Custom target-date funds are beginning to proliferate at the expense of their off-the-shelf counterparts. That’s due to plan sponsors wanting to have greater control over what’s in a fund and have access to a wider array of investments to put in them.

Indeed, about 20 to 25 percent of plan sponsors with target-date funds are likely to switch to customized approaches by 2015, up from roughly 13 percent today, research and consulting firm Celent projected in a recent report.

The firm also estimated that the assets invested in custom target-date funds will grow from roughly $54 billion in mid-2011 to $528 billion by 2015.


Being Aware of Equity Exposure in Target-Date Funds, author Sasha Franger, a fiduciary research analyst for Lipper, delves in the proliferation of target-date funds in investors' 401(k) plans and why the regulators are demanding greater disclosure of their asset allocations and equity exposure rates at the retirement date. Read it now.

The target-date fund category as whole has grown rapidly since the Pension Protection Act of 2006 helped establish them as a default investment option in 401(k) retirement accounts.

But dramatic declines in value during the 2008 financial crisis for investments that were supposed to get more conservative as participants neared retirement caused many investors and lawmakers to question their model. The worst performer that year among target-date funds geared toward near-retirees was Oppenheimer Transition 2010, which fell 41%, largely because two-thirds of its assets were placed in stocks, not bonds.

Customized approaches allow plan sponsors to choose multiple managers and replace them as necessary.

They also give access to asset classes such as commodities, direct real estate, and hedge fund and private equity investments that retail funds may be prohibited from owning.

They also can charge lower fees to plan participants because of institutional pricing, and give the ability to customize the so-called “glide path” for changing over to more conservative investments, depending on the the demographics of a particular workforce.

But they’re usually only available to larger plan sponsors because of the time and cost involved in setting them up and running them. Sponsors also assume additional fiduciary responsibility when they choose managers and tailor glide paths.

“As markets continue to demonstrate volatility, it’s likely, though not guaranteed, that sponsors will look to these custom designs,” said Alexander Camargo, the author of the Celent report.

Camargo said that the lower costs and possibilities for customized glide paths were factors in their growing adoption, but the primary driving force is performance. “Cost is important, but the main concern is performance and specifically risk-adjusted performance,” Camargo said.

David Wray, the president of the Plan Sponsor Council of America, said the rise of customized funds is a natural evolution of the target-date model.

“The ability to use a non-retail solution still requires scale, so it’s not a surprise that the initial implementation [of target date funds] has been pretty much retail,” said Wray. “But over time, the amount of money [being managed] grows and becomes substantial, and that permits customization.”

Wray said that for these reasons of scale, he expected large plan sponsors to continue to move most aggressively into customization. Retail target-date funds would likely also evolve in order to meet the needs of smaller companies, perhaps by giving access to more types of investments, Wray expects.

A plan sponsor looking to set up a custom solution will usually work with a consultant to develop a strategy and glide path and choose managers.

Then, the sponsor will pick an investment manager to help set up and run the funds. The big investment managers in the custom market are JP Morgan Chase, Black Rock, Pacific Investment Management, AllianceBernstein, and State Street.

Tom Fontaine, head of defined contribution investment at AllianceBernstein, said his firm first started offering custom target-date strategies five years ago and now has $15 billion in assets in these plans, including offering them to 3 of the 15 largest retirement plans in the country.

“We do agree that the vast majority of sponsors 5 to 10 years from now will adopt [custom solutions],” said Fontaine. He said that the main reason is that sponsors like being able to choose multiple, best in-breed managers for their funds, and to replace or add to them as conditions warrant.

“What the plan sponsors believe is that by lowering fees and giving access to other investments, they can create something that has better performance over the long haul and if it doesn’t, they can change it,” said Fontaine.

While there isn’t any comprehensive data yet on the performance of custom-target date funds versus their more conventional “off-the-shelf” forebearers, Camargo said that plan sponsors he’s talked to have been happy so far with their custom funds. “I have heard from sponsors that performance is on par with expectations,” said Camargo.

According to the Celent report, custom target-date funds are currently offered to plan sponsors with more than $500 million in assets. That is down from $1 billion just two years ago. The firm expects that the bar will be lowered even further to $350 million over the next four years.

One growing option for smaller plan sponsors, however, is to pool their retirement assets together and have an investment manager create a customized collective investment trust each of the participating sponsors can market. Those sponsors, then, see their clients’ money invested more widely and be dealt with by multiple managers.

“Technology is allowing us to offer this to smaller companies now,” said David Hand, the CEO of Hand Benefits and Trust, which sets up collective trusts for institutions and money management firms.

Upcoming stricter fee disclosure requirements for retirement plans could further drive the adoption of custom target-date funds as participants focus more on fees, according to Chad Parks, who runs The Online 401(k), which develops 401(k) plans for small business and individuals.

“Fee disclosure will put lot of price pressure [on providers], and will force the market to come up with a lot of alternatives,” said Chad Parks.

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