Cover:One Size Does Not Fit All

Comparing Funds

Target-date fund providers' differing philosophies make it hard to compare funds. "When you try to benchmark them, there is a really broad range of how some firms are saying these funds should be managed," says Barbara Delaney, president of adviser Fundemental Foundations of America.

As more big employers freeze their defined benefit plans, Davies says, the finance pros within those organizations have started scrutinizing 401(k) investment options more closely than ever. He sees a new trend emerging from these billion-dollar-plus plans: target-date funds customized to individual employers. "When they look at target-date funds they are not saying, 'I want to review my target-date lineup.' What they say is, 'We have our own ideas on asset allocation. We like passive investing in certain asset classes, and active management in others.' They certainly would never give all their target-date money to a single asset manager," Davies says. "A number of major companies are actively building their own customized target-date fund solutions. They are creating a multi-manager separate-account structure."

The employers may introduce these types of funds for the first time, or map out of existing risk-based or target-date funds they currently use. "They probably will assume a little more fiduciary responsibility than they had before," Davies says, "but, soon, we are going to see announcements of some very large plans going in that direction."

If target-date funds lack customization, where do managed accounts fit in the 401(k) mix? "That is the million-dollar question right now," Larsen says. This investment approach speaks to some of the concerns about target-date funds. "It takes the best of both worlds: It focuses on a target-retirement age, but it is based on your risk profile," he says. "It personalizes the overall asset ­allocation for individual participants."

However, managed accounts have some disadvantages compared with ­target-date funds. The big one: higher costs. Says Delaney, "What is a managed account? It is just a fancy way of charging a higher fee."

"The sell that most vendors push is, 'Yes, it costs more but, over the long term, it will be more customized, and the returns will offset the higher fees,'" Larsen says. "However, it is hard to go in and tell a participant—and quantify it—'If you jump in, it will add more value.'"

Managed accounts average 40 basis points on top of the fund fees, estimates Ellen Rinaldi, principal, investment counseling and research at Vanguard. Target-date options go for about 21 basis points for the funds, with no management fee, she says. Crain acknowledges concern about fees, but says that Merrill Lynch does not charge any investment wrap fee to run its managed-account program.

The 40 basis-point average plus fund fees for managed accounts sounds in the ballpark to Larsen, but he sees typical target-date fund fees averaging about 100 basis points for all expenses. "The shorter-term (2010 or income) funds have lower expenses than the longer-term (2030 to 2050) funds, which are normally more expensive due to equity exposure," he adds.

Managed accounts offer the most value to participants who really get into the investing process, Davies says, which likely limits their appeal to people with sizeable savings outside of their 401(k)s. "Probably a single-digit participation rate makes sense," he says. "If you pay an incremental fee to get a managed account, you have to say, 'What additional benefit am I getting for the 30 basis points? For most people who are not really that interested, it is probably not worth it."

It may not be worth it for really interested participants either, Andonian believes. "A managed account is going to incur fees that a proactive participant does not need to have," he says. He adds that these people, often senior executives and board members, consider themselves savvy investors and "feel like they can beat a managed-account solution."

Moreover, do participants really get totally customized portfolios, anyway? Larsen worries about how some vendors market their managed accounts. "I know of a vendor that tells participants it is going to construct an individualized portfolio for every single participant, based on their parameters," he says. "That is impossible. There are actually seven different asset-allocation models that the vendor uses. In my mind, that is a lot different than telling people that every participant is going to have an individualized portfolio."

So, managed accounts probably will not have a lot of appeal as a stand-alone 401(k) option. Their likely market niche will be in ­conjunction with the Pension Protection Act provision that allows fiduciary providers to offer individual investment advice. Managed accounts get that done in a more cost-effective, scalable way than relying primarily on one-on-one, face-to-face counseling. "With the passage of the legislation, the use of managed accounts will increase," Larsen predicts. "Vendors are looking at putting in place their computerized models, which look and feel a lot like the managed accounts we are seeing now. That will perpetuate the managed account model."

With the industrywide growth of managed account assets, Larsen says, look for fees to drop. "Market pressures are going to drive down the expenses," he says. "In a few years, the current charge of 40, 50, or 60 basis points will be included in the package, at little or no added cost. This approach will be more prevalent than an individual broker or registered rep coming in and saying, 'I am willing to be a fiduciary in the plan, and I will sit down with every individual and give advice.'"

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