A recent Hewitt EnnisKnupp (HEK) blog post, “A Primer on Custom Target Date Funds,” provides an excellent short overview on custom target date funds (CTDFs). The post focuses on defining what a CTDF is, why plan sponsors change from traditional TDFs to custom TDFs, CTDF drawbacks and the myths that need to be addressed with plan sponsors.
The section on myths is interesting in that these myths represent some of the headwinds that plan advisors who advocate CTDFs are most likely to encounter. The three myths identified are that CTDFs:
• increase plan sponsor liability;
• are overly burdensome to design and construct; and
• complicate DC investor communication
The author’s main point about plan sponsor liability is that plan sponsors may actually decrease their liability by gaining greater control over a TDF’s internal investment components, expenses and glide path. The logic is that, although plan sponsors are ultimately responsible for these factors, when TDFs are off-the-shelf generic TDFs, the plan sponsor has no control over what happens beyond the selection of the TDF suite.
In terms of fund construction, the author essentially says that the construction tools are readily available and that they (HEK), “typically help plan sponsors design their custom glide paths in two 1-hour discussions with their Investment Committees.”
The argument that CTDFs are complicated to communicate is dealt with by simply treating it like any other TDF, which is, as many know, perhaps the easiest asset allocation program to communicate. The DC investor matches the retirement date with the appropriate fund and checks the box. Therefore, all that happens when a TDF is switched out for a CTDF is that, “the CTDF approach simply improves the ability of the plan sponsor to put a more cost-effective and appropriately constructed tool in the hands of the participants,” the post asserts.
Growth of CTDFs has been slow (especially in the small and mid-market) and, today at least, generic TDFs continue to dominate fund lineups. However, the trajectory seems to be pointing toward a shift in the direction of CTFDs at some point in the future. This move will be driven by an increasing shift toward advisor-centric plan management. As advisors gain control, they also find themselves in need of being relevant. To simply choose a popular name brand TDF, which is often funded exclusively by passive investments, does not seem to add much value. The next logical step is to add additional value via construction of CTDFs. And, as the blog post attests, the tools for doing so are becoming increasingly available.
Finally, it bears pointing out that the DCIO providers, who have been effectively locked out of the TDF market due to the dominance of a handful of TDF providers, will also be nudging advisors in the direction of CTFDs.
Though the big shift toward CTDFs has yet to occur, plan advisors should begin to consider how they will respond to this movement once it begins to take hold. Or, perhaps, they should consider whether or not to become early adopters of CTDFs — a move that could put them ahead of the game.
