Five Lessons Packaged Target-Date Solutions Can Learn from Customization
As defined contribution (DC) plan sponsors know, the US Department of Labor recommends considering both packaged and custom target-date strategies when choosing a solution. As we see it, packaged solutions can learn a few things from fully customized target-date solutions, which are generally used by large and megasize plan sponsors.
Selecting a target-date solution is a fiduciary act, and plan sponsors must work through the distinctions between custom and packaged approaches in order to decide which is the better fit for participants in their own plans. However, we don’t think the choice necessarily needs to be black and white.
Here are five principles that we believe can raise the bar for packaged target-date solutions:
1) Separate Asset-Allocation and Manager-Selection Decisions
A well-designed asset allocation is fundamental to an effective target-date solution. The percentages of stocks, bonds and other investments, and the glide path—how those percentages evolve through participants’ life stages—form the building blocks of a long-term investing strategy.
But it’s also important to choose the best managers to run each target-date building block, and that poses a number of questions: How has a manager performed over time? Equally important, how has a manager fared in unfriendly markets? Is a manager nimble enough to make course corrections while adhering to the firm’s investment philosophy? Does the manager complement other managers?
Not every firm has the same ability to design glide paths and choose managers. What’s more, some may choose managers who include only their proprietary strategies in the portfolio mix, rather than managers who are the best fit for each asset class. This constraint limits the asset classes that can be used. It also introduces the risk of “correlated alpha”—no manager outperforms all the time, which means that many of the underlying strategies may underperform simultaneously.
That’s why we think it makes sense to assign the asset-allocation and manager-selection roles to different providers. This brings a measure of independent thinking and reduces the potential for conflict that arises when one manager wears both hats.