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
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
Âallocation for individual participants."
However, managed accounts have some disadvantages
compared with Âtarget-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
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 Âconjunction 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.'"