For 401(k) Plans, It’s ‘Back to the Future’

In 1985, Back to the Future, starring Michael J. Fox and Christopher Lloyd, was a box office hit. Fox’s character, Marty McFly, went back in time to 1955 when his parents were in high school, and then with the help of “Doc” Brown (Lloyd’s character) managed to return to 1985. 

In some respects, we are experiencing our own time travel today. If we were to go back in time to the year 2000, we would see a majority of 401(k) plans with a limited number of investment choices all managed by the same investment manager. It was product without process. The term “fiduciary” was seldom heard or understood. Since that time, best-of-breed fund lineups, formed by a prudent investment process, have been the norm in our industry, but that is changing before our eyes with the popularity of target date funds. 

The question is, is anyone noticing?

There’s no question that TDFs have dramatically changed the 401(k) landscape. Studies show that soon 80% of contributions will be allocated to TDFs, for most of which the underlying investments and the record keeper are the same. This is not to say TDFs are a bad thing, but just that having a majority of plan assets with one fund manager goes against everything we as an industry have been educating advisors and plan fiduciaries the past 15 years to avoid. The concentration of assets with one investment manager is reminiscent of the days prior to open architecture investment menus. 

Have we gone back to the future? 

In 2013, the Department of Labor issued “Tips for ERISA Plan Fiduciaries,” which offered guidance that plan sponsors engage in an objective process to evaluate, analyze and document the process when selecting and monitoring a TDF (in fact any investment option). Fortunately, plans have more choice today than in 2006, when PPA was enacted making TDFs the QDIA of choice. Today, there are more than 60 TDF series from which to choose. 

Not long ago, plans were limited to what was available on their record keeper’s platform. The decision was a record keeping one, rather than the product of a sound investment process. But that is changing as more record keepers and third party asset management services are coming to market, offering open architecture or custom models.

 

Recent studies from Callan and others indicate a slow but steady shift to custom and multi-manager target-date and risk-based models. Open architecture or multi-manager TDFs enable an advisor to demonstrate their value more so than an off-the-shelf proprietary TDF. These strategies typically have a pre-constructed glidepath and asset allocation overlay, leaving the advisor to help the plan sponsor select investments from the plan’s core fund lineup. 

Custom models can provide many benefits not found in off-the-shelf target date funds:

It has been written that those who cannot remember the past are condemned to repeat it. We are at an inflection point similar to where 401(k) plans were 15 years ago prior to open architecture. Investment Committee challenges with TDFs are here to stay. Regulators are taking a much closer look at target date funds and the DOL is encouraging plan sponsors to consider non-proprietary fund models. 

Looking forward, plan advisors, DCIO firms and record keepers together can play an important role. It starts with having a conversation with the plan committee to determine a TDF solution that aligns with their investment objectives, risk profile and participant demographics. Next comes educating and informing plan fiduciaries of the myriad non-proprietary fund options available, with the goal of improving retirement outcomes. And lastly, there’s the need to document the prudent process followed by the plan in meeting their fiduciary duty to select investments that are in the best interest of plan participants – by doing so we can get back to the future.