Environmental changes in the retirement industry are impacting advisers in meaningful ways. No longer can they follow the status quo, especially when evaluating a qualified default investment alternative. Since the Pension Protection Act of 2006 and QDIA inclusion on plan menus, the trend toward better evaluating multi-asset-class portfolios has accelerated.
Advisers face a daunting fiduciary task, given the sheer number of options in the QDIA marketplace. Within each QDIA type — balanced or risk-based funds, target date funds and managed accounts — there are a growing number of providers to consider, with more than 50 distinct strategies in the target date fund universe alone. While ample time and consideration has been spent evaluating record-keeper suitability, the QDIA decision has often been an afterthought.
Prior to assessing the particulars of any specific QDIA investment strategy, plan fiduciaries should open up the evaluation process to all QDIAs in the spirit of understanding what's most suitable, based on the plan's goals and demographics.
The industry as a whole has generally been pushed toward target date funds as the predominant QDIA. The reality is that there are a number of situations in which a risk-based fund may be more appropriate. One example is plans in which participants are fairly homogeneous — namely, a consistent demographic, all in one age cohort or a narrow set of age cohorts.
Another scenario: Plans with high employee turnover or in which participants have accumulated a significant portion of their retirement assets outside of the plan. These characteristics suggest the glide path mechanism governing a target date fund may be counterproductive.
Based on the Labor Department's guidance — and conventional wisdom — participant age should be a primary factor to consider when evaluating a QDIA. Consider, for instance, that experiencing a loss at age 65 is much more devastating than the same percentage loss would have been 30 years earlier in a participant's life. However, the magnitude of the loss participants may be able to withstand — their capital risk capacity — is influenced by other demographics, namely participant savings commitments during the accumulation phase and the spending burden placed on their assets during retirement. As such, understanding plan demographics from a variety of angles is critical to identifying the QDIA that may lead to more successful participant outcomes.
QDIA evaluation must be approached differently than single-asset-class analysis. It's imperative that fiduciaries do more than simply ensure that their plan's default investment option meets the broad qualifications. This includes looking beyond the performance and risk-based metrics (often limited to trailing time periods), which many have come to rely on heavily when evaluating core menu options.
The QDIA evolution has resulted in greater diversification across asset classes and investment strategies. Greater diversification certainly has the potential to provide a better overall experience for the participant. However, it also means these products have become increasingly complex, making it necessary for fiduciaries to understand a QDIA manager's investment approach.
As fiduciaries, advisers can ask pointed questions such as: “Is the QDIA manager able to coordinate the investment decisions of the underlying investment managers so that they're all working together toward the QDIA's overall investment objective?” And, “Does the QDIA manager have control and the tools in place to manage risk effectively as market conditions change over time?”
There is clear opportunity today for advisers to help plan sponsors and plan participants in their QDIA selection. With a growing number of industry tools and resources developed around QDIA due diligence, now is the time for advisers to become QDIA experts and understand differences that exist in the marketplace.
Shawn Sanderson is a senior investment consultant at Manning & Napier.