Set It and Forget It?

Ever since passage of the Pension Protection Act of 2006 (PPA), after which the Department of Labor (DOL) approved target-date funds (TDFs) for use as qualified default investment alternatives (QDIAs), plan sponsors have overwhelmingly chosen the funds as the QDIA for their plan.

According to the 2020 PLANSPONSOR Defined Contribution (DC) Survey, 81% of plan sponsors offer a TDF to their plan’s participants, up from 61% in 2014. But not all target-date funds are the same. Their pricing, underlying investments and risk allocations vary dramatically from fund suite to fund suite, as do the assumptions that go into their glide paths.

Citing these variations, lawmakers wrote a letter to the Government Accountability Office (GAO) in May requesting the office review the funds. They said that, although TDFs are billed as offering participants retirement security—i.e., by placing their assets in an age-appropriate glide path that grows more conservative as they near retirement—the funds might actually put some participants at risk.

Lawmakers are not the only ones raising concerns about TDFs. In a recent research paper, “The Unintended Consequences of Investing for the Long Run: Evidence From Target-Date Funds,” academics wrote that managers of the funds exploit investors’ set-it-and-forget-it mentality.

The paper, which attracted criticism from other researchers, says managers do this by delivering lower performance—for example, 2.9 basis points (bps), for each year from the vintage year. An investor holding such a fund for 50 years at that rate would lose 21% in performance. The authors attributed “the negative impact on performance to the fund families using the TDFs to smooth the flow shocks of the affiliated OEFs [open-end funds], as well as to higher fees arising from investing in the affiliated expensive share classes.”

Still, Michael Finke, professor of wealth management at The American College of Financial Services, was recently quoted as saying the controversy on TDFs surprised him, as “most retirement economists view the use of TDFs as qualified default investments as one of the most successful policy changes that resulted from the PPA.”

Either way, Elise Thiemann, investments director with Willis Towers Watson in Chicago, says monitoring and reviewing TDFs is probably the most effective decision a fiduciary can make. For plan sponsors, this is often a task for which they rely on their adviser.

But benchmarking TDFs can provide unique challenges, Thiemann says. “That’s because the underlying holdings of the funds vary so dramatically, and their long-term objectives mean that short-term performance is not always the best indicator. For plan sponsors, the goal is to evaluate the performance of a TDF’s investment mix, rather than individual asset classes,” she says.

To aid with this process, the 2021 PLANSPONSOR Target-Date Fund Survey compiled data from 24 TDF providers, including details about each of their fund families’ underlying funds, attributes and assets under management (AUM); the information is available for benchmarking on planadviser.com. The survey also indicates (see chart) their performance by objective.

According to an analysis of responses to our 2021 PLANSPONSOR DC Survey, only 43% of plan sponsors formally review investments quarterly; 13% do so semi-annually, and 31% annually.

Target-Date Mutual Fund Performance, by Objective*

*Weighted average total return as of December 31, 2020. 
Source: 2021 PLANSPONSOR Target-Date Fund Survey