The lion’s share of dollars flowing into U.S. defined contribution (DC) plans goes to target-date funds (TDFs). Now, TDFs are increasingly moving from off-the-shelf to more customized strategies.
TDFs address one of the more serious challenges in self-directed retirement accounts – inertia. Fact is, participants are highly unlikely to modify their asset allocations once established – especially when they’ve been set by the plan’s default. Fortunately, TDFs offer professional asset allocation oversight in strategies that dial down investment risks based on an assumed retirement age.
Assets in TDFs have surged since the U.S. enacted the Pension Protection Act of 2006. Among other things, the law gave sponsors of DC plans legal cover to automatically enroll participants and invest their money into TDFs or other qualified default investment alternatives (QDIAs).
More than 40% of DC inflows went to TDFs in August 2016, according to the Aon Hewitt 401(k) Index, and TDFs represent about a quarter of all DC assets, which the Investment Company Institute pegged at $7.0 trillion at the end of June. Custom and trust-based TDFs may represent as much as half of all TDF assets.
According to PIMCO’s 2016 Defined Contribution Consulting Support and Trends Survey, consultants expect more plans to adopt custom or semi-custom approaches, especially plans with more than $500 million in assets. Unlike regular TDFs, custom approaches allow plan sponsors to select category-leading asset managers and a broad array of diversifying asset classes. They may also enable a reduction in fees, both for the TDFs and underlying core fund lineups, as more assets flow into investment structures.
Importantly, the glide paths (or retirement-date asset allocations) of fully custom TDFs can be tailored to the unique demographics of a company’s workforce; factors such as longevity, health and wealth can vary widely depending on whether the DC plan sponsor is, say, a professional services firm or a global manufacturer.
Smaller plans may lack the ability to customize their glide paths, yet selecting a semi-custom approach still offers significant benefits – as noted, these include the opportunity to incorporate selected investment managers, whether active or passive, to an existing glide path and potentially reduce overall plan costs.
In PIMCO’s survey, 84% of consultants said they either support or actively promote custom or semi-custom TDFs. The survey polled 66 U.S. consulting firms representing over 11,000 clients with DC assets in excess of $4.2 trillion.
Easing the path
Fortunately, going custom is easier than ever. Recordkeeping, custody and trust capabilities have advanced significantly, as has the number of experienced consultants able to walk clients through the process. Custom or semi-custom TDFs are viable for plans of all sizes, yet they are most strongly recommended for plans with over $500 million in DC assets.
Selecting a plan’s investment default is by far the most important investment decision plan fiduciaries will make. Going custom may maximize a plan’s buying power and improve oversight of both the asset allocation glide path and the underlying investment strategies. Plans also may delegate, or at least share, a portion of their fiduciary oversight by, for instance, hiring a glide-path manager.
In a country where many individuals lack sufficient retirement savings, the embrace of custom and semi-custom TDFs may provide hope for those seeking a better financial future.
Stacy Schaus leads PIMCO’s Defined Contribution Practice.