A Message from RidgeWorth Investments Your role as an advisor has never been more critical. You are the key to helping your plan sponsor clients build an investment lineup that balances their need to promote retirement readiness among their participants while managing their fiduciary risk. Not only do plan sponsors have an increasingly complex array of options to choose from, but it has become clear that a significant portion of the participant population does not feel they have the skills to select an appropriate mix of investments from the options made available to them. The dramatic growth in target date funds (TDFs) is testament to plan sponsors desire to offer an investment solution that may enhance retirement readiness for the unengaged and unskilled investors within their plan. TDFs are designed to help participants manage their investments automatically changing the equity mix to become more conservative as the target retirement date approaches. While there is a proliferation of products, selecting and monitoring TDFs that are prudent in a given client s investment lineup is challenging. Most TDF products in the market today are built using funds from a single investment provider. The difficulty with this approach is that few, if any, fund families have funds that are top performers in all sectors. Yet the plan sponsor (plan fiduciary) does not have the ability to replace an inferior fund. Similarly, a TDF may not be a great fit for the unique characteristics of a particular employee or group of employees. To address these limitations, an emerging trend is to use custom TDFs custom designed for the individualized needs of employees in a particular plan. To help you evaluate whether custom target date services could help differentiate your investment service model and fill a need among your target market and current clients, RidgeWorth Investments engaged Fred Reish, a partner in Drinker Biddle & Reath LLP s Employee Benefits Executive Compensation Practice Group, Chair of the Financial Serivces Employee Retirement Income Security Act (ERISA) Team and a member of the Retirement Income Team to answer important questions about custom TDFs. Why are custom TDFs becoming an increasingly important part of the investment conversation? How does the Department of Labor view custom TDFs? What factors should you consider when designing custom TDFs for a client?
Take Action Today Deepen your knowledge and evaluate the opportunities presented by custom TDFs. Review the important information in our white paper, Custom Target Date Funds: Enhancing Retirement Readiness Assess the role of TDFs in the plans you advise. What percentage of your retirement plan clients offer a TDF? When a TDF is available, what percentage of plan assets is invested in TDFs? Are the TDFs you recommend a good fit for the unique profile of each plan s participants? Are there inferior performers among the underlying funds in the TDFs? Consider whether custom TDF services would enhance your retirement business opportunities. Would custom TDFs differentiate your services in your market? Would your clients and prospective clients view custom TDFs as a valuable option for their plan? How would custom TDFs fit into your ERISA 3(21) investment advisor or ERISA 3(38) investment manager suite of services? Explore the different pathways you can follow to make custom TDFs available to your clients, including: Designing your own asset allocation strategy and glidepath and Tapping into the custom TDF services and tools available through recordkeepers and other service providers. Contact RidgeWorth Investments if you want to learn more about custom TDFs. Learn how RidgeWorth Funds fit into a custom TDF strategy. Let RidgeWorth Investments introduce you to service providers and resources that can help you build custom TDFs for your clients and prospective clients. Call 866-595-2470 or visit www.planadvisortools.com for more information. The assertions contained herein are based on RidgeWorth s opinion. Information provided is general and educational in nature, provided as general guidance on the subject covered, is not intended to be authoritative or individual or specific advice.
Custom Target Date Funds: Enhancing Retirement Readiness Provided compliments of RidgeWorth Investments PlanAdvisorTools.com
Custom Target Date Funds: Enhancing Retirement Readiness by Fred Reish Partner, Drinker Biddle & Reath LLP As advisors seek to help plan sponsors construct retirement plans that help participants reach their retirement goals, an emerging solutions is to provide custom target date funds (TDFs). By creating TDFs custom-designed for the employees covered by that plan, advisors can provide a service that is both valuable and unique. The value is enhanced by the use of a plan s core line-up of investments, which would ordinarily consist of high-quality, low-cost mutual funds. Taking into account the quality and expense of the plan s mutual funds, as well as an asset allocation and glidepath that is appropriate for participants, a custom TDF can be designed that is uniquely appropriate for a particular plan. DEPARTMENT OF LABOR WEIGHS IN This unconventional approach was recently validated and perhaps encouraged by the United States Department of Labor (DOL) in its February 2013 release of a fact sheet titled Target Date Retirement Funds Tips for ERISA Plan Fiduciaries. While the DOL guidance is a good reminder that TDFs should be rigorously evaluated and that they are held to the same level of scrutiny as other funds its discussion of TDFs may have received the most attention. The DOL advises fiduciaries to look at custom TDFs, characterized as any vehicle including managed accounts and asset allocation models based on a targeted retirement date. You can read the fact sheet in its entirety at www.dol.gov/ebsa/newsroom/fstdf.html. The DOL goes on to make several recommendations to fiduciaries about the selection of TDFs including understanding and considering the characteristics of a company and the participant population, such as: Whether other retirement plans are offered Salary levels Employee turnover rates Contribution rates Contribution withdrawal patterns Visit www.planadvisortools.com or call 866.595.2470 for more information. 4
The use of custom TDFs is further supported by the DOL s direction to plan fiduciaries about establishing a process for comparing and selecting TDFs. Fiduciaries and advisors may want to consider whether the target date mutual funds available through a provider s platform align with the employee demographics and whether it is possible that a customized TDF would more closely parallel the retirement needs of the employees. ICI & ABC ADD MORE DETAIL Adding a little more detail to the DOL tips above, the Investment Company Institute (ICI) and the American Benefits Council (ABC) have also identified criteria for fiduciaries to consider when selecting and monitoring TDFs. 1 This article will focus on four particular touchstones: 1. Plan participant demographics 2. Asset allocation and glidepath 3. Component investments within the TDF 4. Other retirement plans offered In March 2010, prior to the release of the DOL fact sheet, the ICI and ABC wrote to the Assistant Secretary of the Employee Benefits Security Administration of the DOL with a list of factors that fiduciaries should consider in selecting and monitoring target date funds. More specifically, the ICI and ABC listed the following considerations to the four touchstones we re focusing on. Plan Participant Demographics Plan sponsors need to consider the characteristics of the participant population. That is not a new approach; DOL and the courts have said for many years that, in selecting investments and services for plans, fiduciaries need to consider the needs of the plan and its participants. While there are a variety of factors that could be considered in that context, the key is that fiduciaries take into account the needs and behavior of the participants. Fiduciaries and advisors may want to consider matters such as: Will older participants benefit more from investment gains in the years close to retirement or will they suffer more from investment losses in the years close to retirement? If older participants have large account balances, greater earnings power and flexibility in deciding when to retire, then it would be reasonable to assume that the TDFs can be invested more aggressively. On the other hand, if participants have smaller account balances, lower income and less investment sophistication, and are more likely to be laid off during an economic recession when the stock market is down, then arguably the glidepath should be more conservative in the years approaching retirement. These are the types of factors that fiduciaries should consider, and that advisors should communicate, in the selection and/or design of custom TDFs. 1 Jan Jacobson, American Benefits Council, and Mary Podesta, Investment Company Institute, to Phyllis Borzi, Employee Benefits Security Administration, March 30, 2010. 5
There is no right or wrong answer to the selection and/or customization of TDFs. Fiduciaries are entitled to evaluate their workforce and to make a decision that is consistent with that evaluation (so long as the evaluation bears a rational connection to the characteristics of the workforce). Asset Allocation & Glidepath Once the fiduciaries and the advisor have considered the characteristics of the plan participants, the next step in developing a custom TDF is to select asset classes and a glidepath that corresponds to those characteristics. Would the participants be better served by a TDF that is volatile in up-anddown markets? If not, then asset classes should be selected that will dampen the volatility and provide a more stable investment experience. Additional considerations are: What asset classes are used in the TDF to achieve diversification? What is the glidepath used by the TDF? What is the TDF s asset allocation when it is most focused on growth? Over what time period and at what pace does the asset allocation become more focused on income? What is the asset allocation at the target retirement date? At what point in time does the glidepath reach its final asset allocation? Is this at the target retirement date (often referred to as a to retirement fund) or after the target retirement date (often referred to as a through retirement fund)? Fiduciaries, with help from their advisors, need to decide if the glidepath be aggressive, conservative or moderate. Generally, for a highly educated, high-earning workforce, a glidepath with an aggressive asset allocation might make sense. Those employees would likely be able to save enough money over time to withstand the adverse effects of market volatility and, if market losses come shortly before retirement, the participants may have flexibility to decide whether to retire or to work a few more years. At the opposite end of the spectrum is a low-paid, low-educated workforce. Those employees may have difficulty saving enough for retirement. They may also be subject to layoffs during recessions when retirement account balances may have dropped. For those participants, fiduciaries may decide that preservation of capital particularly near retirement is important. Another decision to make is whether the glidepath should stop at the targeted age or whether it should continue beyond retirement. 6
While little thought and analysis has been given to this subject, arguably, in order for a glidepath to extend beyond retirement, fiduciaries should have some basis for concluding that participants will stay invested in those target date funds. For example, that could occur where 1) the participants withdraw money from the plan post-retirement; 2) many of the participants rollover into IRAs with the investment provider and continue to invest in the TDFs; or 3) the plan fiduciaries have educated participants on the glidepath who understand the concept that it should be continued after they retire and leave the company. When those circumstances don t exist, it appears that to retirement glidepaths are more appropriate. That would be consistent with, for example, a plan where participants take lump sum cash distributions at retirement and where the plan fiduciaries do not know whether the participants will continue to invest in the TDFs. Component Investment Performance A common complaint of many target date mutual funds is that, while the asset allocation and glidepath may make sense, some of the underlying mutual funds are inferior. This points to one of the benefits of a custom TDF because the underlying funds are from the plan s core lineup they are prudently selected and monitored, and can be removed or replaced. In response to concern of whether underlying funds need to be evaluated, there is no case law on that point. However, based on conversations with experienced advisors, the consensus seems to be that underlying mutual funds should be evaluated and any underperformance should be part of the evaluation of the target date fund itself. Similar comments were filed with the DOL by the ICI and ABC, when they asked, What has been the investment performance not only of the TDF but also of its component investments? Other Retirement Plans Offered Does the employer sponsor other types of retirement plans such as a defined benefit plan or an employer stock plan that will be considered in evaluating a TDF s asset classes, asset allocation and/ or glidepath? An advisor needs to take into account whether the company also sponsors a defined benefit plan. A defined benefit plan could provide additional security and a base of protected income that might justify a more aggressive glidepath. On the other hand, a defined benefit plan may indicate a conservative culture for the company and its employees, which could suggest a conservative glidepath. Similarly, an employee stock plan could mean that the employees overall retirement plan portfolios are tilted toward the aggressive side because of the participant balances in the Employee Stock Ownership Plan (ESOP). In that case, the glidepath of the target date funds might be more conservatively structured. 7
IN CONCLUSION Custom TDFs can be designed to take all of the above factors into account and match them to the needs and behavior of the participants. Custom TDFs offer a number of advantages to plans particularly where a plan is large enough to justify the additional cost of the design and maintenance of the custom TDFs. Custom TDFs also require support from plan recordkeepers who would need to track the asset allocations and handle the re-balancing. When custom TDFs are designated investment alternatives (DIAs) of the plan, the recordkeepers would also need to track and report the information required by the 404a-5 participant disclosure rules, such as historical performance and expense ratios. While it does take some effort, and recordkeeper support is crucial, custom TDFs provide an opportunity for advisors to add value to plans in a unique way. This could be one of the next frontiers of advisory services that can distinguish the skills and values of a retirement plan investment advisor. Provided compliments of Intended for Professional or Institutional use only. Download this and other RidgeWorth White Papers at: http://www.planadvisortools.com/educational-resources. This article was written by C. Frederick Reish, a partner at Drinker Biddle & Reath LLP. Reish is in the firm s Employee Benefits & Executive Compensation Practice Group and Chair of the Financial Services ERISA Team. He has specialized in employee benefits law since 1973 and works with both private and public sector entities and their plans and fiduciaries; representation of plans, employers and fiduciaries before the governing agencies (e.g., the IRS and the DOL); consulting with banks, trust companies, insurance companies and mutual fund management companies on 401(k) investment products and issues related to plan investments; and representation of broker-dealers and registered investment advisers on issues related to fiduciary status and compliance, prohibited transactions and internal procedures. Drinker Biddle & Reath LLP is unaffiliated with RidgeWorth Investments. This material is provided by RidgeWorth Investments for informational and discussion purposes only. The law and Drinker Biddle s analysis contained in this article are general in nature and do not constitute a legal opinion or legal advice and may be relied on by third parties. Readers should consult with their own legal counsel for information on how these issues apply to their individual circumstances. Further, the law and analysis in this article is current as of September 2013. Changes may have occurred in the law since this article was drafted. Information provided is general and educational in nature. It is not intended to be, and should not be construed as, investment, legal, estate planning, or tax advice. RidgeWorth does not provide legal, estate planning, or tax advice. Laws of a specific state or laws relevant to a particular situation or pensions in general may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. Consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation. All investments involve risk. An investor should consider a fund s investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information about the RidgeWorth Funds can be found in a fund s prospectus. To obtain a prospectus, please call 1-888-784-3863 or visit www.ridgeworth.com. Please read the prospectus carefully before investing. 2014 RidgeWorth Investments. RidgeWorth Investments is the trade name for RidgeWorth Capital Management LLC, an investment adviser registered with the SEC and the adviser to the RidgeWorth Funds. RidgeWorth Funds are distributed by RidgeWorth Distributors LLC, which is not affiliated with the adviser. Collective Strength Individual Insight is a federally registered service mark of RidgeWorth Investments. This paper was originally published in October 2013. RFWP-TD-0514