403(b) Curriculum Library


Custom Target Date Funds: Is Now the Time?

Over the past few months, the stock market has experienced unprecedented volatility, due in part to the COVID-19 pandemic. Equity markets have reacted to various headlines in an unpredictable fashion; thus, retirement plan participants across the United States have faced a drastic decrease in their account balances. According to Morningstar, investors who expected to retire this year and had 2020 TDFs lost more than 17% on average, while those expecting to retire in 40 years (with 2060 TDFs) lost 31%, which was a minor improvement versus U.S. equities, which fell 33%, and global equities which declined 32%. In a time of immense volatility, plan sponsors may find it appropriate to consider a custom target date solution as a means of helping to mitigate risk and increase participant returns over the long term.

What is a Custom Target Date Fund?

A custom target date fund (CTDF) allows a retirement plan investment committee to select and control the underlying investment options within a target date fund suite, often using funds from the retirement plan menu, rather than pre-selected investments. A traditional target date fund generally only includes the proprietary funds of the investment manager and limits the usage of outside fund options. Custom target date funds give the committee, in partnership with a 3(38) investment adviser, additional opportunities to provide plan participants with a truly custom investment option, tailored to the unique needs of the plan.

According to the Department of Labor, it is prudent to consider custom target date funds as an alternative to “pre-packaged” target date funds. According to the regulatory authority, custom target date solutions may be able to provide benefits by incorporating the plan’s existing core funds and adding opportunities to further diversify the investment lineup. However, it is important for plan sponsors to consider the cost and administrative tasks involved in creating a custom, or non-proprietary, target date fund solution.

Benefits of a Custom Target Date Solution

Custom target date funds offer several benefits to retirement plan participants and plan sponsors alike. With CTDFs, retirement plan investment committees can create custom glidepaths for their plan participants that are tailored to the shifting demographic needs at each point in the glidepath. The committee’s 3(38) investment adviser analyzes participant demographics and behavior, along with committee preferences, to build a glidepath that is unique to the plan. This custom target date fund may allow for better participant outcomes.

Behavioral economics tells us that most plan participants utilize a Qualified Default Investment Alternative (QDIA) when enrolling in a retirement plan. Because of this, it is of the utmost importance that a plan’s QDIA is a thoughtfully constructed investment that considers each individual participant’s ability to meet their retirement goals. Unlike traditional target date funds, where the control of the underlying funds rests with the fund provider, custom target date funds allow a plan sponsor to exchange underperforming or more expensive funds within the target date suite to potentially increase risk-adjusted returns or reduce the cost of the custom target date fund.

Additionally, with a custom target date fund, committees have a greater ability to monitor and control the costs of the underlying investments. By selecting the individual funds within a target date suite, plan sponsors can opt for passive management in some asset classes and active management in other asset classes. With control over the underlying fund selection, it is also possible to exchange underlying investments to help manage costs and performance. Committees may also have the ability to utilize guaranteed return products to help reduce investment volatility and reduce equity exposure within a CTDF glidepath.

Finally, there is the ability for increased customization with CTDFs, as plan sponsors can name their target date suite to personalize the vintages and make the target date series more familiar and discernable to plan participants. Customization also allows for a more seamless process that does not require advance participant communication when exchanging underlying funds for either lower-cost or stronger-performing alternatives. CTDFs also allow investment committees to create multiple versions of a glidepath based upon participant risk preferences. For example, a CTDF could be crafted to include a conservative, moderate, and aggressive version to further cater to participant preferences.

Plan Sponsor Considerations

While CTDFs offer a number of benefits, there are considerations that plan sponsors need to make. These include the potential need for operational adjustments, more complicated recordkeeper transitions, and custom participant communication.

Using custom target date funds requires a shift in the traditional operational functions of the retirement plan committee. A greater emphasis on the review portion of target date funds is required at retirement plan committee meetings, based on the customized nature of the strategy. Allocations, underlying investments, and employee demographics and behavior need to be reviewed. In addition, frequent and ongoing communication among the committee, the 3(38) investment adviser and the recordkeeper is important.

The unique structure of the custom target date fund complicates the transition from one recordkeeper to another. If a plan transitions to a new recordkeeper, a new custom target date solution would need to be created with that recordkeeper. Alternately, the plan could transition back to a non-customized option.

Custom target date funds also require the creation of their own communications and marketing materials for plan participants. Unlike a traditional target date mutual fund product, where data is available on a variety of platforms (e.g., Morningstar), portfolio performance for custom target date funds is only available from the recordkeeper. The 3(38) investment adviser can assist in these communications and help facilitate the transition for participants throughout this process.

Conclusion

While there are many positive attributes affiliated with custom target date fund solutions, they may not be suitable for all retirement plans. These investment products require additional fiduciary oversight and enhanced recordkeeping abilities. For a diligent plan sponsor looking to enhance its investment lineup and provide a customized product to retirement plan participants, custom target date funds may serve as a suitable addition to a plan lineup. These products can be tailored to reduce risk and increase customization, while providing comparable returns to standard target date funds, potentially at a lower cost. As with any decision, plan sponsors should carefully evaluate the potential benefits of implementing a custom target date solution to their plan lineup.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.

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