Sponsors Need More Target-Date Due Diligence

May 27, 2009 (PLANSPONSOR.com) - Plan sponsors still have a good deal more work to do to make certain participants are getting the full benefits from target-date funds in their investment lineup, a new study asserts.

The Janus Capital Group study asserts, for example, that plans have to not only diversify their lineup as a whole, but make sure each target-date offering has the proper internal diversification as well. “As diversification and transparency become watchwords in a post-Pension Protection Act world reeling from a global financial crisis, plan sponsors not only need to maintain a diversified plan menu, they also must ensure a proper level of diversification among managers within their target-date fund lineup,” the Janus report says.

“The Burden of Good Intentions: Opportunities and Challenges for Target-Date Funds Janus Capital Group,” based on a participant survey and a separate poll of plan sponsors, found a significant lack of understanding by many employees about how the funds operate.Many employers are not fielding effective education efforts about the funds or conducting proper level of due diligence about the fund and its component parts and how the funds fit into the plan’s overall investment strategy as expressed by an Investment Policy Statement (IPS), the report says.

In general, the Janus study pinpointed four central issues with how target-date funds are being used:

  • Many participants do not understand what they are or how to properly use them.Target-date fund holders show a propensity for overdiversifying (either by combining target-date funds of different dates or by combining target-date funds with other mutual funds); for selecting target-date funds for the year they expect to leave the company instead of the year in which they intend to retire; and believing these funds offer pension-like income guarantees.
  • Investor education about target-date funds has been inadequate and ineffective,” the Janus researchers wrote. “Most participants take some initiative to gather information before selecting a target-date fund, but too many target-date fund holders do not fully understand what they own and why they own it.”
  • Financial advisers who understand the strengths, weaknesses and appropriateness of target-date funds have a largely untapped opportunity to add value for their clients. The assumptions made by professionally advised plan participants about target-date funds are often no more accurate than those of participants who are not advised or who seek information through their plan recordkeeper, employer or independent research.
  • Plan sponsors are generally not applying the same level of due diligence on target-date funds or holding them to the same standards as other funds in their investment menu.   Less than half of the plans who responded to the survey have an IPS that covers target-date funds.

Finally, in pinpointing the specific areas of participant misunderstanding, Janus found:

  • More than 80% of respondents who rely on their employer and advice provided through their 401(k) believe that target-date funds need to be combined with others to achieve a diversified portfolio.
  • Approximately 70% of respondents who rely on their employer, plan recordkeeper and advice provided through their 401(k) believe that combining target-date funds with other funds in their 401(k) plan is the preferred way to generate retirement income.
  • More than 40% of respondents who rely on their employer, plan recordkeeper and advice provided through their 401(k) select the year of the fund based on the year they expect to leave their current employer, even if they don't retire at that point in time.
  • Approximately two in 10 who rely on advice provided through their 401(k) and independent investment research incorrectly believe that target-date funds provide pension-like guarantees.

In October 2008, Janus Capital Group hired Brightwork Partners LLC, to survey participants in 401(k) plans. The 503 respondents were employed full- or part-time at for-profit organizations; were contributing to their employer-sponsored 401(k) plan or had a balance of $1,000 or more; and held one or more target-date fund(s) in their account.

Janus also developed a series of questions in conjunction with PLANSPONSOR  designed to provide insight into plan sponsors' target-date fund selection, construction, monitoring, and satisfaction. These questions were included in PLANSPONSOR's annual survey of DC plan sponsors, conducted from July to September 2008. PLANSPONSOR e-mailed approximately 25,000 questionnaires to sponsors of DC plans that were well-diversified by size (less than $5 million to more than $200 million in assets); 6,123 usable responses were received by September 2008 (see 2008 PLANSPONSOR DC Survey: A Little Bit Better ).