Since passage of the Pension Protection Act in 2006, target date portfolios have overwhelmingly become the most utilized choice for the qualified default investment alternative (QDIA). According to the Plan Sponsor Council of America’s (PSCA) 58th Annual Survey, target date funds represent 74% of surveyed plans. This growth has been a resounding success for those Plan Sponsors seeking to place participants on a prescribed path to manage risk exposure over time. However, target date portfolios are built with broad applicability in mind. With a glidepath built for the “average” investor, target date funds warrant additional dialogue on how participants differ from the average. Managed Accounts seek to solve this question and may also provide insight for the future of QDIA assets.
Target Date vs. Managed Accounts
Target date portfolios know one thing about any participant: his or her age. Based on this lone data point, a target date portfolio then assumes a variety of factors about the participant such as the date of work force entry, savings rate and projected retirement date, among others. All of these characteristics combined help inform the glidepath. Recall, the glidepath refers to the prescribed transition an investor will make from a riskier or more equity heavy portfolio at a young age to one with less risk and greater fixed income exposure as he or she nears retirement.
What if your QDIA could know more about you? By pulling additional information from your company’s defined contribution plan, managed accounts seek to reduce the margin of error by assuming less and learning more about each participant’s current financial situation. For example, a managed account would know that you save 30% of your income each year compared to a peer who saves 3%. Even a single data point could have a material impact on how participants allocate their portfolios. Additionally, outside information provided by the participant could further reduce the margin of error. The participant whose spouse has a generous pension accrued would have a dramatically different financial plan than a single participant with only accumulations in a defined contribution plan. The benefit of this supplementary information, whether perceived or real, has not been lost on Plan Sponsors and participants.
According to Vanguard’s more recent How America Saves Survey, plans offering managed account options have grown from 14% in 2011 to 25% in 2015. Given the ability for more customized and potentially better participant outcomes by simply having more data, why wouldn’t Plan Sponsors consider a managed account as an investment option or as the plan’s QDIA? We believe the following items have been and will likely continue to serve as impediments to managed account adoption.
Data
The ability to customize an allocation to a participant is only as good as the data. In select instances, external data can be pulled from the plan’s recordkeeper, requiring no additional effort from the participant. More frequently, the data must be pushed to the managed account by the plan participant. This often manual process creates a meaningful hurdle in that participants, especially younger participants, tend to be more passively engaged in their retirement plan. If participants do not proactively add their financial information and update the model with changes over time, the optimization may be just as flawed as the margin of error from the target date portfolio that assumes an “average” input.
Complexity
Assuming all relevant data to customize a portfolio could be acquired without issue, the next question is what to do with it. While some data points have fairly obvious adjustments to an individual’s allocation, others may not. Back to the example of saving 30%, it is unclear if this extraordinary savings rate allows a participant to take on greater risk because the probability of meeting his or her goal is higher or conversely, a participant has the opportunity to reduce risk and still achieve his or her goal. This quandary becomes a philosophical question, not a math problem with a single answer. Aligning with a managed account provider that shares your belief as a Plan Sponsor in this regard is analogous to the due diligence efforts required with target date portfolios.
Cost
Perhaps one of the most significant hurdles Plan Sponsors and participants face is the cost of managed accounts. Often priced on a sliding scale based on percentage of plan assets that are allocated to the managed account provider, these portfolios are often more expensive than a target date portfolio. Additionally, a target date fund’s expense ratio reflects the all-in cost which includes the management of the glidepath and the underlying investments. With a managed account, the participant is subject to the managed account fee plus the weighted average fee of the underlying investments. In some instances, managed accounts could be meaningfully more expensive than a target date strategy. In today’s litigious fee environment, the cost factor alone may be a nonstarter for some Plan Sponsors.
Need
Even if all the right data is used, philosophical questions are agreed upon and cost is not prohibitive, there is still not a uniform need for customization for plan participants. For example, younger participants despite varying inputs are likely to still have substantially similar allocations given their time horizon for investment is 30 or more years. In this case, younger managed account users might pay more for custom advice relative to less expensive target date funds when they are receiving similar advice. However, for participants nearing retirement, there may be an opportunity for real value given many individuals have materially more complicated financial situations as they approach retirement.
Managed accounts pose the right question: how can we provide a better solution to improve participant outcomes and retirement security? Knowing more about participants, including their current financial standing and their unique preferences for risk, has the potential to help participants achieve more optimal portfolios. Today’s offerings, however, aren’t without additional considerations. Managed accounts have some catching up to do in the areas of cost, transparency and simplicity to compete with target date portfolios as a QDIA. Looking ahead, it seems likely the solution for participants will lie somewhere between the two. The opportunity to include additional information about participants coupled with the simplistic and pragmatic approach of target date funds can be a powerful combination. In the meantime, the choice to add a managed account program, weather the QDIA or not, remains an important fiduciary consideration that requires the same rigor of diligence that any other investment option faces in the selection process.
Please contact any of the investment professionals at DiMeo Schneider & Associates, L.L.C. for assistance with evaluating your plan’s QDIA and managed account solutions.
