If investment practices in larger defined contribution (DC) plans generally migrate down market, it appears that custom target date funds (TDFs) are likely to come to a smaller plan near you. According to research conducted by PIMCO with large plan consultants, assets in custom TDFs grew by 40% in 2015 over the previous year and the number of plan sponsors using them more than doubled.
Why use custom TDFs? Consultants like to be able to control the glide path or how much risk is taken for each age group depending on the behavior and demographics of their client; they also like to be able to choose the underlying investments. Not mentioned is that costs tend to be lower and custom funds can include multi-manager strategies whereas the largest TDFs use only the proprietary investments of the TDF provider.
While TDFs are the overwhelming favorite choice by consultants as the default investment or QDIA (qualified default investment alternative), the percentage that recommend them dropped to 89% in 2015 compared to 96% in 2014 with risk based funds growing slightly – some use both. Semi-custom is also gaining popularity where the consultant uses the record keeper’s glide path but chooses the underlying funds from the plan’s menu of investments or DIAs (designated investment alternatives).
Also gaining popularity are white label funds which describe the investment strategy like “large growth” or “fixed income” and can include several different investment managers rather than forcing the investors to choose the funds themselves. White labelling is favored because it simplifies the process by participants, reduces reliance on brand names and allows plans to add and eliminate funds more easily without having to re-map assets.
Some experts believe that custom funds will not migrate down market because it does not make economic sense for providers to incur the costs for smaller pools of assets and that off the shelf funds provide adequate choices. But some larger advisor groups like NFP Retirement, Sheridan Road, GRP, CAPTRUST, and Pensionmark, each with clients that have tens of billions of assets and more, are developing custom TDFs and white labeled investments at lower costs for their client base which include even the smallest plans. As MEPs (multiple employer plans) grow in the micro market, look for custom TDFs and white label providers to go after that market.
Bottom line: the days of defaulting into a record keeper’s proprietary TDF without proper due diligence are coming to an end. The only question is whether the move away from proprietary TDFs funds be to off the shelf or custom funds?
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