The DoL fiduciary rule is making nearly every retirement plan professional a fiduciary on 401(k) plans.
But past is prologue. As early as 2013, the DoL clearly laid out a guide for advisers entering this brave new world in a fact sheet, "Target Date Retirement Funds – Tips for ERISA Plan Fiduciaries."
There are five key takeaways. For each first-generation target date fund advisers work with, they must:
1. Establish an objective process for comparing, selecting and reviewing TDFs.
Brand recognition is not a valid selection criterion.
The DoL wants a fair process of TDF selection, and fiduciaries should review their TDF choices on an absolute and relative basis. Gone are the days of one size fits all.
Is the TDF family offered only in the plan because of a bundled 401(k), or are they the best fit for the plan?
Start with the plan’s Investment Policy Statement. What are the demographics of the employee pool? What does the sponsor want and why? What do the employees want? Hint: Ask!
Some may want the lowest possible expense. Others would rather pay a bit more for active management, more aggressive/conservative glide-paths or other attributes.
2. Understand the fund’s investments — both equity and fixed income — and how they change over time.
The general goal of target date funds is to have assets grow over time with risk appropriate investments. The fiduciary’s role, according to the DoL, includes “understand[ing] the principle strategies and risks of the fund, or any of the underlying asset classes or investments that may be held by the TDF”.
When assessing equities, remember that target date funds vary greatly in their construct. For instance, according to Morningstar, of all the 2030 TDFs, the range or variance of equity ownership is almost 50%. One TDF manager can have 85% equity in their TDF and another 35%. Advisers need to know how much equity is held in the TDF family they recommend.
And remember that TDF managers can and do change the holdings. In summer of 2015, right before the August market drop, one of the largest TDF managers increased its domestic equity by 15% on all but two of its TDFs. Another increased its international equity 10% across all of its TDFs. Did you, your sponsors and participants know this?
The DoL Fact Sheet points out that : “As the target retirement date approaches, the fund’s asset allocation shifts to include a higher proportion of more conservative investments, like bonds and cash instruments, which generally are less volatile and carry less investment risk than stocks”.
Have you ever looked at the bond holdings of your TDFs? What percent are long-term (20 to 30-plus years), junk or emerging markets?
Not one investment professional we know, using the prudent man rule, would classify these bond types as “more conservative” investments. What types of bonds are in the TDFs you recommend?
Rates won’t stay low forever. How will your clients respond when interest rates go up and bond values drop? It has been decades but bonds have bear markets too! How will your TDF manager seek to protect these assets for those who have the most to lose…employees who are nearing retirement?
3. Determine if the expenses in the TDFs are appropriate for the services given.
Yes, lowering unnecessary expenses will increase investor returns and this is important to all investors. This is one thrust of the new DoL rule.
However, expenses are not everything. The lowest cost TDF may be a bad fit and inappropriate for a plan. The keys are suitability and value. What are you getting for the fees provided? To quote the 2013 Fact Sheet: “Added expenses may be for asset allocation, rebalancing and access to special investments that can smooth returns in uncertain markets…” Can your TDFs smooth the ride in uncertain markets?
Most participants expect their portfolios to be shielded from large losses as they approach retirement. Index-based TDFs offer little to no protection against large losses, unlike dynamic TDFs can.
4. Know if the TDFs chosen have the ability to get defensive in market failures.
In 2008, the three largest TDF 2010 funds lost between 21% to 27% of their value. How would your sponsors and employees feel if they got within two years from retirement and lost a quarter of their retirement savings? Most would no longer be able to retire. Every asset class goes through periods of failure. Why leave your clients vulnerable to these inevitable downturns?
Again, we find that sponsors and participants alike want and expect their principal to be more sheltered from large losses as they get closer to retirement. They know their investment time horizon is shrinking and it is prudent to manage risk accordingly. Revisit the equity and bond sections above. Knowing what is in the TDFs — such as exposure to alternative asset classes — will give you a solid foundation to your process.
5. Develop effective employee communications.
Finally, all this information needs to be communicated to the participants. If they don’t understand the glide path and holdings, they are likely to be disappointed at some point. Unhappy participants translate into a liability for plan fiduciaries. Communication starts at the beginning of the relationship with interaction, education and providing appropriate choice.
For advisors providing retirement plan services, yes, you are a fiduciary. In order to abide by the new DOL requirements you must be sure to educate yourself and your clients. While the process is easy to do, you have to do it for each and every plan.
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