DOL calls GAO target-date fund recommendations vague

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Deciding: David Wray said additional factors should be left to plan executives.

The Department of Labor rejected three GAO recommendations for target-date funds as default investments for defined contributions plans, saying some of them were too vague, but left the door open to include the three proposals in its future guidance.

The Government Accountability Office report, released Feb. 23, recommended that:

• fiduciaries take into account additional factors when considering target-date funds as qualified default investment alternatives;

• the DOL provide guidance to plan sponsors on target-date benchmarks and the importance of considering the long-term investment allocations and assumptions used to develop target-date funds; and

• the DOL should require plan sponsors to provide information to participants about the impact of taking withdrawals from or changing contributions to target-date funds.

The GAO report argued that the financial crisis of 2008 showed that target-date funds varied widely in asset allocations and risk levels, leaving plan participants vulnerable to having inadequate retirement assets.

One recommendation urged the DOL to require fiduciaries to go beyond plan participants' age or target retirement date, currently the only two factors required to be considered, when choosing a default option. Other characteristics to consider would include whether participants have a defined benefit plan, a participant's salary level, the DC plan's turnover rate or participant behavioral characteristics, such as contribution rates and withdrawal patterns.

In its decision, the DOL said that it is unclear from the recommendation whether an amendment to the QDIA regulation should consider “all or some of these characteristics in selecting a TDF” nor does it explain “how a plan fiduciary should interpret or apply such characteristics in selecting a TDF.”

Organizations representing the defined contribution industry were pleased with the DOL's decision.

David Wray, president of the Profit Sharing/401k Council of America, Chicago, said in an interview that recommendations are welcome, but taking into account additional considerations should be left to plan officials, rather than be required through regulation.

“We're opposed to having the government structure how plan assets should be invested,” he said, adding that plan officials should “have the opportunity to pick the right solution for their plan.”

Mr. Wray added that smaller plans offering target-date funds will not have the time or expertise to make such customized evaluations. “A lot of people are looking for the employer to give them a solution, so by definition you need something that is generic. Generic means very little customization,” he said.

Lew Minsky, executive director of the Defined Contribution Institutional Investment Association who is based in Jupiter, Fla., said existing fiduciary obligations under ERISA are already “extraordinarily strong,” and plan officials already prudently consider what makes sense for their plan participants.

“I'm not sure there is an additional need for a bunch of additional "check-the-box' type requirements,” he said. “It's better to provide guidance, which is my sense of what the DOL is saying: "We hear you and we'll weave this into our guidance.'”

The GAO released a response to the Labor Department's rejection of the recommendations, noting that including the recommendations in guidance, rather than putting it into a regulation, “could cause more uncertainty regarding fiduciary obligations.”

The second GAO recommendation urged that the DOL provide information to plan officials on “the limitations of existing target-date fund benchmarks” and the importance of considering the long-term investment allocations and assumptions used in developing the fund's asset allocation strategy.

The GAO report noted that a majority of plan officials and retirement plan experts interviewed for the report said they have difficulty comparing and evaluating the performance of their target-date funds.

“According to several experts, traditional benchmarks, such as Morningstar star ratings, that compare the returns of all funds within a category — such as all domestic large-cap funds — relative to each other, may not be very useful in evaluating TDF performance,” the report stated. “This is because the objectives, asset allocation, investment strategy and underlying funds that make up a TDF can vary among one another and over time.”

And because target-date funds are relatively new to the retirement plan market, they do not have a long track record, which makes it difficult to make meaningful comparisons, the report said.

In its decision on the recommendations, the DOL said it cannot agree with the recommendation outright but will consider it as it completes its own guidance on the selection and monitoring of target-date funds.

Lori Lucas, defined contribution practice leader at Callan Associates Inc., San Francisco, said in an interview that Callan's target-date fund benchmark, developed in 2008, looks at a weighted average of glide paths of all funds in the universe and whether actively managed funds add value over passively managed funds.

Andrea Malagoli, a New York-based director in Buck Consultants' compensation practice, said in an interview that the DOL has not done its due diligence on target-date funds as a default investment option, noting that investment strategies are “kind of all over the place” and “the notion of a glide path doesn't have much real historical or theoretical support.”

"Fairly young'

“The products are fairly young,” he said. “They're not designed to track a benchmark, so it's hard to determine what represents good performance. You can't compare it to a passive benchmark.”

He said he believes the GAO recommendations are “sensible.” “If the whole point of TDFs is they will make the returns more certain, that certainly is not the case,” Mr. Malagoli said.

The GAO report seems to support Mr. Malagoli's claim, noting that the “lack of clear information on investment strategies (in target-date funds) could put retirees in riskier investments than they were led to believe.” The GAO report argued that target-date fund design varies from fund to fund, noting the fees ranged from 19 to 171 basis points and five-year returns among the largest 2010 target-date funds ranged from an annualized loss of 30% to a gain of 28%.

DOL officials also rejected the GAO recommendation requiring plan sponsors to provide information to participants about the “potential consequences of saving, withdrawing or otherwise managing TDF assets in a way that differs from assumptions on which the TDF is based.”

The GAO says the information would help make participants aware, for example, that contributing at a lower rate or withdrawing at a higher rate than a target-date fund's design assumptions could hinder the likelihood of a secure retirement.

But the DOL, in its decision, said that such a requirement “would appear to be a very complicated and subjective undertaking, which could affect a plan sponsor's decision to offer any target-date fund options.”

Sen. Herb Kohl, D-Wis., and Rep. George Miller, D-Calif., requested the GAO review of target-date funds in November 2009, following the large losses retirement plans experienced in the financial crisis.

Both lawmakers declined to discuss the findings, but in news releases both said plan sponsors and participants need more information to better understand target-date funds.

“GAO raises serious concerns and highlights the need for employers to undertake a higher level of due diligence in order to fulfill their duties under the law to act in the best interest of workers,” Mr. Miller, the senior Democrat on the House Committee on Education and the Workforce, said in the release.