Next-Level Options

Art by Taylor Dow

When Gene Huxhold, senior managing director with John Hancock Investment Management, analyzed the employee demographics at a casino in order to choose a suitable target-date fund family for the defined contribution plan, he was surprised to land on the most conservative glide path option in the John Hancock lineup. The firm wound up selecting a glide path where the final equity stake drops to 10% at its target date.

But, given that this well-paid workforce also had a defined benefit plan and a nonqualified program with what Huxhold describes as overall “solid wealth,” an extremely conservative target-date glide path seemed like a “perfect fit. You have to look at the population and see what best meets the needs,” says Huxhold, who is head of DCIO [defined contribution investment only], based in Charlotte, North Carolina.

As target-date funds continue to grow in number and popularity, some advisers and consultants identify an emerging challenge in precisely matching the investing needs of employees with the right fund. For some advisers, this means trying to understand the employees better; for others, it may mean introducing more custom solutions, including managed account offerings, or pursuing new options in environmental, social and governance investments.

“Target-date funds are doing a great job for a majority of participants,” says Lucian Marinescu, certified financial analyst, portfolio manager and head of target-date strategies with Morningstar Investment Management LLC in Chicago. “They understand how the glide path works. And plans have done a great job, educating the participants on the benefits.”

Yet, despite the general advantages the funds offer, Marinescu’s past analyses of various glide path trajectories show as much as a 30-percentage-point equity allocation difference at the beginning of the target-date investment and more than a 40-percentage-point gap at the end across the universe of TDFs available.

Because of this wide range of options, keying in on the ideal fund becomes essential. Morningstar has developed a quantitative process to help clients assess the appropriateness of a given glide path, Marinescu says. That approach bears in mind the total wealth of the participant and draws from the outside data increasingly available through the recordkeeper, as well as average age, salary, savings rate and plan assets.

Assessing risk tolerance is also a multistep process for Mike Geraci, senior product manager of retirement investment solutions for Commonwealth Financial Network in Waltham, Massachusetts. Besides examining company census data such as the employees’ average age and account balance, his firm also considers what kind of business it is and the financial savviness of the workforce.

“If it’s an investment firm, that’s a more qualitative piece where we can look at the risk and see if it aligns,” Geraci says. He also will cross-check the participants’ choices and compare what they define as their retirement age against the target-date fund they selected.

Jamie Worrell, managing director with Strategic Retirement Partners in Providence, Rhode Island, also says greater benefits result from a dynamic qualified default investment alternative that considers the bigger picture for a participant; here, the participant starts in a target-date fund and eventually moves into a managed account. This strategy would factor in “some other element beyond your age and what inputs can we get, assuming we have inertia,” says Worrell. He points to the value of capturing additional elements such as risk tolerance, a participant’s other assets or even spousal assets. If the firm had more information, “how would we alter your portfolio?” he says.

And while younger employees may have had their retirement assets defaulted into a target-date fund when they started investing, Worrell says, it may be necessary to go back and re-enroll some senior employees into the TDF.

“You can have a segment of people who are misallocated for their age,” he says, observing that he regularly sees some participants nearing retirement with 80% allocated to equities. “You have this left-behind population.”

Going Custom?

For advisers looking to improve participant outcomes, custom solutions continue to appeal. Marinescu finds that clients that choose a custom solution usually make the decision based on the team responsible for the retirement plan. If they have a DB plan, they usually have a dedicated investment team that selects the funds and would leverage that expertise into a custom TDF that reflects the same philosophy.

For instance, a client may prefer some managers of certain asset classes to also manage specific assets within a TDF. Second, it may have the capacity to perform due diligence, including employing a consultant to analyze its demographics and determine whether its population needs an option as yet unavailable. Hiring a consultant makes sense when “they don’t really feel like their participants are average from a demographic perspective,” Marinescu observes.

The volatility in the markets has prompted renewed interest in custom choices, especially those that incorporate alternative investments, according to Huxhold. The downside, however, remains that they can be cost-prohibitive.

“Even if one wants to add more of something, such as alternatives, we’re conscious of cost,” he says. These types of custom solutions are most apt to suit mega plans where “the assets have to justify that,” he says.

At OneAmerica in Indianapolis, Steven Kofkoff, vice president, retirement services strategy, product management and innovation, sees growing demand for an option that allows participants to customize their glide path by further refining their risk tolerance as either conservative, moderate or aggressive. OneAmerica calls this alternative RetirementTrack, which the firm introduced in June 2020.

“We also understand that target-date funds aren’t for everyone,” Kofkoff says. “No two participants are alike, and the solutions we offer need to reflect that.”

Making Advice More Personal

For Kathleen Kelly, managing partner with Compass Financial Partners, a Marsh & McLennan Agency LLC company, in Greensboro, North Carolina, the solution she sees is traditional but with added support. “We still believe the universe of off-the-shelf target-date funds is sufficiently broad and diverse to really address most plan sponsor needs,” Kelly says.

To enhance the success of TDFs, she says, her firm engages participants to improve their own investing and retirement outcomes. The firm performs surveys to learn what topics these employees find most interesting; then, from the results, the Compass financial wellness team creates a series of custom webinars and sessions, which are delivered by financial coaches and educators and explore themes such as investing or student loan debt. Of late, the hot topics are market volatility and inflation, she says.

“You’re then able to say, ‘We listened to you—thank you for your feedback,’” Kelly says, referring to these surveys. “‘We’ll now deliver a 12-point plan about financial wellness.’”

A company’s communication style tends to reflect its values. Some companies prefer dedicated benefit apps. Others are trying to limit email so may blast advertisements on monitors in break rooms. Others want all communications to resemble the look of their brand in font and color, while at the opposite end of the spectrum, some want it to explicitly come from a third party.

“This is where we’re always willing to try things,” Kelly says. “We want to meet the employees where they are.”

And while managed accounts are attractive due to their more personalized approach, where Kelly foresees investors’ greatest need arising is in generating reliable income at retirement. For most people, the additional cost of a professionally managed portfolio would generate too little value to offset the benefits of a target-date option, she says.

“The target-date is a very effective, very efficient tool,” Kelly says. “But the next frontier is the decumulation piece, and how do you enable participants who may have never been comfortable in the accumulating phase to then turn around and become an actuary, accountant and investment manager of their life’s savings?”

Retirement Income

Kelly expects further interest and growth in creating guaranteed income solutions and is watching products from BlackRock, Prudential, State Street and TIAA. The next steps that could lead to more widespread adoption, Kelly says, include broadening such products’ availability, which the Setting Every Community Up for Retirement Enhancement, aka SECURE, Act facilitated by creating a fiduciary safe harbor.

“Participants would like some form of guarantee—it’s just getting to a place where [the solutions] are available, understandable and priced right,” Kelly says. “The last six months have reminded everyone that markets do go down, and there’s a sequence of return risk.”

Huxhold also says he sees growing interest in retirement income. But he anticipates the need for advisers to create new software or find a way for employees who have had multiple jobs and numerous DC plans to bring it all together. “Technology is going to let us do more at the participant level,” he says.

Marinescu, too, predicts more conversation about retirement income, and demand increasing for institutionally priced products. Currently, due to the ease of personalization, lifetime income products are most effectively handled in the context of a personalized portfolio with advice such as one receives from a managed account, he says. “It’s more of a natural progression of thinking about how much income the portfolios will generate and whether the current volatility will change—that this [growing interest in income] will continue,” he says.