed to the back burner by more-pressing legislative concerns, it is unlikely to go away for good, especially given the Obama Administration's enthusiasm for greater transparency in the financial markets.
In the meantime, the Department of Labor is still expected to finalize proposed new regulations that would, under Section 408(b)(2) of the Employee Retirement Income Security Act, require plan-service providers to make additional disclosures about the compensation they receive and any conflicts of interest that may exist among them and other involved parties.
For plan sponsors, one of the biggest challenges of these proposed disclosure requirements will be figuring out how to account for revenue-sharing and soft-dollar arrangements that are common among 401(k) vendors and present them to plan participants in a way that can be easily understood. Some plan sponsors may decide that the simplest way to do that is to eschew the types of investment options that enable those arrangements, such as mutual funds with lush expense ratios and 12b-1 marketing fees.
That might mean stocking your plan's investment lineup with low-cost index funds or even exchange-traded funds (ETFs). In fact, this disclosure issue was another reason Stanford opted to emphasize index funds in its investment lineup. "We wanted to be able to educate our employees about the importance of fees and how that played into your ability to accumulate money for your retirement," says Diane Peck, "and the fees for the actively managed funds were not as transparent as they needed to be."
ETFs are similar to mutual funds, but trade intraday on stock exchanges and are sold on a commission basis. They haven't captured a big share of the 401(k) market yet, in part because many recordkeeping systems aren't equipped to handle them, but they are making inroads.
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