Saturday, October 04, 2008

Reference Points

For most 401(k) plan participants, this has been a good quarter—to lose your statement.

Sure, we all know that the lower prices make this a good chance to invest new contributions at a bargain price (once we get past the concern that those prices won’t continue to fall), but there is a very real possibility that some (many?) participants will see a 09/30 balance that is lower than it was a quarter ago, wiping out three months’ worth of contributions (and then some).

It is interesting—and perhaps fortuitous—that, even as the markets struggle, asset allocation choices are available on a growing number of retirement plan menus. That they are increasingly a favorite as a plan default option—even as a growing number of automatically enrolled participants are defaulted into them—represents, IMHO, one of those rare occurrences where a much-needed solution is actually available and in place before the crisis it is designed for hits.

Having said that, it is also a year when even diversified portfolios are taking it on the chin. And participants defaulted into those choices—even participants who actively embraced the convenience of the “just pick one” solution—may not fully appreciate the benefits of that alternative.

On the other hand, these are the kinds of markets where the benefits of diversification should stand out, but only if you are able to provide them a point of reference. In a quarter when the S&P 500 shed 9% of its value, those target-date funds may look very good indeed.

The Bigger Picture

There is another aspect to this, of course—because all target-date funds are not created equal. Despite the commonality in naming structures, there are marked differences in fees, in their choice of fund structures and, most critically, in their glide paths—the underlying asset allocation, and the philosophy that underpins it. Of course, plan fiduciaries have an obligation to prudently select and monitor all investment options, a standard in no way diminished or excused when it comes to these target-date funds (or, more broadly, the qualified default investment alternative (QDIA) enclave to which they now belong).

Still, their relative newness has made it difficult to objectively evaluate their appropriateness, at least according to traditional standards, while their limited availability on specific recordkeeping platforms has perhaps made it seem less necessary (after all, if you only have one target-date family to choose from, what choice do you really have?).

But with the passage of time, we now not only have more choices, we have begun to accumulate track records, and just as significantly, a more refined sense of purpose for these offerings—some have, in fact, refined their purposes. True, as things stand today, for many, the gap between their stated goals and the reality of their asset allocations looms large—and, IMHO, the stated goals of many are still obtuse to the point of obfuscation. Nonetheless, we are rapidly reaching the point where such ambiguities can be appreciated.

The passage of time has also brought a new generation of indexes for these funds. Perhaps not surprisingly, in view of the breadth of philosophies underlying the various glide paths, this new generation of indexes—most of which are only just being brought to market, and some of which are still in incubation—bring to the table different philosophies about how these offerings should be evaluated. In other words, while this new generation of indexes purports to provide a standard against which target-date fund choices can—and should—be evaluated, there is not yet a consensus on what standards should be applied.

That’s not necessarily a bad thing, of course. People, even experts, have different notions of what constitutes an appropriate asset allocation, and people—perhaps especially experts—are certainly entitled to their varied opinions.

What that means for fiduciaries—and for those who counsel them—is that the selection of that benchmark could be as important as the funds we measure against it.

— Nevin E. Adams, JD

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