We applaud Donald Trone’s efforts to identify prudent selection and monitoring criteria for qualified default investment alternatives as discussed in his July 23 Fiduciary Corner column.
However, as one of the most experienced life cycle managers in the country, Manning & Napier Advisors Inc. considers evaluating the overall QDIA even more important than separately evaluating each component.
After all, plan sponsors lack the flexibility to replace a portion of the QDIA but rather have to live with the results of the overall portfolio.
Additionally, numerous academic studies have confirmed that asset allocation decisions are generally more important than security selection decisions. Focusing on the performance of the underlying pieces fails to capture the QDIA manager’s asset allocation decisions.
The reason for employing tools such as auto-enrollment with a QDIA is to give plan sponsors a means to help their participants meet retirement goals. In order for this to happen, a QDIA needs to focus on both capital appreciation and asset protection.
In actuality, it may be largely irrelevant how the underlying-asset-class investment strategies have done if the total option lacks appropriate asset allocation (or glide path) and has been unable to help participants meet their retirement goals.
In addition, the growth of index-based fund-of-fund retirement target funds has further increased the importance of the asset allocation decision (and its evaluation). For these types of potential QDIAs, security selection is typically passive, and the evaluation of the component pieces results in nothing more than ensuring that the component pieces’ performance doesn’t trail their benchmarks by more than their fees.
Questions regarding whether these products are meeting participants’ retirement goals or if they provide sufficient downside protection can be answered only by looking at the overall QDIA. As such, the evaluation of the overall QDIA and its manager’s asset allocation decisions is of utmost importance.
Furthermore, plan sponsors should determine if the QDIA manager has a successful track record making asset allocation decisions over a variety of market conditions. Although it is generally useful to consider a manager’s short-term performance in the context of the environment, performance evaluation over bull and
bear market time periods helps provide insight into a manager’s ability to add value over different market environments.
Mr. Trone’s proposed two- to three-year manager and product track records — along with one-, three- and five-year peer group evaluation time periods for managers and funds — generally fail to capture the full range of market environments. It would be best for plan sponsors to evaluate their QDIA options over at least one complete market cycle (for instance, from April 1, 2000, to the present) and ensuring that the manager and overall investment process have been in place over that period, as well.
Likewise, the growth in life cycle products since the last
bear market means that there are potentially a significant number of QDIA managers who don’t have a track record that includes a sustained declining-equity-market environment.
Experience wanted
Plan sponsors touting the importance of life cycle funds and/or QDIAs to recently, or soon to be, auto-enrolled participants surely need to have a sense of the downside participation a QDIA and its manager have historically experienced. We think the key is for the QDIA manager and the overall investment process (made up of the component pieces) to have a proven track record of helping participants reach their goals.
As plan sponsors begin to evaluate the numerous and ever-increasing options available to serve as QDIAs in automatic-enrollment programs, they would be wise first and foremost to consider the QDIA manager’s commitment to, and experience in, making asset allocation decisions.
Furthermore, well-managed QDIAs should be able to demonstrate an ability to provide downside protection in difficult market environments to reduce the risk of participants’ abandoning their savings program in the face of market declines.
Although evaluating the component pieces of a QDIA may be helpful in identifying firms that are building default options as a “bolt on” business to help boost struggling proprietary stock or bond funds, plan sponsors considering making this important decision for their participants should focus primarily on how well the total QDIA option performs relative to its stated goals.
Mark Macpherson, a chartered financial analyst, is senior risk management analyst with Manning & Napier Advisors Inc. in Fairport, N.Y.
