Target-Date Funds Could Be Costing Your Plan More Than You Know

Michael Schultz, RFC, CFS, president, Venn Wealth & Benefit Services discusses variables that should be considered when doing due diligence on TDFs.

Target-date fund (TDF) assets ballooned to roughly $880 billion dollars in 2016, according to April’s Morningstar 2017 Target-Date Fund Landscape annual survey report. And Cerulli Research Associates estimates that TDFs will capture roughly 90% of all new 401(k) plan contributions by 2020.

Considering the kind of money flowing into the funds, and the wide variance in expenses, performance and risk factors, should plan sponsors be increasing their due diligence on these investments? The following are variables that should be considered when undertaking that process.

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Advantages of TDFs

TDFs are a “set-it-and-forget-it” or “autopilot” investment. They tend to be better suited for the participant who is not financially sophisticated enough to allocate for himself. They also provide for diversification because the money will be spread over several mutual funds and be rebalanced and reallocated over time as the person’s retirement age approaches. From an administrative standpoint, they can also ease automatic enrollment.

Disadvantages of TDFs

On the down side, the glide path can vary from one of these funds to another. Some TDFs may be more exposed to risk by the time their target date arrives. Most utilize their own funds as part of the investment mix and may not be the best option within their respective asset class. The autopilot quality can also give participants a false sense of security, making them pay less attention to their portfolio over time or when the market is unstable.

Further, participants tend to use TDFs improperly. A TDF is supposed to be a one-stop shop: Pick a date you plan to retire and the TDF closest to that date. However, participants will tend to mix other asset class funds with their TDF, which defeats the intended benefit. A participant could be tactically choosing other investments to overweight an asset class or sector to improve performance, but if he is this sophisticated at allocation decisions, why would he use a TDF to begin with?

The Data

There were 143 funds in the category “Target-Date Funds 2015,” based on information collected from Morningstar Advisor, and the data presented for these funds revealed significant differences.

Net Expense Ratio

The net expense ratio ranged between .08% and 1.75%, which equates to a 1.67-point spread. As a plan sponsor, if you have the more expensive TDFs in your lineup, you had better be prepared to defend your decision to utilize them.

Allocation Range

You would think TDFs with the same target date would be similar in their allocations. The equity allocation ranged between 24.3% and 55.8%, while the bond allocation ranged between 32.5 and 74.6%. Even the amount of cash held ranged from .52% to 30%.

Performance Range

Performance difference is no exception. The five-year performance ranged from 3.1% to 8.3%. Participants not getting the better returns could be missing out on thousands of dollars over time.

Standard Deviation

Lower volatility is perceived as more conservative, and standard deviation measures the volatility of a fund’s return in relation to its average.

TDFs are supposed to have a glide path toward more conservative assets, such as bonds as they get closer to the target date. In a rising rate environment, bonds can be as risky and volatile as their equity counterparts. The iShares 20+ Year Treasury Bond ETF [exchange traded fund] is a good fund, but it has a three-year standard deviation of 11.44, compared with the SPDR S&P 500 ETF, which has a three-year standard deviation of 10.04. How does a participant know if the TDF is adjusting the bond position to protect against the effect of rising rates?

Follow the Money

As a plan sponsor, are you paying fair value for an adviser if TDFs are recommended or utilized more heavily? As mentioned earlier, the funds are a “set-it-and-forget-it” investment that doesn’t require allocation changes or rebalancing.

As an example, we’ll take a $3 million plan with 50 participants, assume the adviser meets with each participant for 30 minutes twice a year and provides no other 3(21) or 3(38) fiduciary services. Keep in mind, if most assets are in TDFs, there isn’t much to talk about on visits because of the autopilot nature of the investment. If the adviser receives .50%, this equates to $15,000 a year, or $600 an hour. If we instead use an hourly rate of $150 and the same time assumption, this totals just $7,500 a year, compared with $15,000. Making this single negotiated move would result in a 50% savings staying with the plan or in the pockets of participants.

It’s not that TDFs are completely worthless. As a plan sponsor, you need to understand your participant demographics, needs, amount of service needed and any limitations of your plan provider. TDFs have been manufactured and brilliantly marketed by a very powerful financial service industry. It’s important to understand that they are not superior to other investments when it comes to performance. So, if they’re not superior to other investment options, then you should ask yourself … who stands to profit the most from their use?

Michael Schultz is president of Venn Wealth & Benefit Services, LLC. With over twenty years of experience in the financial service business and a Bachelor’s Degree in Accounting from Penn State University, he has been a strong advocate for plan sponsors and participants to improve the overall effectiveness of retirement plan strategies.

The information contained herein is for informational purposes only. None of the information constitutes a recommendation by Venn Wealth & Benefit Services and is not intended to provide tax, legal, or investment advice. Venn does not guarantee the suitability or potential value of any particular investment or information source. Certain information provided herein may be subject to change. None of the information contained herein may be copied, assigned, transferred, disclosed, or utilized without the express written approval of Venn.

 

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Strategic Insight or its affiliates.

Investment Products and Services Launches

BNY Mellon releases fund focused on income generation, and AI Insight announces new liquid alternative research. 

BNY Mellon Investment Management has announced the recent launch of Dreyfus Global Multi-Asset Income Fund, which began offering its shares on November 30, 2017. The fund uses an actively managed global multi-asset strategy that focuses on income generation.

 

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BNY Mellon’s Dreyfus Corporation serves as the investment adviser of the fund, and Newton Investment Management (North America) Limited serves as the fund’s sub-investment adviser. Paul Flood and Bhavin Shah are the fund’s primary portfolio managers. Flood, the fund’s lead portfolio manager, is the lead manager of Newton’s global multi-asset income and multi-asset diversified return strategies. He joined Newton in 2006. Shah is an investment manager on the multi-asset team at Newton, and joined in June 2011.

 

“With the launch of Dreyfus Global Multi-Asset Income Fund, we see the potential for U.S. investors to capture attractive income streams globally, while diversifying risk through Newton’s multi-asset, active approach,” says Joe Moran, head of distribution, The Dreyfus Corporation, A BNY Mellon company. “Across the investment landscape we are seeing a shift away from one asset class products focused on a single region in favor of products that invest across the full spectrum of asset classes, and we are responding to that demand with what we believe are our ‘best-in-breed’ boutique offerings.”

 

Newton allocates the fund’s investments across asset classes seeking to construct a diversified portfolio focused on income generation, while maintaining the potential for long-term capital appreciation and managing the risk profile of the fund’s portfolio of investments. Newton allocates the fund’s investments among equity and equity-related securities, debt and debt-related securities, and, generally to a lesser extent, real estate, commodities and infrastructure in developed and emerging markets. The fund seeks to gain exposure to various asset classes principally through direct investments in securities, but the fund also may use derivative instruments and investments in other investment companies, including exchange-traded funds, and real estate investment trusts for such exposure.

 

“Investors need investment options that can deliver not only a current income stream, but that take a long-term approach to capital appreciation. We see Dreyfus Global Multi-Asset Income Fund, which aims to provide current income while maintaining the potential for long-term capital appreciation, as an opportunity that can provide for both needs,” says Flood. “The Fund draws upon Newton’s strong heritage of managing multi-asset portfolios, deep experience across global markets and rigorous fundamental analysis to unearth our highest-conviction ideas for investors.”

 

The fund offers Class A (DRAAX), Class C (DRACX), and Class I (DRAIX) shares with a minimum initial investment of $1,000. The fund also offers Class Y (DRAYX) shares generally with a minimum initial investment of $1,000,000.  Additional information regarding the fund can be found on Dreyfus’ website at www.dreyfus.com.

 

AI Insight Announces New Liquid Alternative Research

 

AI Insight Inc. will begin offering liquid alternative research reports in 2018, enabling advisers to compare the details and financial performance of alternative investment mutual funds.

 

Given the growing popularity of liquid alternatives and need for research around this asset class, the reports are designed to provide financial professionals with the information they need to understand the complexities of these investments, while making it easy for them to document for regulatory compliance.

 

AI Insight also announced the release of a whitepaper, Understanding the Complexities of Liquid Alternatives, which provides information around liquid alternatives, including regulators’ guidance and definition of liquid alternatives; different types of funds; supervision; and training and documentation recommendations.  

 

AI Insight wrote the whitepaper in response to regulators’ increased focus on liquid alternatives, including the release of a Financial Industry Regulatory Authority (FINRA) e-learning course, Understanding Alternative Mutual Funds in August 2017 and a recently reissued Investor Alert by FINRA and the Securities and Exchange Commission (SEC), Alternative Funds Are Not Your Typical Mutual Funds.

 

In addition to making the Understanding Alternative Mutual Funds FINRA e-learning course available on its platform, AI Insight currently offers over 80 CE courses eligible for .5 to 2 credits toward the CFP and other designations, as well as prospectus- and PPM-based research and training.

 

To support its liquid alternative research capabilities, AI Insight has hired Lucas Johnson, CFA, to help lead the initiative. Johnson was formerly a due diligence analyst with National Planning Holdings, Inc., where he specialized in due diligence reviews of liquid alternatives and other alternative investments.   

 

“We are excited to welcome Lucas to the team to help expand our liquid alternative research capabilities,” says Sherri Cooke, president and chief executive officer of AI Insight. “AI Insight is dedicated to providing advisers with the tools and resources they need to understand the risks, rewards and investment strategies of complex products.”  

 

More information on AI Insight’s e-learning catalog can be found here.

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