Feature:Qualified Success?

The news about qualified default investment alternatives (QDIAs) in 2009 was that there really was no news. The market volatility of the fourth quarter of 2008 did not have much impact on QDIAs, says Stephen Utkus, Head of Vanguard’s Center for Retirement Research in Malvern, Pennsylvania. Few sponsors reconsidered QDIA choices, he says, because retirement plan committees understand portfolios decline sharply in a bear market. Instead, their reaction to the market was to stick with their choices because the portfolios still made sense.

The economic downturn, however, did expose some flaws in QDIAs, particularly the most popular QDIA choice, target-date funds. Because a number of target-date funds—notably those designated for participants planning to retire in 2010—were heavily weighted in equities, participants close to retirement saw steep declines in their account balances late in 2008.

“Target-date funds are neither the problem nor the solution to making sure people have enough income in retirement,” says Jamie Kalamarides, Vice President of Retirement Solutions at Prudential Financial in Hartford, Connecticut. While target-date funds currently reign supreme in the QDIA realm, Kalamarides sees a future migration to other products that offer downside market protection prior to retirement and income guarantees. This is going to get increased focus in coming years, he predicts, with both the Internal Revenue Service and Treasury interested in providing this protection to participants.

Yet, while the economic downturn did not lead to sponsors changing their QDIA selections, it has led to a number of debates. Utkus notes that there is an ongoing debate as to whether QDIA funds, whether target-date funds or other QDIAs, should be managed actively or passively.

There is also a policy debate as to whether participants understand how their QDIA funds work, says Utkus, and at least an inference that sponsors should do more to ensure they understand. Many believe that the Department of Labor (DoL) will issue guidelines or a checklist of what plan sponsors should consider but, almost by definition, participants are in QDIAs by default, notes Utkus. How much disclosure can be effective to a participant who did not even take the time to sign up for his 401(k)?

There also has been a debate on glide paths, how the shifts in asset allocation take place over time. There is a political debate, says Utkus, that glide paths are too risky. The overwhelming consensus of retirement plan committees is that they are not, he says. In contrast to sentiments in the political realm, there has been no big shift away from equity exposure at retirement in the marketplace, says Utkus. Committees realize that, when participants retire, they are going to live for decades and need a balanced portfolio, he says. Committees also take into account that participants have Social Security and other assets, he adds.

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Another debate since the financial crisis lies in the appropriateness of target-date funds as the QDIA of choice. Some believe that, while target-date funds are appropriate and adequate for accumulating assets before retirement, they do a poor job of providing steady, reliable retirement income. “They’re good at getting people to retirement, not through retirement,” says Kalamarides.

Additionally, while target-date funds take into account time horizon, they do not take into account risk, says Kalamarides. The wild market fluctuations of the fourth quarter of 2008 demonstrated that participants, he says, often could not handle volatility.

That said, target-date funds are here to stay, acknowledges Kalamarides, but target-date funds will evolve from just being accumulation solutions to including guarantees. That way, he says, the risk of having a bad year just before retirement or outliving assets will be mitigated.

There is an increased awareness by large-plan sponsors not just about time horizons, but also risk tolerance, says Kalamarides. He predicts that, in 2010, large-plan sponsors will begin adopting next-generation QDIA products with guarantees. The trend will shift from accumulation solutions to QDIAs that take over longevity risk, he says.

There is also an emerging trend for QDIA pricing now that more plans are moving to automatic enrollment, says Utkus. Three to four years ago, when plans started automatically enrolling workers, there was little money in those default funds, says Utkus. As those assets grow, there will be more and more money in these QDIA funds, and there will be pressure to find lower-cost vehicles, says Utkus. As more money flows into funds, Kalamarides says that plans can graduate into better share classes and get better pricing.

Another emerging QDIA trend is reenrollments. Previously, when participants were reenrolled after fund changes, says Utkus, participants were mapped to similar funds. The new trend, he says, is to map everyone to the QDIA unless they specifically opt out. This could mean even more money in QDIA funds, putting increased downward pressures on fees, he notes.

The long-term question people are discussing now is how to provide participants with adequate lifetime, guaranteed retirement income in a defined contribution universe, says Kalamarides.

“If you’re going to put people on auto-pilot, you don’t just bring them to the point of retirement, but through retirement with guarantees of lifetime income,” Kalamarides says.

—Elayne Robertson Demby  

SIDEBAR: Investment "Help"?   

It is a long-accepted tenet that most retirement plan participants want—and need—help to make good investment decisions, and a recent study suggests that it makes a difference.

The new report, a collaboration between Hewitt Associates and Financial Engines, titled “Help in Defined Contribution Plans: Is It Working and for Whom?” comes to the unsurprising conclusion that participants who get (investment) “help”—defined in the report as target-date funds, managed accounts, or online advice—are better off than those who do not, in all but the most extreme circumstances (in 2008, the most-conservative allocations, no matter how undiversified or age-inappropriate, did better than more diversified portfolios, according to the report). On average, the median annual return for Help Participants was almost 2% (186 basis points) higher than for Non-Help Participants, net of fees, according to the report.

Additionally, those participants using “Help” have portfolios with risk levels that the ­survey’s authors suggest are both “more appropriate for their retirement horizons and more efficiently allocated among the options in their plan.” Factors contributing to that risk “gap” were the tendency of “non-helped” participants to make no adjustments in their portfolio (or risk level), and a gravitation toward larger holdings in company stock over time. In fact, the survey noted a particular concern—in view of a more limited time to recover from mistakes—that the greatest variability in observed portfolio risk levels was found among retirees and near-retirees not using “Help.”

On average, across the more than 400,000 plan participants represented in the report, about a quarter use at least one of the types of Help offered within their 401(k) plans. However, average usage of Help overall varied across the seven plans in the sampling, from a low of 15% to a high of more than 35%.

Of the quarter of participants using Help, 9.8% are invested appropriately in target-date funds (e.g., 95% or more of their balance in that offering—as an interesting side note, of the 75% not using “Help,” 43% have allocated some money to target-dates, but less than 95%. The average portfolio allocation among those participants was 36%), while 9.7% were enrolled in managed accounts, and 5.8% use online advice.

The report looked at participant behavior, portfolio risks, and returns during a particularly volatile period in the markets—January 1, 2006, and December 31, 2008—across a dataset of seven large plans representing more than 400,000 individual participants and more than $20 billion in plan assets.

—Nevin E. Adams, JD 

This article originally appeared in the April issue of PLANSPONSOR Magazine.