Retirement Plan Consultants
Teds are not created equal. Too often, they consist of proprietary funds that limit trustee oversight, and the proposed DOLE rules provide more transparency but do not affect the underlying strategy of a plan. Pension advisors should review their investment opportunities, analyze the “sliding paths” of the funds and ensure that the chosen strategy best meets the needs and demographics of plan participants.
Bear markets provide greater control over financial markets, and financial products in particular. Just as many regulations as the laws that followed the Enron crisis, however, seem to have emerged only after the damage.
Since the beginning of the decade, Ted’s assets have increased at parabolic rates. The competition among mutual fund companies to buy sticky assets in the lucrative 401 (k) market was tough. Unfortunately, given the fierce competition in the bull markets from 2003 to 2007, many of these companies have built riskier asset classes to achieve more attractive performance records.
And many investors and pension advisors rated these investments as the fund companies expected – based on performance.
Let’s be honest: who would buy a 2030 fund that undercuts the performance of a competitor in 2030?
The problem is that no two Ted’s are created equal. For example, on a bull market, a 2030 go-go fund made up of 70 per cent shares should outperform its counterpart in another 50 per cent equity exposure.
The reverse, however, will be reflected in a market downturn and will worsen as the decline continues.
Yield fluctuations illustrate the radical differences in allocation to equities of the same target category with a drastic share exposure of between 65 and 25 percent. Take, for example, the market turbulence of 2008, when investment losses for funds with a target date of 2010 were as high as -41 percent and as low as -9 percent, with an average loss of -23 percent, according to Morningstar.
The devil is in the details
The statutory provisions in the Pension Protection Act 2006 made target funds a qualifying standard investment alternative (ADDIA) that provides secure protection for plan trustees. They have quickly become an integral part of the retirement market.
Just as with plan sponsors and independent investment advisors who oversee funds and remove certain funds from the plan’s investment options when needed, similar funds are required for funds on the reporting date, but often are not properly managed.
According to industry-leading ERINA attorney Fred Relish and Relish & Richer, his law firm finds “a general and vague language that describes the selection and monitoring of funds with a key date”.
The majority of plan sponsors are very proud of the fund review process outlined in their investment policy, but they tend to lag behind in terms of target funds in this area. The reason is simple. Most of the target funds consist solely of own funds of the underlying fund family and / or its affiliates.
For this reason the sponsors have – without fault of the plan sponsors – only limited control possibilities with regard to the participations.
According to Relish, “A plan sponsor must also be aware that the management of the target fund is limited in the selection of underlying investments and / or has conflicts of interest (for example, if the manager of which fund is out by the deadline) practical reasons or due to a written restriction to select only the mutual manager’s mutual funds?) ”
It is unlikely that an independent investment advisor will have the best offer in its class across the full range of asset classes. Most would agree that the main menu for retirement investments consists of a multi-family, first-class investment portfolio. The target date strategy should not be different.
Unfortunately, most plan sponsors have a single family target date lineup that invests entirely in proprietary funds. For example, the three largest fund families invest entirely in own funds as underlyings.
Since it is estimated that 50% to 60% of flows of assets flow into key date funds and plan sponsors who lack the ability to monitor and remove the underlying assets, it is even more monstrous to recommend proprietary funds with a standard investment cut-off date.
Criteria and standards
We reviewed the 401 (k) planned investment for a large institution with assets in excess of $ 330 million. It offered 16 investment opportunities, including eight proprietary funds, seven of which are held on record. The proprietary Ted’s attracted more than 40 percent of plan assets or nearly $ 140 million.
The funds were then analyzed and rated using 10 criteria and standards across five different categories, including track record, performance, risk-adjusted return, volatility and costs. A Fund must meet at least seven of the ten criteria to be passed.
An examination of the underlying funds showed that all 20 underlying investments were in fact own funds of the fund family. Worse still, 20, 11 or 55 percent of funds do not meet trustee standards and are ineligible investment opportunities.
Unfortunately, none of this information has ever been released or reviewed by the Plan Supervisory Board – until now. It is a compromising situation that needs to be resolved.
I believe it is the duty and responsibility of the trustees to participants in the plan to know this information and, more importantly, respond to it. Everything else is, in my opinion, a breach of the fiduciary duty.
Just as you decide whether your plan investment philosophy is that funds in a down market decline less (more conservatively) or rise more (more aggressively) in an up-market, plan sponsors should first decide if they want theirs Funds on the deadline wish to retire their employees “to” or “through”. The formula for this is the slip path of the fund.
The glide path is a fixed allocation to stocks, bonds and cash. The younger a participant, the more exposure to shares. As the participant nears retirement, the allocation automatically reduces the concentration in stocks and shifts to more conservative bonds and investments. Unlike mutual funds on the cut-off date, these slippaths can be adapted to the needs and demographics of plan participants.
This is a comparison of two example slip paths (“to” and “through”) that illustrate the change in inventory load over time.
The concept behind the “through” approach is that investors need to increase their wealth throughout their retirement. Conversely, the “to” strategy offers lower risk to retired investors who are not tolerant of riskier equity allocations.
Neither right nor wrong, but it is the duty of the Plan Committee and / or the Investment Adviser to decide which strategy best fits the needs and demographics of the plan participants. Are you not sure if you are ready for the task? Well, if you have a TDD in your investment portfolio, you have already made the decision – formal or random.
I’m not sure how many of us can say that when we chose the TDD strategy, we deliberately chose which style (gradually) fits the plan best, especially if it was over three years were elected.
One reason is that not many tools were available so far.
I believe that we should be judged by our decisions, based on the circumstances prevailing at the time of the decisions. So if we do not have the tools, the measures become understandable.
With the times, however, the circumstances have changed. Plan sponsors can not continue with the current approach as if they were still best practices today. As new procedures become available, plan sponsors need to rethink the evaluation and selection of TDD strategies.
Quadrant and glide path analysis
Such prudent and documented selection procedures should include:
1. analysis of asset allocation;
2nd glide path analysis;
3. needs, age and behavior of participants; and
4. Assessment and monitoring of fees.
Each target date has a unique glide path and falls into one of four quadrants for equity exposure. Plan sponsors and advisors need to know what decisions they have made in relation to both and document them.
These tools and reports should provide a framework for identifying and evaluating funds at the key date that are more in line with the overall goals and needs of plan participants. The goal of the tools is to help the planning sponsors assess the desired equity exposure of their plans for participating in or near the plan and the diversification of asset classes – two key features of Ted’s.
The framework also encourages plan sponsors to understand and consider the characteristics and behavior of their workforce as part of the target date selection process – factors that, according to the Department of Labor, should also be considered by trustees when designing the investment menu for a particular company -Beitragsplan.
On 30 November 2010, the DOLE proposed new rules requiring plan trustees to provide extended pension plans to plan participants. The proposal would also expand the investment information that must be disclosed on the standard qualifying investment alternative of a plan, even if it is not a target date fund.
This transparency is intended to help participants make more informed decisions about their investments. However, the majority of participants investing in Ted’s do so because they do not have the time, the knowledge or the inclination to regularly analyze and manage their investment portfolio.
Only time will tell, as participants get more information on a topic that they treat from others, the results expected by the DOLE are achieved.
The proposed regulations do not encourage a revision of the deadline strategies but provide additional transparency and control. In other words, plan participants continue to be offered the same strategies that produce the same investment results as before, but with government-mandated disclosures.
Rethink TDD strategy
The solution is to change the strategy and / or process by which they are created – and not to support the current product through stronger state regulation.
In the multilateral target date fund structure, the underlying investment funds are selected from a wide range of investment managers. To go one step further, custom key date models are used to create the key date funds with assets already included in the options menu, which are monitored by the planning committee (and, if applicable, an independent investment adviser).
This gives the plan sponsor greater fiduciary oversight and oversight, thereby fulfilling his fiduciary duties and being better prepared for the participants.
Once the appropriate Goal Glide Path philosophy has been established, the Plan Committee or the Investment Adviser will, in trust, create the Goal Futures Funds using the underlying Plan Menu Options.
The same monitoring standards that apply to the underlying funds also apply to Ted’s. When a fund is removed from the general fund schedule and replaced, it will automatically be removed from funds with the target date and replaced. This should be an automated process that does not require any additional steps.
This transparency and consistency provides an additional level of fiduciary protection and general caution. As the investment in securities entails certain risks, it is not possible to provide anticipated guarantees regarding the account values at the anticipated retirement age of the participant (the target date).
In addition, many platforms allow the inclusion of “satellite” strategies, which are not available in most retirement plans to create custom target data from areas such as commodities or emerging markets. They provide an additional level of diversification, but are not usually recommended for a core investment menu.
In investment monitoring, trustee obligations may be shared but not fully transferred to another entity. So the money ends up at the planning committee.
Since the committee approves the glide path and the underlying investment options, Custom Teds gives the plan sponsor more control, customization, and transparency. They also add an extra level of trust and prudence.
However, creating the target date from a core listing is not enough. The employer is also required to have a documented and prudent strategy for monitoring and exchanging the underlying funds. If they do not follow a structured process, they follow the same erroneous target date fund strategy that plagues our industry.
Please note: As investment in securities entails certain risks, no guarantee can be given in respect of the account values, even at or until retirement. The success or desired results of fund strategies at the reference date can not be guaranteed.