Sunday, August 14, 2005

'Style Conscious

We all know that one of the hardest decisions for most plan participants is choosing how to invest their retirement savings. These days a widely touted solution is the asset allocation fund, or the lifestyle fund (I’ll use the terms interchangeably here, but there are differences) - an option that allows a participant to make a single investment choice: a fund pre-mixed to match an asset allocation deemed appropriate for a particular risk tolerance and/or retirement date. Not only have these options increasingly been promoted to participants – they have also become the solution du jour as a default fund choice for plan sponsors, particularly when combined with automatic enrollment.

What hasn’t garnered the same level of attention is a potential irony regarding these funds. These very same funds that purport to make investment choices so much easier for participants, might actually present plan sponsors (and thus advisors) with a more difficult decision, IMHO.

Consider that in choosing these funds, you have the very same fiduciary standards for due diligence in fund selection that you have with any other investment option. However, many of these don’t have a three-year track record, nor is there any kind of qualitative rating, such as the ubiquitous “star” ratings. Moreover, even those with track records lack a consistent benchmark against which to evaluate their performance.

Sure, many of the fund providers have crafted synthetic benchmarks against which their offerings can be compared – but there is no consensus on what an "appropriate" asset allocation mix is for different target dates, either in terms of how much of each asset class, or even in terms of how much should be invested in stocks versus bonds, much less how much should be in what kinds of stocks. In sum, to the extent they exist at all, their benchmarks exist only against what the provider claims is an appropriate mix.

Fees are still all over the place - some charge a "wrap" on top of the underlying funds, and while others don’t, some take advantage of the opportunity to cobble together relatively high-priced retail share classes under the lifestyle umbrella, while for some their very point of differentiation lies in the exotic (and expensive) asset classes they incorporate in their model. More fundamentally, some rely on models comprised solely of proprietary offerings, while others eschew that approach totally, and others rely on a mix.

Aside from all of those challenges, the ultimate irony – particularly in this day of burgeoning fund menus - is that a plan sponsor who wishes to include a lifestyle offering on their plan menu will likely have a choice of just one lifestyle fund family.

Of course, these obstacles will almost certainly be less of an issue over time, as the market matures and the application of lifestyle funds expands. Still, IMHO, plan sponsors who embrace the logic and simplicity of a lifestyle offering need to realize that they have their work cut out for them.

- Nevin Adams

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