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Plan Sponsors Ask…


Q: We offer target date funds1 as the qualified default investment alternative (QDIA) in our defined contribution (DC) plan. Does it matter which ones we offer? Aren’t all target date funds the same?

A: Fundamentally, all target date funds are designed to allocate participants’ assets based on their age and years to retirement, and deliver returns to help them create adequate retirement income. There are many options available, which is good for plan sponsors and investors, because it means lower fees and more choices. But they aren’t all created equal.

So how do you know you’re offering quality target date funds in your plan? One key element to evaluate is relative performance. In other words, how are your target date funds performing when measured against peers or industry benchmarks, for example, and why are they under- or outperforming? According to Mercer’s 4Q2016 target date fund survey, some factors influencing performance include glidepath, asset allocation strategies, how an individual provider determines those strategies and alpha — or the excess returns relative to benchmark performance — from active management.

If all that makes your head spin, consider consulting with an investment advisor or professional who can help you determine if your target date funds are performing as they should, or if it’s time to shop around. As mentioned above, there are plenty to choose from.

Q: Is it important to do periodic reviews of the conservative options in our investment lineup, and if so, when should we evaluate those offerings?

A: Good question. It’s always a good idea to review your investment lineup regularly to make sure the options are performing in line with your expectations and investment policy statement, and that you’re fulfilling your fiduciary obligations to participants.

Recent observations from Rocaton Investment Advisors say there’s no time like the present to undertake a review of your plan’s conservative, or capital preservation, options. Some participants may over-allocate toward conservative choices, thus sacrificing better returns, in exchange for a better night’s sleep. But investing too conservatively brings a different kind of risk, so plan sponsors are wise to educate participants about investment allocation in general — and to ensure they are offering quality investment options at all risk levels.

Another reason to review your plan’s conservative investment options is new money market reforms that took effect in October 2016, involving liquidity fees and redemption issues that may impact participants. Further, considering that a best practice is periodic review of the plan’s investment structure, many DC plan sponsors are streamlining their investment menus and considering alternative options, in light of new regulations. The low interest rate environment, the evolving stable value landscape, and increasingly high profile fiduciary litigation are other factors prompting plan sponsors to re-evaluate their capital preservation options.

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Q: We’re hearing that many DC plans are adding a retirement income component using something called a ìhybrid QDIA.î What is it, and why should we pay attention?

A: You heard right. Industry watchers say the evolution of QDIAs and retirement income solutions are two key DC industry trends to keep an eye on in 2017.

A hybrid QDIA contains both a target date fund solution and a managed account, and a participant’s assets are automatically switched from the former to the latter at an age pre-selected by the plan sponsor.

Such a solution addresses an important gap in plan design when it comes to retirement income. Recent research from Cerulli found that 37% of DC plan sponsors prefer terminated or separated employees leave their assets in the plan and draw income from it. However, 90% of plans aren’t designed to accommodate systematic or ad hoc withdrawals — a benefit desired by participants age 60 and older.

So a hybrid QDIA enables participants to draw income directly from their DC plan assets. Less than half of DC plan sponsors currently have a retirement income option, and their primary offerings are target date funds and managed accounts, Cerulli found. Thus, a hybrid QDIA solution could be a natural addition. Further, Cerulli noted that managed accounts are generally better suited than target date funds for older investors because they typically have larger balances and more complex financial situations, which necessitates the need for more personalized advice.

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1  Please note the principal value invested in these funds is not guaranteed at any time, including at the specified target date.