View Points November 26, 2014

Open Architecture vs. All-Proprietary Target-Date Funds

The diversity of investment options available for today’s 401(k) plans can be overwhelming, so it is important for employers to understand the nuts and bolts of the investments they’re choosing.
Reported by

Many plan sponsors believe that offering a lineup of target-date funds (TDFs) is imperative, particularly for participants who are not utilizing personalized advice but still want and need a professionally managed solution for their assets. 

But TDF offerings are by no means all alike. TDFs are typically offered by asset managers, banks, trust companies, and insurance companies in the form of mutual funds or collective trusts. Mutual funds or collective trusts may utilize either proprietary-only or open architecture investment strategies. Most TDFs rely on proprietary-only strategies. This means that asset allocation, manager selection, and security selection are all provided by the same firm. As a result, these funds are filled exclusively with proprietary investment choices.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

Open-architecture funds are distinctly different. Depending upon whether the TDF is a “fund of funds” or a collective trust, the fund may search for and select non-proprietary funds or third-party managers to act as sub-advisers to the fund. Plan sponsors would do well to consider the key differences between proprietary-only and open-architecture target date funds. When it comes to flexibility, cost, aligned interests and track record, the benefits of open-architecture target date solutions are hard to ignore.

Flexibility

Since open-architecture TDFs are not wedded to a single firm’s underlying strategies, they can include a mix of different investing styles and seek out leading managers with the goal of delivering increased levels of diversification.

Frankly, it is unreasonable to expect any single firm to offer the best funds with demonstrated track records in every asset category, because every investment firm has its strengths and weaknesses. Open-architecture funds have the freedom to bring top funds or sub-advisers together under one umbrella, regardless of their “house brand” affiliation. This means an open-architecture fund could include large cap, multi-sector fixed income, emerging markets and small cap strategies, all from different managers that are considered among the best in class in their respective strategies, and better diversify the TDF relative to proprietary-only target date funds.

The use of third party sub-advisers means open-architecture TDFs are less vulnerable to groupthink. With proprietary-only strategies, all of the fund managers are typically relying on the same research, analysts, and economic outlook to form their point of view, which can be risky. TDFs that work with a number of firms help to mitigate this risk for plan participants because these funds have the benefit of a broad range of research, processes and schools of thought about the markets.

Costs

Though it might seem counterintuitive, some open-architecture funds, particularly collective trust funds, have an additional ability to control costs since they have the flexibility not only to search for a wide variety of strategies, but also to negotiate on price in a competitive search process.

Proprietary-only strategies may be restricted to their own underlying strategies, and by extension, the fees or expenses associated with those strategies. This can drive up costs, particularly for smaller or more specialized asset managers that lack the bandwidth to support a TDF for the defined contribution plan market. These costs can translate into higher operating expenses being passed on to plan sponsors and participants.

In an open-architecture lineup, the fund sponsor typically has negotiated pricing with its sub-advisers, and these savings can be passed on to the participants. With open-architecture funds, plan sponsors and their participants get access to investment managers selected based on portfolio fit, performance and pricing criteria; and specialist sub-advisers get access to the very large defined contribution market that may otherwise be out of reach. It’s a win for everyone.

Aligned Interests

Most plan fiduciaries would never consider constructing an all-proprietary core investment menu as part of their plan. Today, a typical mid-size defined contribution plan may offer 10 to 12 mutual funds from several providers. Essentially, that’s open-architecture, and it has been adopted because plan sponsors recognize that a diversified offering can help better serve participants.

Open-architecture TDFs are constructed using a similar approach. Unlike funds that are limited to using only proprietary products, open-architecture TDFs can select from an unconstrained universe of strategies, and make adjustments as warranted. This helps mitigate the potential for conflicts of interest to factor into decision-making, and provides better diversification. 

Track Record

Open-architecture target date funds can define the criteria for the type of third party fund or sub-adviser they want, and therefore focus on identifying managers and funds with demonstrated expertise. Proprietary TDFs are limited to offering what’s on their shelf, so while they may be able to offer a product to fill a particular slot, it can be harder for them to demonstrate their process for selecting the best funds for plan participants.

The Case for Open-Architecture

The idea of a one-stop, proprietary TDF line up may appeal to some, but the reality is that an open-architecture model offers a level of flexibility and transparency that cannot be dismissed. Plan sponsors need to apply the same level of rigor, due diligence and fiduciary process to their target date family selection as they do when putting together their retirement plan’s core offerings.

Asking the Right Questions

As part of the ongoing evaluation of the plan’s investment offerings, plan sponsors can start a dialogue with TDF providers by asking the following:

  • How many different investment managers are represented in the underlying funds?
  • If the underlying funds are all from one firm, do they use centralized research and economic forecasting?
  • Are the underlying funds all active, all passive, or both?
  • How much overlap is there among holdings in the underlying funds?
  • What is the TDF manager’s process for selecting and removing the underlying funds?
  • Are the underlying funds owned by mainly institutional or retail investors?
  • Are the lowest-cost share classes being used for each underlying fund?
  • What is the portfolio management tenure of the underlying strategies?
  • Has the TDF provider ever replaced an underlying strategy?
  • How well have the underlying strategies performed?

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author(s) do not necessarily reflect the stance of Asset International or its affiliates.

Data & Research November 25, 2014

Provider Mobile Capabilities Slowly Improve

Mobile-optimized sites with transaction capabilities are slowly but surely entering the retirement planning picture, according to Corporate Insight research.
Reported by

A new analysis from Corporate Insight, “Mobile App Alternative: Reviewing Mobile-Optimized Websites,” takes a look at mobile-optimized sites available to retirement plan participants.

Two main points emerge from the current research, according to Drew Way, senior analyst of the Retirement Plan Monitor at Corporate Insight. First, the industry is finally seeing the arrival of retirement plan account transaction capabilities via mobile sites. “When we first looked at the retirement space and mobile offerings, not a single firm offered real transaction activity via mobile,” he tells PLANADVISER. Today, four providers in Corporate Insight’s coverage group of 17 top retirement plan providers offer at least one type of transaction capability on their mobile site, with more providers expected to offer mobile transactions over the next year.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

Second, plan sponsors and recordkeepers are increasingly focused on the role of mobile and whether it can be an avenue to increase engagement, Way says, and plan sponsors generally feel this technology is a great opportunity for engagement.

Fidelity seems to emerge as the most noteworthy provider in the survey, Way says, with a great mobile website and a myriad of ways to engage participants. For example, a comparison tool on Fidelity’s mobile site allows participants to input their age, and recordkeeping data automatically pulls the contribution rate, balance, a rate of return, and a comparison to their peers across four regional averages. Participants are ranked by ZIP code, state, region and across the country, Way notes.

The comparison data adds an element of gameification—playing into the naturally competitive drive most people have—and makes them realize they’re either seriously lagging or beating their peers, or that they’re right on track. “A lot of the other firms we looked at offer some limited projections, but this is more robust,” Way says. “Adding the competitive element to the mobile site can really drive people to increase the contribution rate.”

Fidelity’s ready-or-not questionnaire is also noteworthy, Way says. This feature helps participants understand even what preparedness means at a basic level. An interactive graphic depicts how their peers answered important retirement readiness questions.

TIAA-CREF also distinguishes itself for great education content on the mobile site, as well as a savings tool that allows the participant to remove items from a daily budget, Way says, showing how much money can be saved in the long run.

On balance, Way feels, the larger providers are outperforming the smaller ones. “But our data on the smaller providers is limited, as all 17 firms we looked at are pretty much the biggest providers, so we’re really only looking at the big players,” he says.

As the firm has noted in previous reports, Way says, “it’s really clear that retirement providers are lagging behind other industries on their mobile website offerings. Even firms with really great desktop websites are lacking.”

T. Rowe Price, for example, has a loaded desktop website full of great tools and resources, Way notes, but their mobile website lacks transaction capabilities, although they do offer transactions on their phone apps. “So that’s an example of where firms have had to focus on either the app picture or the mobile website picture,” he says. “That in itself is a challenge for a firm, deciding where to invest in technology.”

Way cites industry scuttlebutt that says that T. Rowe Price is working on the mobile site right now, and he mentions that a number of other providers are dumping resources into this area. Before long, provider mobile sites will show significant improvement, he feels.

“I’m very eager to see what’s going to roll out in the next year, especially looking at the last year,” he says.  He also notes that mobile websites are not nearly as popular as apps right now among providers, and a few stats in the report support this.

“If you want to make an app, it has to be developed separately for each different operating system—one for the iPhone, one for Android, and so on,” Way points out. A well-designed mobile site, on the other hand, just needs one, which different mobile devices can access through the same site. That’s just not true for apps, he says, which is especially important in the retirement plan space, where providers need to catch up quickly.

According to a recent survey, Way notes that a full 4% of plan sponsors cited mobile technology as a major deciding factor in switching or seriously considering a change in retirement plan providers. “While 4% doesn’t sound like a lot, some of these firms have multibillion dollar defined contribution plans, so it’s a huge opportunity for those who are leading on mobile development,” Way says, “especially when you consider that the largest plans out there are going to get fairly similar fees and services offered from all the different providers. Mobile really can be a critical tiebreaker.”

«