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Move to All Passive TDFs in DC Plans Troubling Trend

Passive TDFs in DC Plans As most plan sponsors with DB (defined benefit) pension plans use a mix of active and passive funds, and most advisors recommend a combination, the move
to all passive TDFs in defined contribution (DC) plans is a troubling trend. Why is it happening and what are the potential results?

Though some large pension funds like Calpers have moved to an all passive lineup, most DB plans use a combination to achieve higher returns. There are higher costs associated with selecting and monitoring active money managers and there may be more risk, but DB plans are less prone to second guessing by participants and lawsuits about fees. DC plan sponsors, driven by concerns about fees, fiduciary liability and lawsuits and less by returns, are drawn to passive investments, especially in TDF as their default option or QDIA. While there be more protection by going all passive, is the move a good thing for employees or increasing income replacement?

There is no such thing as a passive TDF – by nature, they are actively managed due to their asset allocation and glide path taking a more conservative approach as investors get closer to retirement even if the underlying investments are passive. The more important analysis is whether the TDF is a “to” fund where is it most conservative when the investor turns 65, or a “through” approach where more risk is taken into retirement. The active v. passive argument can be misleading distracting plan sponsors from the real issues determining which approach is better for their employee population based on demographics and behavior.

More telling is that an overwhelming percentage advisors use a combination of active and passive for clients realizing that while some asset classes are right for index funds, others are not.

Passive investing is appealing to plan sponsors afraid about second guessing an investment that underachieves their benchmark. But no lawsuit has punished a plan sponsor for underperforming funds if there is a prudent process free of conflict of interest.

As markets get more efficient, beating a benchmark is hard as BlackRock has learned moving more of their active funds to a more passive approach in a recent announcement. But when plan sponsors realize that there is greater risk and costs in older employees not able to retire on time, just as DB plans understand the risk of underperformance resulting in unfunded liabilities, the lemming like move to all passive funds might subside.

Fred Barstein

Fred Barstein

Founder & Editor-in-Chief at 401kTV | TRAU | TPSU
Fred Barstein is the Founder & Editor-in-Chief of 401kTV. Fred is also the Founder and CEO of The Retirement Advisor University (TRAU), a collaboration with UCLA Anderson School of Management Executive Education and The Plan Sponsor University (TPSU).Mr. Barstein was also Founder and Editor-in-Chief of NAPA Net.
Fred Barstein
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