Custom TDFs (Target Date Funds): A “Better” Option?
Custom TDFs (Target Date Funds): A “Better” Option? TDFs are among the most popular investment options offered by a majority of defined contribution (DC) retirement plans today. According to a recentfrom Columbia Threadneedle Investments, more than 20 million participants in 100,000 401(k) plans hold TDFs. By 2020, TDF assets are projected to grow to as much as $4 trillion and represent 50% of total 401(k) assets at that time.
To date, most DC plans have adopted traditional TDFs because they’re easy to implement and explain to participants, and simple for participants to use. In addition, TDF providers offer pre-packaged investment options that are automatically rebalanced as plan participants near retirement, all at a relatively low cost.
All fine and well, but these “one-size-fits-all” TDFs have some limitations, including that they don’t allow for any sort of customization that reflects the unique needs of a DC plan and its participants. As such, many plan sponsors are turning to custom target date funds, which even the Department of Labor endorses as a potentially “better” option for participants.
Why custom TDFs? Under ERISA, plan fiduciaries are required to act prudently and in the best interests of participants. Custom TDFs don’t satisfy these obligations in and of themselves, but they offer several advantages over traditional TDFs that can help plan fiduciaries meet their ERISA responsibilities more effectively.
With custom TDFs, retirement plan sponsors and decision-makers have more control over the selection of the funds’ underlying investments, asset allocation and glide path (the shift in the fund’s allocation over time). From the Columbia white paper: “The plan fiduciary can select the most appropriate asset allocation and the best-in-class underlying fund offering in each asset class, as well as shape the asset allocation glide path in a manner that is prudent for the unique characteristics of its workforce.”
In addition, using custom TDFs allows plan sponsors to “optimize” the underlying funds, because they provide the opportunity to choose the top fund providers and managers in each asset class. Traditional TDFs typically are proprietary, and their underlying investments may consist entirely of funds from a single fund family. Many plan fiduciaries recognize that it’s unlikely that one fund company has all of the best managers in every asset class. As such, they generally include different fund managers in different asset classes in their core fund menus. In fact, according to a Callan survey cited in the Columbia white paper, “more than 90% of plans using custom TDFs stated that the ability to ‘use best-in-class underlying funds’ (and/or leverage core menu options) was an important reason for their decision to use custom TDFs.”
Finally, using custom TDFs enables plan sponsors to incorporate investments from the plan’s existing fund menu. Since the plan’s core funds have likely already been vetted based on performance, fee structure and appropriateness for the plan, and since they may already be familiar to participants, including them as underlying funds in the custom TDF simplifies the process of monitoring and communicating about them to participants.
These advantages highlight the key reasons why custom TDFs are gaining popularity. For plan sponsors who want to ensure they are fulfilling their fiduciary responsibilities under ERISA, and who are seeking additional flexibility and appropriateness beyond traditional pre-fabricated TDF solutions, custom TDFs are certainly worth considering.