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Is a Custom Option Right for Your DC Plan?

Many plan sponsors and consultants may be considering customized investment options for their DC plan investment menus, but there are a number of issues to consider before going down that path.

A new white paper by Vanguard – “Considering custom for your DC plan” – offers commentary on the potential benefits and drawbacks of including nonstandard investment options, particularly white-label funds, in a 401(k) plan.

Addressing whether customization provides potential benefits to plan participants that outweigh any additional responsibilities and costs assumed by the plan sponsor, authors Michael Palazzi, James Martielli and John Croke explain that, ultimately, the choice “involves a series of tradeoffs and depends on a plan sponsor’s unique situation, objectives and preferences.”

The authors suggest that plan sponsors and consultants should identify the issue they are trying to solve and think about the specific reason for considering a custom TDF or white-label offering:

  • Do they want to offer options with clearer, more descriptive names?

  • Do they want to combine options that are similar?

  • Do they want to include additional asset or sub-asset classes?

  • Or, do they have strong views about using a specific manager for their plan?

More specifically, the paper offers three areas of focus for plan sponsors considering a nonstandard investment approach, dubbed the three Cs: consolidation, control and cost.

Consolidation. The paper suggests that, by eliminating some options while combining and renaming others, the plan menu can be more instructive, making it easier for participants to understand a fund’s investment strategy. To that end, white-label funds that are either managed in house or outsourced provide an opportunity to streamline the DC investment menu. “Through thoughtful white-label design and implementation, the sponsor may consolidate multiple investment strategies into a single, broadly diversified option that provides significant exposure to the desired asset class,” the authors state.

They further advise that in considering a customized approach relative to a pared down investment menu or low-cost passive alternative, plan sponsors “should observe quantitative and qualitative benefits that can be reasonably expected to offset incremental costs.”

Control. Customization also gives plan sponsors more control over the investment vehicle’s design, according to the paper. If a sponsor has specific investment beliefs that require allocations to certain asset classes or manager strategies, customization can help implement them, the paper further notes. But while strong investment beliefs can be a motivator to consider customization, sponsors should “evaluate whether these beliefs are long term and strategic in nature or reflect a more short-term view of market conditions.”

Moreover, the authors suggests that the trend toward unbundling of recordkeeping and investment menus is also evidence that plan sponsors want more control. They emphasize, however, that with white labels, not only does the plan sponsor need to ensure all administrative functions are fulfilled, but they also have to design the portfolio or hire a third-party fiduciary to perform these functions.

Cost. Finally, the authors emphasize that, as with any fiduciary decision, it’s important for plan sponsors and consultants to evaluate potential benefits against the added costs and responsibilities when assessing the use of white-label funds. “Ultimately, plan sponsors must consider their organizational readiness and decide how they want to spend their ‘fiduciary budgets’ in terms of the all-in fees for fund administrative services,” the report states.

It further notes that large DC plans may be able to spread costs over a larger asset base and save on costs by using a customized TDF series or white-label fund, but for most plans, customized options cost more than a standard option, meaning that the potential incremental return must be greater than the costs.