Asset-allocation fund solutions have, to put it mildly,
exploded on the retirement plan scene—aided in no small
measure by the sanction of the Department of Labor (DoL)
final regulations regarding qualified default investment
alternatives (QDIAs). However, the recent market turmoil
has drawn a fresh, heightened scrutiny to the philosophy
and structure of these popular defined contribution choices
and, certainly for plan sponsors, reminded us all that
there are differences—significant differences, in fact—in
how these vehicles are constructed, how they are managed,
and even the philosophies underpinning those designs.
Now, the "right" answer for your program will,
in many respects, be unique to your program. On the other
hand, there are certain basic questions that plan sponsors
should know the answers to in choosing an asset-allocation
solution.
Getting Started
1.
Are we talking about
lifestyle
or
lifecycle
funds?
The terms are used interchangeably all too often. However,
funds that structure their allocation based on an
individual's risk tolerance (risk-based) generally are
called lifestyle funds. Those that base that allocation on
a specific future date (date-based) are referred to as
lifecycle funds or, more broadly, target-date funds. While
the latter was cited more specifically in the DoL QDIA
regulations, a properly structured risk-based fund could
work as well. Some plans have both on their plan menu, but
that can complicate plan communications.
2.
Is a risk-tolerance questionnaire part of the
process?
In my experience, no matter how short and
"approachable" the process of ascertaining a
participant's tolerance for risk, it is never going to
be something that is comfortable for most. Still, if you
are employing a risk-based solution, you have to have
something to base that tolerance on—and you should be
comfortable with that process/document. Additionally, today
there are several risk-based target-date offerings that
combine both approaches.
3.
What kind(s) of history/benchmarks are
available?
Just a couple of years ago, there were no benchmarks to
speak of in this space (other than those constructed by the
firms managing those funds). Of course, just a couple of
years ago, there were not enough funds in this space with
enough history to make for a meaningful evaluation.
However, time has provided the history many funds were
lacking (granted, many would just as soon not have that
fourth quarter 2008 result included)—and a new generation
of benchmarks and indexes has emerged along with the
explosion in these funds. However, take note: The
benchmarks today are as varied in their underlying
philosophy and construction as are the funds
themselves.
Fund Construction
4.
Are the funds composed of proprietary offerings, or
are they "open architecture"?
The "debate" over the relative advantages of open
architecture versus proprietary offerings has long been
part of retirement plan administration choices, and it is
part of the target-date decision as well. Those advocating
the benefits of open architecture generally tout the
ability to pick "best-of-breed" investment solutions (while
readily being able to dump those that fall short), backed
by the notion that no one firm can possibly be that best
choice across every asset class. Those pushing proprietary
choices take issue with that latter point, while pointing
to the benefits of their intimate knowledge of their own
product set—not to mention the relative cost efficiencies
of a proprietary product. There is no right answer, but the
determination should be part of your evaluation.
5.
What
is
an appropriate asset alloÂcation?
This is the million-dollar question for target-date funds
these days. At a high level, this is no more complicated
than deciding what is the right mix of stocks and bonds,
international and domestic, alternative investments, and/or
cash for investors at every stage of their investing
life—or than picking the firm(s) that you trust to know
what that right mix is.
6.
How much of what is on your glide path?
The "glide path" sounds like a complicated concept, but it
is actually nothing more than how the shifts in asset
allocation take place over time. It is the path that these
investments take your money on throughout your investing
life. Still, for some funds—particularly newer, smaller
funds—the asset-allocation strategies outlined in the fund
prospectus or fact sheet may still be "aspirational," may
not yet incorporate all the specific strategies that the
fund manager has in mind for that time in the future when
the funds achieve a certain critical mass. Know what the
targets are—and know if those targets are part of the
current strategy.