As target date funds continue to expand in usage and popularity, we wanted to point out four things you might have missed in the 2013 Target Date Retirement Funds DOL memo, which also address what exactly the DOL wants out of a QDIA.
TDFs are the “most common qualified default investment alternative used in 401(k)s today, and they claim a sizable portion of the average investor’s retirement portfolio”. Selecting a qualified default investment alternative, or a QDIA, that complies with the Department of Labor (DOL) regulations can serve dual purpose in that it can potentially reduce fiduciary liability for providers and help participants most effectively save for retirement with their needs, not the provider's needs, met first. It is the provider's fiduciary responsibility under the DOL first to be selecting and monitoring investments that are in the end investors' best interest. However, the responsibility does not stop there.
Warning, Assumptions Ahead
A. "If employees don't understand the fund's glide path assumptions when they invest, they may be surprised later if it turns out not to be a good fit for them."
Not all target date funds are made the same. While it is difficult to ensure every participant understands what they are getting, the best way to fulfill your fiduciary liability is knowing exactly what is inside the glide path of the funds you are recommending. This includes knowing the underlying funds used, the exposure to different asset classes, and when the TDF will reach its most conservative allocation (at or after retirement). Then, document the information and your recommendation. If a participant decided they were unhappy with the outcome of their TDF, and regulators asked questions, you should be able to answer them and back up your recommendation. Cost and brand name are not satisfactory criteria alone.
Bonds Have Bear Markets Too
B. "As the target retirement date approaches (and often continuing after the target date), the fund's asset allocation shifts to include a higher proportion of more conservative investments, like bonds and cash instruments, which generally are less volatile and carry less investment risk than stocks."
The notion of “to” versus “through” is significant as it determines how conservative the investment will be at the retirement date, versus after. However, this quote from the DOL fact sheet is important to us for a different reason. The point of increasing “conservative investments” is to reduce risk in the TDF close to retirement. In recent years bond yields have been so low that TDF providers are struggling to compete with each other on performance. So they are packing the fixed income portion of the glide path with high risk bonds such as high yield (junk), emerging markets or long duration (30+ year) bonds. As a financial professional, we would not consider these investments conservative in general, much less if we were to incur a bond bear market which many are saying may be unfolding currently.
You Get What You Pay For
C. "Added expenses may be for asset allocation, rebalancing and access to special investments that can smooth returns in uncertain markets, and may be worth it, but it is important to ask."
The saying “You get what you pay for” also applies to a target-date fund. Fully educate yourself on fees and take a deep dive into what is provided for that fee. First, the fees advertised are often misleading due to the exclusion of trading costs which can often double the total cost to the participant. Second, guarantee you know what you are paying for and that the value goes along with the price tag. The DOL agrees that the lowest cost option is not always the most appropriate, and a slightly higher cost “may be worth it”. What is best for the plan’s participants? Would a TDF with the ability to protect against large market losses like those seen in 2008 be worth a few extra basis points of annual cost? According to a recent Cerulli study, I think they would probably say yes.
It's Not All About the Brand Name
D. "Non-proprietary TDFs could also offer advantages by including component funds that are managed by fund providers other than the TDF provider itself, thus diversifying participants' exposure to one investment provider."
As a provider, selecting the most well-known brand does not relieve you from fiduciary liability. Brand recognition alone especially does not satisfy a valid TDF selection reason. Additionally, the largest TDF providers typically only use their own funds within their TDFs. Looking at the prospectus of the most well-known TDFs, you will find they often use subpar proprietary funds just to garner assets, not because it is the best fund for the job. They also can charge fees on the underlying funds in addition to the TDF fee itself, which is often referred to as “double dipping”. Using a TDF of an independent provider can help you avoid these kind of traps that the DOL will hold you responsible for.
Your obligations as a fiduciary should be mitigated on the occasion you understand and follow these four important messages within the 2013 DOL memo. Remember: brand recognition, lowest cost option and so called “conservative” investments some TDFs include are not necessarily legitimate standards for a retirement plan. Benefit both yourself and your clients by addressing these shortcomings when evaluating a 401(k) from the ground up.
