All the industry-talk about investment fees and retirement readiness has led more sponsors to think about how to increase the effectiveness of target-date funds (TDFs).
More than two-thirds (67.8%) of defined contribution (DC) plans also offer target-date funds as an investment option, according to PLANSPONSOR’s 2011 DC Survey. Furthermore, many plans continue to use the funds as an appropriate investment for those not actively electing an investment option: Approximately one-third of defined contribution plans now use automatic enrollment, and approximately 54% of plans utilize target-date funds as the default investment.
Conversations about target-date funds tend to center around three topics: customizing these funds to a particular plan, moving to an indexing approach and even re-enrolling existing participants.
Custom Target-Date Funds
The buzz about customizing target-date funds apparently exceeds the number of plans actually doing so. “There is a lot of discussion of customization,” says John Ameriks, a principal at The Vanguard Group Inc., who leads Vanguard’s Investment Counseling & Research group. “We do not actually see a tremendous amount of customization.
Some sponsors have looked at the pros and cons and decided that the cons outweigh the pros.” Jerome Clark, portfolio manager of the T. Rowe Price Retirement Funds, says, “From our perspective, we know that there are some mega plans incorporating open architecture for custom target-date funds. As far as penetration across the board, we are not seeing that.”
Across all plan sizes, 22.5% of plan sponsors say they are considering implementing custom target-date funds (11.8%) or already are using custom funds in their plan (10.6%), according to the DC Survey. However, when broken down by plan size, the large (between $200 million and $1 billion in plan assets) and mega (more than $1 billion in plan assets) are much more likely to be using or considering the investment option. One-third (34.4%) of large plans and 47.3% of mega plans say custom TDFs are already in place or are being considered.
Sponsor fears of the “maverick risk” of deviating too far from other plans helps explain this, Ameriks says, along with the dread of implementation and ongoing oversight issues. “They are thinking about the role of a target-date fund as the default [investment for automatically enrolled participants]. They are saying, ‘Maybe there is a place in the plan to do something cutting-edge, but it is probably not in the default fund.’”
Sponsors customizing target-date funds generally use their plans’ core-fund options, and those do not always line up well with the target-date fund components needed, Clark says. “A lot of plans do not have the level of diversification that you see in a typical target-date fund,” he says. “What is prudent or appropriate in a target-date fund may not necessarily be prudent or appropriate in a basic lineup.”
Other sponsors have decided that their participant demographics are not different enough from average target-date fund investors to need customized funds. “People tend to find that there is not that much difference from the broader group,” says John McNichols, senior vice president of investment product management at Fidelity Investments. “In the end, most folks are comfortable with our glide path and asset allocation.” Customization could make sense in some cases, such as when a plan has many participants significantly older or younger than the norm, he adds, or when the employer also has a defined benefit plan.
“We have gotten past a lot of the discussion about target-date customization really being about plan demographics,” Ameriks says. “If you are talking about 12 or 13 target-date funds, or whatever you do, you still have 12 or 13 funds, and you are not addressing everyone’s individual needs. [Sponsors] are talking more about using both target-date funds and managed accounts that will gather information at the individual level and provide some true customization,” he says.